Could we really see a bear market develop in residential property in this country? Such an event is not without precedent. In the early 1990s, house prices fell – in some areas by as much as one-third.The reason for dwelling on this unnerving prospect is that in the US we have seen disappointing sales figures for new and secondhand houses while mortgage applications have been declining. Recent consumer surveys also suggest that American households are not convinced that now is a good time to buy residential property. Add to this the belief that the number of people withdrawing their applications for a mortgage without going ahead is up sharply and it is little wonder that US house price inflation has almost disappeared. Given that housing affordability is at a historically low level, concern about the depressing effect the state of the residential property could have on economic growth is understandable. When houses become too expensive, then some readjustment is necessary. In the US, it is hoped this cyclical adjustment in the value of housing cost to incomes will not be severe. Even so, it is expected to curb economic growth by at least 0.5 per cent next year. Perhaps we should look back to the last time that property values retraced their steps. Fortunately, there are few parallels with today. The fall in house prices in the early 1990s was caused in part by changes to the rules concerning mortgage interest relief. Chancellor Nigel Lawson had eased monetary policy as a consequence of the stockmarket crash of the autumn 1987. Cheaper money, coupled with a buoyant economy, fuelled strong demand for residential property – a demand that was given a boost when the Chancellor announced he would be ending the practice of allowing two people to claim tax relief on a joint mortgage. The rush for couples to buy houses and secure their mortgages resulted in a sharp upward spike in house prices as the decade drew to a close. The drop-off in demand for houses that followed the ending of the tax benefit came against a background of rising interest rates and slowing economic activity. The situation today may be that houses are less affordable than has been the norm but there has been a moderation in the pace of inflation. There is also a housing shortage. This does not mean that house prices cannot fall, but it does point to a situation where house-price inflation will perhaps continue to be moderate. Affordability does make a difference but the conditions for falling house prices depend on influences such as a recession or sharply rising interest rates. Fortunately, neither appears to be emerging yet but it will pay to be vigilant, given that this particular asset class hardly appears a steal at current prices.
Brian Tora is Investment Communications Director at Gerrard Investment Management