Saturday 19 July 2014

An Historical Property Value Calculator

I bought my first house, for cash, in 1977. Having saved up, and lived on baked beans for three years, buying clothes from jumble sales etc., we eventually had the £5,000 needed to buy the three-bedroom town house, with small gardens to front and back. At the time, my wages came to £2,500 a year. As a comparison, if I were the same age and doing the same job today, my wages would be around £15,000 p.a. or six times as much. If the house were six times as much, it would be around £30,000, therefore. It isn't. A similar house today would sell for around £80,000, even in the weak local market. In other words, it would be nearly three times as much as it should be, had it risen in line with wages. But, there is no reason it should have risen by that much. In general, wages should rise by more than prices, in line with the rise in productivity.

I sold that house in 1988 for £22,500. In the meantime I'd added some value by taking out walls, putting in a bathroom and modern kitchen and so on. But, even assuming I'd added 10% extra in value, to take the initial value to £5,500, that still represents a four fold increase in price in just eleven years. In fact, this demonstrates a fact I discovered a while ago, in looking at the rise in various asset markets, over the last sixty years, which is that, although its thought that the main rise in these markets has occurred over the last ten to fifteen years or so, this is not the case. The main rise in asset markets occurred during the 1980's, as the conservative governments in the US and UK, under Thatcher and Reagan, attempted to build low-wage/high debt economies, and particularly from the second half of the 1980's onwards, injected large quantities of liquidity into the newly deregulated financial markets, thereby sparking an explosion of debt, and debt fuelled asset price bubbles.

An example of that is that the Dow Jones Index rose from 1,000 in 1982 to 10,000 in 2000, a rise of 1,000 %, whereas, between 2000 and today, the Dow has only risen from 10,000 to 17,000, a rise of just 70%. Between 1950 and 1960, UK house prices rose by 31%, between 1960 and 1970 they rose by 96%, reflecting the "dash for growth" of Reggie Maudling, and the so called Barber Boom. But, between 1970 and 1980, they rose by 380%, and rose a further 154%, between 1980 and 1990. By comparison, they rose by 70% between 1990 and 2000, and a further 60% between 2000 and 2011. This demonstrates that the real crisis in UK housing was created in the 1980's and 90's, as a result of the policies adopted by Thatcher. All the massive money printing has been able to do, since then, is to keep that bubble inflated, and to reflate it, whenever it has burst. It also shows that the argument that the high prices are due to shortage of supply is nonsense. It would have required that the main period of short supply was during the 1980's and 90's.  The extent of this inflation of asset prices in the 1980's and 90's can be judged by the fact that this was a period of economic stagnation, and of stagnant or falling real wages.

To illustrate the effect of this, let me relate it back to my own experience. Having sold my first house in 1988, for £22,500, I bought a three bedroom detached house for £30,000. Working backwards then, the 1977 value of that house would have been around £7,500, and, in fact, I know that is the price they were sold for at that time, because I saw them being built. Then, working forward to today, on the basis of a six fold rise in wages, would give a current price of around £45,000. In fact, when I sold the house, at the start of 2010, I sold it for £150,000 or more than three times that amount. This gives an indication of just how much current house prices are out of whack with where they should be, on any kind of rational historical basis. In fact, as stated above, even this overstates where house prices should be, because rationally wages should rise by more than prices.

If we assume a 2% p.a. rise in productivity then between 1977 to today, we should expect wages to have risen by around double the rise in prices during that period. In that case, the house price should only have risen from around £7,500 to about £22,500, or about a sixth of what it was. As prices of assets always revert to the mean over the long term, and usually have to go through a period when they drop below it, this gives an indication of just how much the drop in house prices will actually be when it happens. It means that prices will need to drop by between 80-90%, or near the same amount they fell in Japan when the asset price bust happened there in the 1990's.

A few weeks ago, the Open University had a programme on BBC, narrated by Sandi Toksvig, about property. It set out that, of the price of a £200,000 house, between £50,000 and £100,000 of the cost was the price of the land. A further £50,000 was the actual cost of construction of the house. The rest was made up of the costs the builder has to pay, to the local Council, to cover the Section 106 Agreements, to provide roads, schools, and other amenities, as well as social housing, plus the profit of the builder. This shows how significant the price of land is to resolving the housing crisis. Builders interviewed made the point I set out a few weeks ago in, Building More Houses Will Note Cure The Housing Crisis, that they will not build houses unless they know that there are customers for them, at prices that provide the builder with normal profit.

Because, high land prices force up the price of new build houses – because all the other above costs, other than the actual construction cost, tend to be calculated as percentages on the cost price – this necessarily makes new houses unaffordable for large numbers of people, so demand is constrained. At the same time, supply is constrained, because the builders will not build large numbers of additional houses for which there is no effective demand.

The programme illustrated this by referring to John Prescott's challenge to builders to produce a low cost home, setting aside the cost of the land. Builders, architect designed homes, that could be sold for £60,000, not counting the land, which it was proposed would remain in the ownership of the state. But, in fact, it was shown that when the houses were sold, they were not sold for £60,000, but for £300,000 including the land!

Even Tory Minister Nick Bowles has pointed out - Would You Pay £47 For A Chicken? – that if the price of chickens had risen by as much as houses in the last 30 years, then you would be paying £47 for a chicken, as opposed to the £5-6 they cost in the supermarket, and by the same token, a jar of coffee would cost £20. That gives a similar figure for how much house prices are overvalued as that I arrived at above, of about 8 to 9 times where they should be on an historical basis.

As the Bank of England has eventually realised that this could mean a serious problem, as global interest rates are rising, and inflation is also likely to be rising too, it has started to use its macro-prudential tools, and to give the warning, to those able to read the Kremlinology, that its time to get out of the water, before the shark attack. Unfortunately, even the supposedly savvy investors of the bond and equity markets, seem to have been so inoculated, by years of central bank money printing, that they either don't believe or don't recognise the warnings they are being given. The chance that home buyers who have been led to believe that house prices only go one way – up – will recognise those signs is pretty remote.

Central banks have tried, in recent years, to obtain the results they require, by sending out such messages, rather than actually implementing measures to bring them about. Mario Draghi has succeeded in getting banks across Europe to take money, through the LTRO, and use it to buy the bonds of peripheral European countries, to force down the yield on their bonds, by warning that the ECB would do “whatever was necessary” to bring that about. In fact, as money has also moved out of emerging markets, it has moved into peripheral European bonds to such an extent that they now, ridiculously, have yields lower than in the US! Carney is trying to do the same thing. He is trying to say, there is going to be a property crash, so stop bidding up property prices now, and keep out of the market. That avoids him having to raise interest rates for now, or to impose more stringent rules on mortgages than have so far been introduced.

Its not likely to work. There has never been an occasion where property bubbles have been deflated gradually.  Given the massive bubble in UK property built up over 40 years, its impossible to see how it can end well, as in much of the country we seem to have hit the limits of how many more “bigger fools” can be pulled into the market to buy overpriced housing. Despite “Help To Buy” and other measures to keep the bubble inflated, in many parts of the country, the bubble is barely being kept inflated despite all the furious pumping by the state.

According to Moneyweek the solution, as I've suggested, requires not building more houses but reducing the price of building land. But, as I've also suggested, the price of building land will not be reduced unless either land is nationalised, or else, the bubble in property prices is burst.

The Moneyweek article refers to this survey

It shows that domestic buildings cover just 1.1% of the land area of Britain. So much for the idea that we are an overcrowded island! Including roads and other non-domestic buildings, only 4% of the land mass is built on. As Moneyweek state,

“If England’s 20 million homes cover just 1.1% of its land, you could increase the housing stock by 20% – 4 million homes – and only build on another 0.2% of land. Surely, we can find the space to do this.

Even if you give each home a large garden, you’re still talking less than 1% of English land to increase the housing stock by 20%.”

In some areas, there is more land taken up by golf courses than by residential property. The majority of all this land that is being underused, is still in the hands of the landed aristocracy, of people like the Prnice of Wales, and Duke of Westminster. Moreover, in these conditions, it also pays the builders to accumulate large land banks rather than to build houses on them.

Carney realises that the burst in this property bubble is inevitable and will be very nasty. He's telling the banks in so many words, to start to pull in their horns even further, despite the government's desire to get them to lend more, to keep the bubble inflated, to bolster its own election hopes. But, the bubble is so big, as the above figures demonstrate – even the OECD and IMF a couple of years ago said that UK property prices were 40% over valued against the historical average – that when it bursts, the banks will be taken down by it. That is why they have tried to keep the bubble inflated for as long as possible.

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