A question we would all like to know the answer to however the fact is no one knows for certain, but there are some signs of caution suggesting a fall in house prices is possible.

Firstly builders have been offloading stock at discounts, it may be that their liquidity position requires them to raise cash quickly, but it could also be that some may see the market getting a little difficult in the coming months.

Many banks also introduced stricter lending criteria at the end of November, some of the best-buy fixed rate deals were withdrawn and replaced with new products at a higher rate of interest. RBS also increased the deposit requirements on its key tracker product (currently with a rate of 2.89%) from 20% to 25%.

Some views coming from analysts are suggesting that the banks do not have confidence in the property market and some are now anticipating a “double dip” in house prices in 2010. Interestingly the Nationwide’s Chief Executive (Graeme Beale) was quoted as saying “The growth in house prices over recent months appears to be driven by lack of supply” and further … “growth in unemployment throughout 2010 will inevitably exert downward pressure.”

Going back to our heading, are house prices going to start falling? Our view is that it is likely we will see a fall in house prices in the coming months, but in the medium term we feel the market will start to recover on a more permanent basis.

There have been many analysts and companies reporting on house price predictions, so we thought that we would also make the case in our blog putting forward our predictions, backed up with reasoning,  as to how we see the prospects for UK house prices.

Firstly we need to consider some of the many factors affecting property prices, some of the key ones are:

1. Availability of mortgage financing
2. Net debt in the UK economy
3. House price affordability
4. Unemployment
5. Inflation (CPI)
6. Population growth

Some of these factors are inter-related, but understanding how they will play out helps to understand what will happen on property prices. So lets first look at each of the above factors and their likely impact on property prices.

1 – Availability of mortgage financing.  Just about everyone understands that the banks are not lending freely at the moment but what we do not know is by when this will be resolved.  The key issue for banks is their loan books, this is the total lending they have taken on, and very importantly the risk of those loans.  Only recently Bradford & Bingley announced more right-downs of its loan books due to default and mortgage fraud – a clear example of how banks are still seen to hold risky loans that will go into default.  Until the majority of UK banks / lenders have got their loan books into a healthy position their own risk ratings will be high, making it expensive for them to raise funds, and in turn expensive to provide mortgages to us. Another factor is the ratio of liquid (e.g. cash) assets banks now need to hold, the Government has raised the targets to help ensure banks are more secure, but this also means that banks have to increase their liquidity ratios (e.g. increase cash deposits) before they can lend more freely.

The best guess is that mortgage financing will start to improve through 2010, but it may not be until 2011 or even 2012 before banks can lend normally again – although it is unlikely they will ever go back to the reckless sub-prime lending that was a key characteristic of the credit crunch.  Thus our assumption is that property prices will not really see the positive effect of improved mortgage finance (similar to pre 2008 levels) until 2011.

2 – Net debt of the UK economy. The UK has one of the highest debt levels in Western Europe, both personal debt and Government debt.  The impact of high Government debt will mean cutting expenditure in future years which will reduce economic growth, and raising taxes which will reduce disposable incomes and thus also reducing economic growth.  The impact of personal debt is less clear, whilst many will seek to reduce debts the UK has always been (in recent years) an economy with high levels of personal debt.  Much will depend on consumer attitudes to personal debt, if we all seek to reduce debt this will have a significant effect on reducing economic growth.

The best guess is that we will go though a period of up to 5 years or more where the need to reduce overall debts will reduce the UK’s economic growth.  The reduction in debt will have a negative impact on property prices.

3 – House price affordability.  Historically metrics have been used such as 3 to 4 times household income to determine the level of mortgage that is affordable.  The reality is though that this metric does not allow adequately for mortgage interest rates.  If we assume a longer-term average mortgage interest rate of 5% to 6% then households can afford mortgage at multiples of higher than x4 of their income.  The best comparable measure we have found is the cost of renting versus the cost of buying.  For example if a £100,000 house costs £500 pcm to rent then this equates to 6% per annum paid on rent;  with any further increase in rents it starts to become more attractive to buy rather than rent based on mortgage interest rates averaging around 6% over the medium term.

The best guess is that we are now close to the bottom of the market where first time buyer properties are now becoming cheaper to buy than rent, this in effect tells us that house price affordability is starting to look positive.

4 – Unemployment. Few people would doubt that higher unemployment will have a negative impact on property prices,  largely due to increased repossessions for non-payment, and of course the fact the anyone who is unemployed will find it almost impossible to get a mortgage. Unemployment is continuing to climb, many analysts suggest that it could reach as high as 3.5 million in the second quarter of 2010, if this happens it will have a significant negative impact on property prices.  But also, when unemployment starts to fall, which most analysts expect to see in the second half of 2010, it will start to inject more optimism in the economy which should then start to feed through to house prices.

We expect that higher unemployment will have a downward pull on property prices over the winter, but come the third quarter of 2010 this should recede, by 2011 unemployment should no longer be having a significant negative impact on property prices.

5 - Inflation (CPI).  Inflation will affect property prices, maybe not immediately but in the long term is does have an effect.  The reason is that many employers will use the UK inflation figure as a basis to determine wage increases.  As wages increase then so in turn does the buying capability of the wage earner.  Higher salaries mean that higher mortgages can be obtained, which in turn feeds through to increased property prices.

The best estimate we have on the impact of inflation is that it will have a gradual impact on property prices in the coming years, helping to stabilise absolute prices and then supporting modest future increases.

6 -Population growth. Based on Government statistics published at the end of 2008 the UK will experience population growth averaging close to 1% per annum over the next 10 years.  This is particularly significant as house building has fallen dramatically over the last year and it could take at least another year before house building starts to ramp up to a reasonable level, thus creating a temporary shortage – or at least this is a possibility.  Also linked into population growth is the type of new housing, over the last 5 years there has been a trend to smaller units, e.g. one and two bedroom flats, if more population growth is skewed toward family units then this will have a significant impact on demand for ‘family properties’.

The best view is the population growth will have a significant impact creating more demand and pushing property prices up in the coming years, as the slack is taken up in the current market this impact is more likely to be seen from 2011 onwards. The impact could be more significant for houses / family homes.

HOUSE PRICE FORECAST IN SUMMARY

It is complex to forecast house prices, so many variables not to mention the emotional attachment placed on owning your own home.  Based on a balance of the above factors we expect the recent reports of price increases to fall back in the winter of 2009-2010, most particularly due to the increasing unemployment.  As we move through the latter part of 2010, with unemployment passing its peak and on the decline, coupled with improved bank financing, we expect a more robust market, prices stabilising with modest increases.  As we go into 2011 the rate of increase in property prices could accelerate, much will depend on the improved lending conditions and the supply of new housing stock – which we think will fall short of demand in the medium term. We do not see that property prices will double in the next 10 years (a projection  some talk about), but we do see some more robust price increases from 3 years out.

Many people will remember the plight of the early 1990s when many homes were in negative equity following the crash in house prices, people were unable to move home simply because they owed more than the value of their homes.  Today the issue of negative equity is much worse, and here is why.

Firstly it is estimated that around 1 million homes are in negative equity, these are in the worst situation.  But even if you have 10% or 15% equity it is still almost impossible to move to a similar (or higher) price property unless you have cash savings as mortgages typically require at least 15% equity.

According to John Charcol the number of homes with less than 10% equity is around 2 million, and the number of homes with less than 15% equity is around 2.5 million.  That is around 2.5 million homes were people are effectively unable to sell and buy another property, in effect causing the market to stagnate.

The problem gets worse when you consider those who hold sub-prime or self-certificated mortgages, which is an estimated 1 million properties.  As it is virtually impossible to obtain a sub-prime mortgage and at the very least challenging to obtain a self-certified mortgage, this adds another 1 million properties to the list where people cannot afford to move home.

Overall this equates to a staggering 3.5 million homes where people cannot move, that is around 15% of homes, almost 1 in 6 that simply cannot afford to sell up and buy somewhere else to live.

The solution is not only about property price recovery, it is about bank lending, unless banks start to lend at higher LTVs (Loan to Valuation) then it may be some time before the property market can get back to a normal buying and selling activity.

The credit crunch has had a huge impact on building of new homes, recent reports suggest only 100,000 homes will be completed in 2009. Worse still is the lead time to build homes, this includes land acquisition, planning permission, and construction, from start to finish this can take several years. The result is that when the economy does recover and house building ramps up, it will be some time, possibly 2 to 3 years before sufficient numbers of new build homes are completed.

Some people may say that this is not such an issue as we already have spare housing capacity, this is true today, but the fact is the UK population is growing every year.

Recently published figures by the UK Government forecast a population growth of around 1% per year over the next decade. And 1% of UK population is around 600,000 people each year, assuming an average of 3 people per home that requires 200,000 new homes each year, double the number currently being completed.

But the future shortage of homes could be much worse, for example much of the new housing completed in recent years has been flats. This has created an imbalance suggesting whilst there will be an increased demand for all housing it could see a more acute shortage of houses.

So when will we start to see the effects of the housing shortage? The best guess is shortly after the economy recovers, so probably from 2011. The effect could see a higher rate of inflation in houses (compared with flats) from 2011 onward.