The house price bubble in Britain began inflating in the 1980's, as Thatcher, having defeated the working-class, after the Miners' Strike of 1984-5, began to pump liquidity into the economy, to finance the growing debt economy, in which households were encouraged to borrow to finance consumption, as their wages stagnated. It was given a twist higher with the further encouragement of debt and speculation resulting from the deregulation of financial markets – the financial Big Bang of 1986 – which occurred in both Britain and the US. It was the start of the process that led to the global financial meltdown of 2008, and why Britain was one of the worst affected by it. UK house prices have been continually inflated since the 1980's, in the same manner as the prices of financial assets, suffering the same kinds of crashes along the way. According to Nationwide, the average house price is now 10.9% higher than a year ago.
All of this liquidity acted to inflate asset prices, which was its intention, as the global ruling class, the top 0.01%, owns all its wealth, nowadays, in this form. In those economies where home ownership was dominant, it meant that house prices were also inflated. As with meme stocks, this creates an inevitable dynamic that leads to bubbles, and the subsequent bursting of those bubbles. As George Soros says, for a speculator, when you see a bubble starting to inflate, the thing to do is to rush towards it, because that is the way to make money – provided that you then, make sure to get out well before that bubble inevitably bursts. In other words, it is the application of the bigger fool principle. For big speculators like Soros that is possible, but for the small retail speculator, its usually not, as they found a few weeks ago, when they found they could not sell out of their positions in Gamestop. For any illiquid asset, this problem is compounded, and property is probably the least liquid asset of all. Shares and bonds can usually be sold at the press of a button, if the market is falling, even if you take a loss on your position. If house prices are falling, even if you can find a buyer, the process takes months to complete, by which time, prices can have collapsed, buyers disappeared, pulled out, waiting in anticipation of even lower prices down the road.
The current rise in UK property prices is rational in the short term, for the reason Soros describes, but only just, because, given the illiquid nature of property, and given the background conditions, the likelihood of prices crashing in the near future is extremely high, meaning that anyone buying now will be unable to get back out again quickly. In other words, it is likely to be totally irrational tomorrow!
The reasons for the current pop in prices is fairly easy to see. Large numbers of people have been given cash by the government as replacement incomes during the period of the lockouts. Those furlough and other payments went on for much longer than was originally proposed. They should have ended last September, and are still in place. At the same time, households ability to consume was constrained, meaning that their disposable income rose, leading to some debt being paid down, and even saving being accrued. For months, due to the lock downs, house purchase itself was not possible, meaning that planned purchases were delayed. The government has also further fuelled demand with its Stamp Duty holiday, and with large areas of business closed down, the demand for capital was suspended, leading to falling interest rates. At the same time, central banks printed more money tokens and bought even more bonds, raising their prices and reducing their yields, which created a further puff into the inflating asset price bubbles over the last year.
There has been a further factor, which is that large numbers of people living in London, and other large cities have felt encouraged by COVID and by the lock downs to move into more rural areas. In part its a desire to obtain more living space, and, in part, a result of the shift to online home working. Someone who is able to sell a poky flat in London for £1 million, and instead buy a four bedroomed detached house and garden, for £250,000 somewhere in the sticks, is not likely to quibble over the odd ten or twenty thousand pounds, here or there, on the price, in the same way that someone local to the area would, and so that has an inevitable short-term upward effect on the prices of all these houses being bought in those areas. A similar thing can be seen with what has happened to house prices in Cornwall.
So far, the continuation of furlough and other payments means that the large expected rise in unemployment has not occurred. In fact, as I predicted, as economies open up, there has been a significant increase in the demand for labour, because the process involves a rapid change in pace of economic activity. But, it is a combined and uneven process. There is a shortage of 70,000 lorry drivers, 180,000 bar and restaurant workers and so on, but that does not mean that there will not still be large scale unemployment as the furlough scheme ends. The workers in demand will not necessarily meet with the supply of the right kinds of workers who are unemployed, they may be in the wrong place and so on. Furlough schemes encourage employers to retain workers, but employ them less efficiently, part-time and so on, but when they end, they will have an incentive to dismiss workers, and use a smaller number more extensively and intensively. Rising wages for those in employment can go hand in hand with rising unemployment, and deprivation for many, as they see inflation rapidly eroding their incomes.
More importantly, as firms do open up they will need to borrow on a large scale, at the same time that governments are borrowing on an astronomical scale to finance all of the unproductive consumption and handouts they have undertaken, and are committed to continue to undertake. When it comes to house prices, far more important than what happens to wages, is what happens to interest rates. Interest rates affect house prices in two different ways. Firstly, a rise in interest rates means that, mortgage rates rise. With rates very low, even a modest absolute increase can make a huge relative difference. For example, suppose someone has an interest only mortgage on a £200,000 house, at a rate of 1%. That is £2,000 a year in mortgage payments, or about £175 per month. If the mortgage rate rises to just 2%, this means that the annual mortgage payment also doubles to £4,000 a year, or around £350 per month. To compensate would require wages rising by £2,000 a year. Yet, those rates are historically low for mortgage rates. The historical typical rate is around 7%, which would mean the annual interest being £14,000, or around £1,175 per month. So, this kind of rise in mortgage rates acts as a big factor in determining demand, and so house prices.
But, interest rates affect house prices in a second, and more fundamental way, and that is as a result of the process of capitalisation. If interest rates rise, then the capitalised value of all revenues on assets falls. That means that asset prices fall, including land. If land prices fall, then a major factor in the price of houses also falls. Currently, land prices are about seven times as high as a proportion of house prices, as they are historically, as a result of this long-term asset price inflation that has been fuelled by central bank liquidity injections. Suppose the cost of building the average new house breaks down as follows Land £70,000, Labour and Materials £30,000, Profit £100,000. Builders will only build houses they know they can sell at the selling price of £200,000, so that they can make the average profit of £100,000. If they built more, then, to sell them, they would have to reduce the selling price to say £150,000, which would take away £50,000 of their profit, meaning their capital could have been better used elsewhere. However, if, as a result of rising interest rates, the capitalised value of assets falls, and the price of land falls to £10,000, the builders costs are significantly reduced. They can make the average £100,000 profit, now with a selling price of just £140,000, indeed, they can make the average rate of profit of 100%, with a selling price of just £80,000!
But, at a selling price of £140,000 the demand for new houses would increase substantially, so that builders would then have an incentive to build many more, thereby, increasing the supply, with a consequent knock on effect to all other house prices. Moreover, at £140,000 not only would builders make much more profit in total, because of their much increased production, but they would actually also make surplus profits, because their rate of profit would now be 250%, as against the average rate of profit of 100%. That, of itself, would encourage builders to build more, and others to enter the building industry so as to obtain these surplus profits, which would increase supply and push down house prices, thereby increasing demand, and output further. When pundits talk about the need to increase the supply of houses so as to reduce prices, they first need to look at the question of the need to reduce land prices, which requires a rise in interest rates, as well as breaking the feudalistic monopoly on land ownership, and monopolistic restrictions on supply imposed by measures such as The Green Belt.
The current pop in house prices is likely to be part of the closing scenes of the drama prior to the denouement. By all historical measurements UK house prices are in a huge and unsustainable bubble. Like all bubbles it must eventually burst. Historically, the average UK house price has been equal to around 2-3 times average earnings. Median average earnings are currently around £31,000, which means that the average house price should be around £90,000, whereas it is actually around £240,000. But, also, historically, homebuyers have, generally, been married couples, in their mid to late 20's, whereas, since the 1980's, and particularly in the last 20 years, as the bubble has inflated, every single adult has been encouraged to think they should have their own home, if not be a homebuyer.
In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents.
(Halifax)
So, the historic ratio gives an inflated figure for what current house prices should be. Its clearly more affordable for two people to be buying a house, particularly two people in their mid to late 20's, than it is for a single person still in their teens, or early twenties. Rather than 3 times average earnings, therefore, something like twice average earnings would be a more realistic figure, which would give an average house price today of around £60,000, or about a quarter of the actual current average house price. In fact, given that house prices have been so much inflated above their long-term average, for so long, a reversion to the mean would suggest that they would need to fall below that long-term average for some time, either as a result of a large drop, or as a result of a continual decline in real terms.
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