Charts as at 11th April 2008

House Prices as a Percentage of Trend

In simple terms this chart represents overbought and oversold RPI-adjusted house prices compared to trend growth, which is 2.5% a year. A figure above 100% means hosue prices are higher than the trend price, under 100% they are lower.

The first version of the chart was published at the end of December 2006. Updated in April 2007 and updated again in August 2007. Although reported on Citywire in September, an image (which can be seen here) was not included in the article. The latest update, which was released before the most recent Nationwide house price figures, is the version below:

As can be seen, the two previous times the level went above 115% of trend, a correction in RPI-adjusted house prices followed. As for a support level, in four of the last five RPI-adjusted house price corrections the 77%-82% of trend range has proved support.

Using quarterly figures, prices peaked Q4 1973 at 125.51% of trend, then fell to 79.735% of trend in Q4 1977. More than a 45 percentage point decline.

In Q2 1989 prices peaked at 117.57% of trend, then fell to 62.56% of trend. A 55 percentage point decline.

For the 1990s crash the green support line (range) did not hold. A theory for why is given below. Which is also why it is indicated as an initial downside target, not the final target.

In the 1970s and 1980s inflation was considerably higher. In August 1975 the annual rate of RPI inflation peaked at 26.87%. Since nominal house prices at that time were rising by considerably less than that, they were actually falling in real (i.e. inflation-adjusted) terms. Allow for the 2.5% p.a. for trend growth not being achieved either and you can understand why the near verticle decline in the blue line to the 1977 bottom.

House prices started to bounce but by Q4 1979 recession forced a top on the market price. Even though high inflation meant that house prices still rose in nominal terms, they only managed to get up to the 99.77% of trend level before bouncing straight off.

With a bottom close to the previous one in Q2 1982, prices-relative-to-trend set off again. At this time inflation was begining to be broken. Still high by recent standards, but lower than what was recent back then.

The 1989 peak saw what I call a fall of two halves. The first was the big nominal fall. The second was RPI erosion. Prices fell about 20% form almost £63,000 in Q3 1989 to an initial bottom of £50,168 in Q4 1992. After that they just bobbed along for three years as they rose a little and then came down to £50,930 in Q4 1995. In those final three years the RPI had put on 8.26%. Factor that and the lost three years of 2.5% p.a. trend growth and you can see why it fell below the green support line.

The impact of nominal losses on the mindset of homeonwers needs to be accounted for. Previously inflation had hidden the decline in real values with what, on paper, appeared like gains. When house prices actually fell, because there was less was inflation to take the sting out of the tail, people felt it. They were poorer. On paper. In black and white. Hence the mildly vascillating prices for the last 3 years as homeowners tried to restrengthen their finances. Not wishing, or able, to re-enter the market. No one taking risks.

In the words of Debt Advice Bureau director Stephen Rose, "A nominal gain may not be a real gain. But a nominal loss is a real loss".

Given the even lower inflation and interest rates preceding the latest boom the dangers of a much deeper correction are tangible. Which is why a decline to the green support line is the first target, but may not be where prices finally take us. Though how much of the decline will be nominal and how much inflation, only time will tell.

 

House Prices Adjusted for RPI

This chart adjusts house prices for Retail Price Index inflation. What you get is a chart in December 1952 pounds. In December 1952 an average house was £1,891, according to Nationwide. In October 2007 it peaked at £186,043. Take out the impact of the RPI and that comes all the way down to £9,040 in 1952 money. Quite a bit different.

The analysis is based on the March house price figures. At the time the average house price, according to Nationwide, was £179,100. Adjusted for the impact of the RPI it becomes a near 5.5% decline from the peak as it falls to about £176,000 in October-2007 pounds. Although submitted to Citywire on April 9th, this chart was not used

When the original version of the above chart was produced in December 2006, we drew specific attention to the top green line as it appeared to indicate a resistance level in inflation adjusted prices. They did not want to break through it. At the time we put forward the "Three Fails and Your Down" argument.

The bottom green line shows possible support on the way down. The downside targets also marry quite nicely with the Percentage of Trend chart, particularly if you end up with either a drawn out decline or the sort of price stagnation experienced in 1993-1995.

The 1989-1995 house price correction breaks through the green support line, as it does in the previous chart. This is a concern. At the very least it could well suggest a lower target for RPI adjusted prices over the long term. Draw a line form the 1959 low to the 1995 low and extend it. A much lower RPI-adjusted bottom. It could also play into the bureau's preferred a-b-c theory. Think teh moves down-up-down which took place from the 1973 peak to the 1982 low. But this time on a much larger scale because of the lower preceeding inflation and the much greater excesses to be shaken out of the market.

An absolute bottom in house prices will not be seen until people are saying "I am never going to own property again". One buy-to-let speculator was already filmed saying just that on the an edition of the Tonight television programme. When it becomes the mantra of the crowd, that will be the time you want snaffle every property you can. Until then, watching the data and keeping one's powder dry seems the sensible strategy.

 

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Charts and analysis produced in conjunction with in:specie™. Source: ONS, Nationwide Building Society, in:specie™ calculations.

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