Building Societies Association
Building Societies Association
House Prices in 2008
Contact: Andrew Gall
Date: 29 Jan 2008 		Print page  |   Email 

Predicting house prices is always fraught with uncertainty, but given the slowing in house price growth experienced in late 2007, the turbulence in the financial markets, and the prospect of slower economic growth in the year ahead, attempts to forecast prices in 2008 are particularly difficult. This article summarises these predictions and looks at some of the underlying factors.

House prices last year

According to Nationwide Building Society’s index, house prices grew by 4.8% in 2007. At the start of the year, prices grew strongly, buoyed by demand in London and the South East. However, towards the end of the year, price growth had lessened considerably, with Nationwide’s index showing month on month price falls in the last two months of the year.

This was partly due to the cumulative impact of increases in interest rates by the Bank of England, which peaked at 5.75% in 2007 (although rates were cut to 5.50% in December). Another major factor is likely to have been the effect of the turbulence in global financial markets on the price and availability of credit. The Bank of England’s survey of credit conditions showed that lenders reduced the availability of credit in the third quarter of 2007, and some increased the cost of the credit they were offering.

2008 predictions

The table below summarises published forecasts for house price growth in 2008. The consensus is for house prices to be slightly down, by 0.4%, in twelve months’ time. However, this would imply that prices will fall by around three percent in real terms, that is, when general price inflation is taken into account.

Activity in the housing market is expected to slow in 2008 because of already stretched affordability, tighter lending criteria, and a predicted slower rate of economic growth. However, house prices are likely to be supported by a shortage of supply and relatively resilient employment.

As in previous years, the range of predictions for house prices in 2008 is wide, as illustrated in the chart below. Some commentators suggest falls in the year of up to 10% are possible, which would take prices to the level they were at in the summer of 2006. At the other extreme, the more optimistic forecasts are for price growth of around 5% in the year.

Supply constraints

It is often claimed that the constrained supply of housing to the market puts upward pressure on prices.

The importance of constraints on supply on the level of house prices are shown by their impact on a model from PwC (1). In 2006 the model did not incorporate supply constraints and suggested that housing in the UK was overvalued by as much as 25%. When the model was adapted in 2007 to include a measure for housing supply, the extent of the overvaluation was found to be closer to 10%.

In the UK planning regulations have restricted increases in the supply of housing, in comparison to the United States, where there has been a rapid response in supply. The chart below shows how the number of completed new dwellings has responded much more slowly in the UK than in the US as prices have risen since the mid 1990s.

In the United States house prices have declined in 2007 despite, at least until recently, relatively robust employment and continued economic growth, partly because constraints on housing supply have not provided support to US house prices.

Buy-to-let

Buy-to-let has been one of the main drivers of demand in recent years with buy-to-let loans making up nearly 10% of outstanding mortgage balances by the third quarter of 2007, compared to less than 1% ten years earlier (2).  Some analysts have voiced concern that buy-to-let demand is vulnerable to falling house prices, as inexperienced investors may sell, having bought in anticipation of rising house prices rapidly delivering capital gains.

However, survey evidence (3) suggests that landlords have invested with long time horizons. In the near term, reductions in interest rates and higher rents (if fewer first time buyers are able to enter the housing market) may also increase investors’ returns.

Confidence and expectations

The existence of any overvaluation, and that it might not be possible to fully explain the current level of house prices by reference to factors such as incomes, interest rates and housing supply, raises the possibility that speculation and the expectation of higher prices have also fuelled demand.

The greater the role of expectations in explaining current house prices, the greater the risk that sentiment could suddenly turn negative, and that expectations of falling prices could build on themselves, so much so that the market may even fall below the equilibrium level of house prices, as prospective buyers hold back from the market and some owners rush to sell before prices fall further.

Therefore, the pace and future direction of house prices may depend crucially on sentiment and expectations. However, BSA research (3) conducted in May 2007 suggested that the housing market may be resilient to falling house prices. Investors and frustrated first time buyers would be keen to enter the property market if prices fell, while the supply of houses to the market would be constrained by people holding back from selling.

Admittedly, this research took place against a background of rising prices, before activity in the housing market slowed in the latter months of 2007, but PwC note in their report that there has been considerable inertia in house prices historically. Any downward adjustment in house prices towards a more sustainable level may therefore play out over a prolonged period. Furthermore, the majority of analysts’ price predictions in the above table suggest that a sudden, self-perpetuating, negative shock to expectations is not the most probable outcome this year.

This is likely to be because, even though economic growth is forecast to slow, unemployment in the UK is not expected to balloon in 2008. And with the Bank of England expected to reduce interest rates further as the year progresses, the supply of property onto the market is unlikely to be substantially increased by forced sales.

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