House prices and the planners
House prices are overvalued, say the experts. At least, that’s what they said last year. In the last 12 months, however, the average price of a British home has risen by a further 18 per cent. This doesn’t mean that the housing bears were wrong. Rather, it is a reflection on the inefficiency of the housing market, which in this country might have been designed specifically to provide an endless cycle of booms and busts.
Over the past 50 years, the price of the average house has hovered a little above three times the owner’s income. According to Tim Congdon of Lombard Street Research, there are good reasons for this ratio to remain stable. First, the amount of income people allocate to their housing needs does not appear to change much. Secondly, a large part of the price is due to builders’ wages and the cost of materials. Thus house prices can be expected to rise in line with income. Currently, the house price to earnings ratio is somewhat above its long-term average, approaching four times. It was even higher in the housing booms of the mid-1970s and late 1980s but fell back on each occasion.
Were house prices to come off their current levels, the situation would not be too bad-a decline of roughly one fifth would suffice to bring them back in line with average historical prices. Unfortunately, the current housing boom may well continue for some time. The reason for this lies in the peculiar nature of the market. Under normal market conditions, rising prices and profits engender an increase in supply. For instance, when telecoms and technology companies were highly valued in the late 1990s, a vast number of new firms were established and quickly floated on the stock market. Over-supply caused the technology bubble to burst and share prices to revert towards their intrinsic value.
In Britain, however, the supply of new housing is determined by central planners who allocate land for housing according to long-term demographic forecasts regardless of price. Matters are made worse by local authority Nimbies who grant far fewer planning consents than the number required by Whitehall. Furthermore, the house-building industry has become more concentrated in recent years, with companies like Taylor Woodrow buying up a number of their competitors. These house-builders are wary of losing money as they did in the early 1990s after the speculative boom collapsed and they were forced to sell houses for less than their cost. The housing industry, therefore, has an interest in restricting supply in order to keep prices high. Last year fewer houses were built than at any time in the past half century.
The failure of supply to meet demand is the root cause of volatility of the British housing market (in the US house prices are more stable). The government is slowly waking up to the problem. In a recent speech, Gordon Brown promised to remove barriers to planning and building in order to prick the housing bubble in the southeast. Perhaps the chancellor remembers the experience of his hapless predecessor, Norman Lamont. Ten years ago, roughly one in five mortgage-holders was suffering from negative equity and the number of repossessions by building societies exceeded 75,000. Needless to say, negative equity did not enamour the government to its people. Lamont resorted to various measures in an attempt to shore up a falling housing market. Unless he moves quickly, Brown could find himself in a similar position.
Calling the bottom on the market
Since the stock market started its descent a couple of years ago, investors have been trying to call the turn. But to date, each rally has turned into a rout. With the US market down more than 12 per cent since the start of the year, Americans and foreigners alike want to know whether it has finally hit bottom.
The complicated way of answering this question involves attempting to predict profits from trends in future business investment and household consumption, both of which are difficult to forecast. Other factors, such as changes in productivity, wages, currencies, inflation, the condition of the global economy, and so on, must also be considered. Furthermore, investors must ask whether the relationship between share prices and profits will remain above its long-term average, as it has done in recent years, or whether it will decline still further. All this requires too much time and effort for my liking.
A simpler method to gauge the direction of the market is to examine the behaviour of its participants. Richard Bernstein, the equity strategist at Merrill Lynch, observes few signs of capitulation from yesterday’s bulls. Bernstein finds his fellow strategists on Wall Street remain remarkably optimistic, an indicator which normally bodes ill for the market. In the first quarter of this year, US equity mutual funds attracted more money than in the same period three years ago, when the bull market was still going strong. According to Jim Grant, of Grant’s Interest-Rate Observer, cash as a percentage of US household assets is around 15 per cent today, compared to 25 per cent during the bear market of the late 1970s.
All this suggests that, despite the battering they have received over the past couple of years, investors remain too confident. In answer to the question, “when will the market bottom?” Bernstein replies, “when investors stop asking questions about it.”