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From The Sunday Times

November 11, 2007

Home economics - the property market

David Smith

Spare a thought for the homeowner trying to work out what is going on in the housing market, let alone the potential first-time buyer. If you’re buying, is it best to wait? And, if you’re selling, should you do so quickly?

It is a confusing time. The statistics are contradictory, the headlines scary. So it is useful to apply a bit of analytical rigour to where housing might be heading. This, I am glad to say, the economists at PricewaterhouseCoopers (PWC), the accountants and management consultants, have done. As a firm, it has no property axe to grind.

Let us start with the basics. By how much are houses overvalued, in Britain compared with their long-run average? PWC’s first answer, based on its housing model, is that prices are 20% higher than they should be. Bring in other factors, such as supply constraints – the lack of new houses relative to the rise in the number of households – and this figure drops to 10%.

An overvaluation is still an overvaluation, so what happens next? PWC has put probabilities on various outcomes. On the sensible assumption that no forecast is ever exactly right, and using a statistical technique known as a Monte Carlo simulation – not, as its name might suggest, a spin on the roulette wheel – the firm came up with some interesting results.

There is, PWC says, a one in five chance that by the end of 2010, house prices will be lower in cash terms than now. This is split between a 15% probability of a cumulative fall of 0%-10% and a 5% chance of a drop of 10%-30%. Mainly, though, the odds favour continued, if more muted, house-price rises: a roughly 30% probability of an increase of 0%-10% over the next three years; a 32% chance of a 10%-20% rise; and a 15% probability of prices climbing 20%-30%. While PWC sees only a 3% probability that prices will go up by 30%-40% by 2010, it completely excludes a fall of more than 30%.

“There is clearly some risk of house prices falling over the next three years, but these risks are mitigated by continuing housing-supply constraints,” says John Hawksworth, PWC’s chief economist. “The most likely scenario is a slowdown in the housing market rather than an outright fall in prices.” The chances of a fall in “real” house prices – adjusted for inflation – are rather greater, but still only one in three, according to PWC.

People will have their own views on this, and any forecast is only as good as the assumptions on which it is based and the model used. On one thing, however, the forecast appears uncontentious: while there is a minority view around that house prices are about to enter a Rip Van Winkle slumber from which they will not emerge for years, it is a fact of economic history that, over time, house prices rise by more than inflation.

So, when PWC looks forward to 2020, it sees less than a 1% probability that house prices in cash terms will be lower than now, although there’s a one in six chance that they will not be any higher in real terms. More likely, they will continue to outstrip inflation even if the government provides the 3m extra new homes Gordon Brown promised last week. The question is by how much.

I wonder if this is the same PWC that has trousered large wads of taxpayers money from the government as consultancy fee's? If so, then I suggest they might have more of a vested interest then your correspondent indicates.

Jonathan Speck, London, UK

If banks are to stop lending in multiples of 6-8 x salaries back to the 3-4's
how is it possible to avoid drops of 30-40%
Demand or no demand.
oh and take the speculative effects out

Andy , south east, uk

A pretty woolly set of figures; and, as you say, only as good as the assumptions, which we are told nothing about. House prices have always kept pace with earnings rather than inflation - understandable because people can only afford to spend a certain proportion of their income on housing, and house numbers and populations do not fluctuate much over short periods.

But in periods of ultra-cheap credit, as we've just had, prices can depart from the normal rate of increase, especially when a lot of people suddenly think houses are a sure route to riches. Trends may be influenced over the long term by demographic changes; sudden jumps like we've seen in recent years are always corrected eventually. Unless we all suddenly wish to beggar ourselves over the desire to own a house (cf. it's different this time).

David, guildford,

pack of rubbish. the summer subprime-loan crash was according to falsely rosy scenarios and models never to have occured. still it has and will devastate economies much more within 2-3 yrs. the UK housing market is on the verge of fatal slump only to be aggravated by British debt's unbearable burden.

lizz, tallinn,

Ah yes, the mathematical model, the panacea of the modern financial world. Those models they used to work out the risk on US sub-prime mortgages worked well, didn't they?

Tom, London,

The only fly in the ointment to your analysis Clive (Sussex) is that scratchcards are not somewhere to live, In terms of investment it is a good match, but there is alos the factor about alternate housing options. Interesting to see an analysis from a firm who are not wither mortgage lenders or estate agents

Ben, folkestone, uk

I am not an economist but I find it puzzling that these predictions ignore the role speculation has played in the phenomonal rise in house prices, and that house prices are unaffordable to first time buyers. Citing supply and demand as someting that will keep prices high also seems very short sighted to me. Are they really saying that lack of supply is responsible for the rise in house prices? I'm confused. Has supply really lessened so much in the last five years? And what happens when demand drops off the scale, which is what seems to have happened in Belfast at the moment? Here, there certainly is no shortage of supply. I can't see beyond a significant correction at the moment, but I don't have the credentials of PWC. Maybe I'm missing something.

Gerard Garland, Belfast,

The simplistic citing of these probabilities ignores the underlying risks to be considered. A 1 in 5 (20%) chance of a fall in prices means that an average earner borrowing 6x salary to buy an average priced house could be looking at a loss of up to Â£60k if the worst of these predictions materialises whilst still being saddled with a ridiculously expensive mortgage. A better way to look at it is to think of scratch cards, which typically have around a 1 in 5 chance of winning a prize. At a pound or two, the occassional flutter is fine. Most people would take a different view if a scratchcard cost two years gross salary. This is a better way of viewing what we are talking about with the current housing situation. The odds of losing are said to be 1 in 5, but the cost if you do lose could easily be two years gross salary. Furthermore, the predictions suggest little profit if you 'win'. Why play a game where the cost if you lose is extremely high and the prize next to nothing if you win?

Clive, Sussex, UK