When will property prices hit bottom?

Published on Saturday 3 January 2009 12:24

SCOTLAND is heading for its biggest fall in house prices on record when the Nationwide publishes its end of year property data on Tuesday.

Values are expected to have plunged by around 12% in 2008, decimating borrowers' equity.

This will follow Halifax Bank of Scotland's report on Friday disclosing that house prices across the UK fell sharply in December by 2.2%, pushing them 16.2% lower than a year ago. This is the worst drop in housing market history, with prices now falling at twice the rate of 1992, the worst year of the last recession.

Millions more will be hit by negative equity, leading to a sharp rise in the numbers handing back the keys and abandoning their homes.

In Scotland, annual deflation is expected to be slightly more muted than that of the wider UK, with average house prices slumping to around 135,000. This is still significantly lower than the 159,896 average for the whole of the UK.

And it confirms data from the Edinburgh Solicitors Property Centre, pointing to a 12% house price fall over the past 12 months in the capital.

And there is undoubtedly worse to come. One encouraging sign is that a key measure of house price affordability, the house price-earnings ratio, is falling to more normal levels. This is the ratio of house prices to male full-time average earnings, which has tended over the decades to fluctuate around 3.5 to 4 for the UK as a whole.

In 2007 it peaked at 5.8, indicating that average prices had galloped to unsustainable levels. The good news is that, for the UK as a whole, that ratio is falling back rapidly to more normal levels and has now reached 4.4.

Unfortunately, just as prices overheat in boom times, so they undershoot when the market enters meltdown. Like a runaway rollercoaster, house prices pitch and soar.

During the last recession, for example, the house price-earnings ratio bottomed at just over 3 in 1995. But once it hit rock bottom, prices began to rise sharply again, climbing 35% over the next five years and by more than 80% in the following decade.

On that basis, though, the outlook from here is bleak. If prices again plunge to a ratio of 3 against earnings, this could push UK average values down as low as 108,000, a collapse of 45% from the peak in 2007 of 196,002.

However, there are reasonable grounds to suspect that prices will not dive so far this time. There are underlying structural changes in the way we buy houses which have seen house prices climb naturally over recent decades as more women work, and family assistance and inheritance have played a factor.

Over the past 10 years, for example, the house price-earnings ratio has averaged 4.5, indicating that across the wider UK values have already returned to more normal levels. In other words, most of the pain should be over.

Unfortunately, commentators expect further deterioration from here as the market again overshoots, not least against a background of rising unemployment and repossessions.

But if the ratio bottoms at 4, this would see prices flatlining at 145,360. This would indicate a further 15,000 off average values, and a fall from the peak of around 50,000; a more palatable fall of 25%.

The position in Scotland is slightly more worrying in that the house price-earnings ratio is still historically high and falling more slowly, partly because it is always more modest than across the UK as a whole, and partly because price collapses have been slightly less dramatic. It peaked at 4.7 at the end of 2007 and has only fallen back slightly from that level.

Nevertheless, Scottish house prices remain the most affordable in the UK, with a home affordable to someone on average earnings in two out of three districts, compared with a UK average of only 14% of areas across the UK.

It is against this background that the Bank of England will next week meet to decide on the UK's level of interest rates. Observers believe it will be forced to cut borrowing costs again, by as much as 1%.

However, it is not clear the extent to which borrowers will benefit from further cuts as banks resist Government calls to pass on any further rate reductions.

Bank of Scotland chief economist Martin Ellis says: "I believe we will see rates fall by a further 1%, partly because interest reductions are not being passed on in full. The bank feels it needs to be more aggressive to have an impact for homebuyers."

A 1% reduction would slice the base rate to a level never seen since the Bank of England was established in the 17th century, and would bring jubilation to borrowers who locked into tracker mortgages charging below or close to base rate.

But the number who benefit is likely to be tiny. The UK's biggest building society, the Nationwide, said it would be imposing conditions in its contracts which allow it to ignore any base rate cuts below 2.75%.

Nationwide spokesman Steve Blore said: "Our standard variable rate, which is 4% currently, will be cut, but we have some tracker borrowers who are only paying 1.24% because they borrowed at a 0.76% margin below base rate.

"We have done everything we can to support borrowers. But some of them now are paying very low rates indeed. We think it is time to consider savers, who are also being hit by historically low rates.

"Many savers rely on the income from their savings to live, and we believe, now rates have fallen to a level where many borrowers are comfortable, we must turn to the interests of our savers."

Other building societies including the Skipton and Yorkshire also have clauses preventing their mortgage rates falling to negligible levels. Only the Cheltenham & Gloucester has indicated that its borrowers will be allowed to track rates down to zero.

Many borrowers are now hovering on standard variable rates, having come off fixed or tracker deals and found it impossible to remortgage on better terms elsewhere. Even though lenders may not trim by the full amount of the rate cut, they are likely to adjust their rates to some extent, cutting borrowers' monthly bills.

According to the research group Defaqto, the cheapest standard variable rates last year were offered by First Direct, Direct Line and HSBC.

Next, customers with big building societies were the winners, with borrowers with Nationwide and Skipton paying least.

The most expensive included Northern Rock, BM Solutions (part of the HBOS Group), Bank of Scotland and Standard Life.