Tuesday, October 19, 2004

Checking in on the demise of the UK housing bubble . . .
House prices are falling at their steepest rate for nine years, prompting speculation that interest rates may have peaked. About 30 per cent more chartered surveyors reported a fall than a rise in house prices over the three months to September.

The Royal Institution of Chartered Surveyors (Rics) said the drop, the biggest since 1995 and the second consecutive [monthly] fall, was a reaction to the three hikes in interest rates over the summer. Inquiries from prospective purchasers were down for the fifth consecutive month and the number of unsold properties rose to its highest level for almost a year. . . .

The Ernst & Young ITEM Club forecast unit, which uses the Treasury's model, has said it does not believe there will be a housing crash. Rics echoed this, saying it was unlikely that the housing market would experience a deep or prolonged slump in prices in prices as long as the economy remained stable and people were confident about job security.
John Calverly of American Express isn't so sure, however.
It is hard to believe that house prices can rise faster than earnings for much longer. The ideal scenario would be for house prices to flatten out now in nominal terms, allowing the house price-earnings ratio to moderate over time as incomes grow.

The monetary policy committee would doubtless be ecstatic at this outcome. But, with the current ratio at about 5.5 times earnings, even a move down to 4, still well above the long term average, would require a 28% drop and take eight years at the present 4% rate of earnings growth. Markets tend not to be so well behaved.

More likely is that we will see a significant fall in house prices. The longer it is spread out, the more likely that earnings growth can take some of the strain of the adjustment. The Bank of England is moving very cautiously at present because consumer price inflation is under target and there is a good chance economic growth will remain solid for the next year at least.

In the longer term, we risk an economic shock of some sort, perhaps a new bout of consumer price inflation requiring the Bank of England to raise rates, or a US downturn. Then the housing bubble could be an accident waiting to happen.
If anything, the risks seem lower in the UK than the US. For you regular readers, you know I'm quite interested in the California housing bubble in particular. Some quick computations suggest California makes the UK look downright tepid.

In 2003, median household income in San Diego County was $49,886; in Los Angeles County it was $44,674; in Orange County, $60,118. Giving each the average national personal income gain from 2003:II to 2004:II of 5.2% puts their 2004 median household income at $52,480 for San Diego County; $46,997 for Los Angeles County; $63,244 for Orange County.

According to the National Association of Realtors, the median sales price of existing single-family homes in the San Diego metro area in 2004:II was $559,700; in the Los Angeles metro, $438,400; in Orange County, $655,300.

Thus my quick back-of-the-envelope number crunching suggests the housing price-earnings ratios in each area are:

San Diego . . . . . . .10.7:1
Orange County . . . 10.4:1
Los Angeles . . . . . . 9.3:1

Makes the term "bubblicious" wholly inadequate.

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