Successfully predicting house prices involves good economic models, an appreciation of the sociological dynamics of aspiration, and a trader’s flair for the waves of market psychology.
Like those who tell the time from a stopped clock, the people who predict that British house prices will tumble will be right one day. But in the meantime, the rise continues and London estate agents are salivating at the prospect of City bonuses in January. Last week, the principal mortgage lenders announced that they would help new buyers by offering loans of five times income and 125 per cent of value.
If house prices have risen, so have the values of most other assets. Including the only asset category that really is safer than houses – long-term real government bonds. If the recently issued 50-year indexed stock had existed when Britain’s housing boom began, almost 10 years ago, it would since have doubled in value. From that perspective, what has happened to house values is less remarkable.
Asset bubbles emerge when the dominant motive for purchase is the expectation of selling on soon to someone else at a higher price. Such bubbles necessarily burst, because that expectation must sooner or later be frustrated. In this sense, there has never been a housing bubble except in certain, very limited areas of the market: the overwhelming majority of those who buy houses plan to live in them.
In the absence of bubbles, prices oscillate around uncertain estimates of fundamental value. These speculative prices typically display positive serial correlation in the short term – if prices have just gone up they tend to keep going up – and negative serial correlation in the long term – periods of above average increase are followed by periods of below average increase. If we knew when the short term became the long, we would all be rich, but we do not.
This pattern is one of mean reversion – prices return to a historic norm. For five years now, the expert consensus that British houses are overvalued has relied on one central fact – the ratio of house prices to incomes is at a historic high. But while there are some good reasons for expecting the price-earnings ratio of stocks to revert towards its long-term average, there are no similarly persuasive reasons for expecting the same of house prices. Houses are both an asset and a commodity and the analysis required is much more complex.
A house provides space and shelter and, in the American mid-west, these are the principal attributes of a house. There is more land there than anyone could build on and usually not much to choose between the prestige or convenience of different areas of the spacious cities. House prices are low, stable and tend to move in line with incomes.
London, Dublin or Barcelona, like Manhattan, California and Hawaii, are very different. Most of the price reflects the location rather than the accommodation. You cannot make more houses on East 69th Street or in Belgravia. Nor can you make more houses at the most prestigious addresses, because it is in the nature of prestigious addresses that there are not many of them.
Well located houses are what the economist Fred Hirsch called a positional good. House prices are consequently a product of sociology as well as economics. That combination explains why it is Britain, Ireland and Spain, not France, Italy and Germany, that have seen the fastest rises in European house prices and why Hawaii, California and New York, not Idaho, Mississippi and Nebraska, have been the hot spots in the US.
The aspirant rich do not displace the very rich from the best houses but they make the very rich pay more for them. This is the self-defeating character of the search for the symbols of status and affluence. So it goes on down the scale. The level of house prices depends not just on levels of income but on social mores and the distribution of wealth.
Successfully predicting house prices involves good economic models, an appreciation of the sociological dynamics of aspiration and a trader’s flair for the waves of market psychology. Not many people combine these skills. My files tell me I wrote about house prices in 2001 and 2004 and concluded that the only information anyone offering confident predictions about house prices gave was that you should not pay attention to them. It is still true.
