OSL Finance Blog

The housing market may now be trapped in a long-term bear market and may not bounce back to the peaks it reached in 2007 for generations, a leading economic consultancy has warned.

British property prices benefited from a 25-year bull market since the 1980s, pushed up by low inflation and real interest rates, and the influx of millions of younger less well-off buyers who were suddenly able to get hold of mortgages, according to Lombard Street Research. But the organisation has given warning that homeowners must prepare for what could be a similarly long period in which economic forces work in the opposite direction.

The warning, from LSR’s senior economist, Jamie Dannhauser, will cause particular concern, since it comes amid hopes that having slumped by around a fifth since the peak of the bubble, the housing market has now recovered.

However, Mr Dannhauser said that although house prices may continue to rise for some months, buoyed by short-term factors such as low interest rates and thin trading, the impact of the credit crunch may mean that the long-term direction of the market could take a turn for the worse.

He said that although the past 25 years had been punctuated by two housing crashes, the long-term trend for house prices had been overwhelmingly positive.

“There was a big 25-year adjustment that came through three factors, which are one off shocks – inflation, real interest rates and credit availability,” he said. “The real story now is credit, and more specifically what is happening in the mortgage market. For people who are bullish on housing as a medium term investment, that is a big question. It seems highly likely that given this banking shock there’s been a step change in availability of credit.

“My medium term view now is that real house prices over the next three to five years will be flat at best. But it’s quite conceivable that the equilibrium level of real house prices of 06/07 will not be reached again.”

This implies that although nominal house prices may once again shoot through the levels they hit at the peak, the price when adjusted for inflation and the cycle may never again attain such a level.

The warning came as LSR said that its housing affordability indicator, in conjunction with The Daily Telegraph, showed that house prices became marginally more expensive in the final quarter of 2009. The indicator, in which 100 points represents the average affordability level since the early 1960s and a higher figure means prices are undervalued, dropped from 118.6 points to 118.4 points, meaning homes became slightly more overpriced. The indicator compares house prices to families’ incomes and mortgage payments, and was one of the most reliable yardsticks in the run-up to the recent slump.

Affordability started to deteriorate for the first time in the third quarter of 2009, as house prices began to pick up enough to compensate for the fall in mortgage rates. Although prices rose by more than most economists expected last year, Mr Dannhauser warned that this was partly a function of the fact that so few people were putting their homes on the market.

“One reason prices have bounced back is because the volumes have been so thin. The effective level of housing demand is still way down on previous levels – particularly at the first-time buyer level.”

In the Budget last month the Government pledged to exclude first-time buyers from stamp duty up to a level of £250,000, in a move which is intended to draw more buyers into the market.