A History Of House Prices
April 10, 2006
Is housing a good investment? It often seems that you can't pick up a paper without reading about the latest house price survey and wild predictions of either boom or doom. But let's step back and look at the long-term picture to get some perspective. This means we have to look at some numbers, so brace yourselves!
House price history
According to the Nationwide, house prices have increased by an average of around 9% a year since it started monitoring them in 1973. By way of comparison, the average rate of inflation over that time period has been about 7% a year. The Halifax House Price Index starts from 1983. Since then, it shows house prices have increased by around 8% a year as opposed to inflation of 4.5%.
It's important to take such figures with a major pinch of salt if you want to use them to assess what sort of returns you can expect from housing. For example, house price indices only include houses that have been sold in the period concerned, which will represent only a small fraction of the nation's total housing stock.
To complicate matters further, individual surveys measure their data in different ways which is why it's common for different surveys to come up with different price movements each month. And if you drill down into regional or local data, the small sample sizes can make the figures even more unreliable when comparing movements from one period to the next. In practice, we reckon even monthly movements on a national level are fairly inconsequential. Indeed, quarterly movements are also relatively unimportant. The housing market does not tend to shift direction overnight.
In addition, if you concentrate purely on house prices, you're ignoring two other key components that affect the overall return you can generate from a property. Firstly, any rental income you could receive is ignored. By occupying your own home, you are saving yourself the rent you would have to pay if you lived elsewhere. Secondly, house price indices do not reflect the cost of maintaining and running a property. These two components do offset each other to some extent so it's fair to say that house price indices give a rough approximation of overall returns.
Both the main house price indices show the same story and that is that house prices have beaten inflation by a small amount over the long term. So there is a reasonable case for saying that housing is a decent investment, even if the actual returns tend to be less than most people think.
Housing returns are a lot steadier than those from the stock market however, which is one of the reasons property appeals to so many as an investment. Despite this, over short time periods house prices have fallen in the past, although it is rare for them to do so. Most recently for example, in the period from 1990 to 1995, house prices fell by around 10%.
Where next for house prices?
Unfortunately it's impossible to say what will happen to house prices in the future with any degree of accuracy. However, one reasonable indicator in the past has been affordability in relation to average salaries. The most widely used yardstick is that housing is fairly valued if average house prices are three times average salaries. At the moment this ratio is around six times, indicating that housing is very expensive. This has led some people to predict house prices may be due for a fall.
Interest rates are low at the moment though and this means people can get a bigger mortgage than they could several years ago but for the same monthly payment. So other commentators, who believe housing is not overvalued, argue that the proportion of our earnings spent on mortgages is still comparable with historic levels, being in the region of 30%. However, an important flip side of this argument is that inflation doesn't make the monthly amount you pay increasingly more affordable as the years go by. People who bought their properties in the 1970s and 1980s saw their monthly payments reduce significantly in real terms as they got near the end of their mortgage term.
So what can we conclude from all this? Given that house prices are high when compared to many traditional measures, the likelihood of large gains in the near future would seem to be remote. Likewise, with a relatively healthy economy, a sustained period of falls also looks pretty unlikely. Yes, we're sitting firmly on the fence on this one! But sitting on the fence does give you the best all-round view of course.
We think it's best to see your home as a place to live in first and foremost and secondly as a long-term investment. Prices can fall in the short term so when house prices appear high on some measures, as they do at the moment, it's especially important not to overstretch yourself and to make sure there is some slack in your budget to cope with the unexpected. We'll look at this in more detail in a later article in this series.