Is a Property Market Overvalued?

Modelling the Property Market

First time buyers and amateur investors tend to have a habit of modelling the market in no end of ways. They look at what the average buyer is borrowing or how much of their disposable income they are using or basically search down any data that will support their argument that the market will crash violently and they will be able to buy a two bedroom in EC1 for £50,000.
No matter what you put in your fantastic spreadsheet remember this:



A perfect example was the Halifax, much of whose business rests on the property market. In January 2004 they predicted house prices for the year would rise by 8%. Six months later they revised this figure to a rise of 16%, they were admitting to being 100% wrong.

And they can just as easily be wrong in the other direction. In late 2007 most lenders were predicting a market where prices would remain static the following year. By March they were all revising their forecasts again. The effects of unknown global events make prediction a very rough guess at best.

A full analysis of the 'property experts' used by the media and their track records is in Making House Price Predictions



So why is it, with all the research based on seemingly sensible data, that the property market does not react the way it should.

There are two fundamental reasons:

• The Property Market Innovates
• Averages just don't work

The Property Market Innovates

Simply put lenders and property sellers continue to find ways to ensure prices can continue to rise over the long term. In the 1960s this was the introduction of the mortgage. Highly unpopular at the time when debt was frowned up they have now become a way of life and allowed property prices to rise faster than salaries.

In the 1990s it was 100% mortgages which rid the need for buyers to find a deposit. In the millenium it is shared ownership so the buyer only needs to find 50% of the property value.



A classic historical example was work carried out in the 1800s which looked at the rapidly rising population of the UK and concluded there would soon not be enough food to go round and starvation along with civil unrest could not be far away. But agriculture innovated. The number of people living on this small island is now far beyond what our victorian mathmaticians imagined and there is still food on the table.

The Futility of Long Term Averages in Property Prices

One of the key measures commentators on the market use when speculating the future of the housing market are long term averages. For example, the logic goes that if the average property price has reached four times the average salary then real estate values can no longer move up.

But these is a highly misleading methods. Highly misleading but easy for people to understand and so ideal for newspaper columns or the evening news.

Average Salaries and Average Property Prices

Average salaries and average property prices are infact only related in the weakest of terms. Ask any statistician to find you the correlation (connection) between the two and they will conclude it is extremely low.

Broadly this is because the connection at any level is affected by the following:

• Buying for holiday homes
• Buying for retirement
• Buying to let
• Buying for business
• Buyers from outside the region
• People who can afford to, but won't buy

Buying for Holiday Homes

A perfect example of this is North Wales where properties captured the imagination of residents from Manchester, Birmingham and London who purchased cottages for their weekend breaks and vacations. It wasn't long before locals were priced out but the market was, and remains, driven by populations removed from the locality.

Buying for Retirement

This can be seen at work in Norfolk and Cornwall where large numbers retiring from the city cash in their properties and purchase houses in more distant locations moving prices beyond the means of locals.

Buying to Let

This is especially prevalent in university cities and towns. Nottingham, for example, has a large student population and this attracts investors from richer cities such as London. Their earnings and purchasing power cannot be taken into account, neither can their numbers be predicted. In cities such as New York these investors have priced the local population out completely so the large majority of people expect to rent for their entire life, they do not expect prices to come down so they can buy.

Buying for Business

Many businesses who have staff that travel on a regular basis buy property to house them. Thus a bank might buy thirty apartments to be used by their staff rather than pay hotels or rental agencies. They don't take mortgages, they buy for cash.

Buyers from Outside the Region

Property is a global commodity. In the financial district that is the city of London 40% of real estate is owned by non-British companies or individuals. In Spain there are areas almost exclusively owned by non-nationals and so any sort of analysis looking at local salaries is generally pointless.

Can afford, Won't Buy

In the same way that buyers can drive the price of property above local affordability (on paper) there can also be scenarios where property prices are well within the grasp of the population but they just don't want to buy. In Germany, for example, there is a culture of renting with someone else taking care of the maintenance. Statistically property prices should rise dramatically as there is a large gap between prices and the buying power of purchasers but it doesn't as actual demand does not exist.

Average Trends in Property Prices

Another favourite measure is to look at averages in historical data. For example taking the Nationwides house price data from 1971 the average rise per year is around 3%. Therefore we can conclude any annual rise above this is a sign of the market overheating. Or the long term average for mortgage debt is x% of GDP and so any figure above this must mean there are two many mortgages.

But historical data is exactly that and should not be confused with the future. Take a simple situation where Mr A puts 1,000 into a bank account that offers no interest and leaves it for 10 years. His long term 'average savings' are 1,000 ( 10 x 1,000 / 10). In year 11 he adds another 1,000 so now his long term 'average savings' are 1,090.

A bank clerk might look at the account and think, we have a client that wants to borrow 1,300 so we could use Mr A's savings for that. But someone looking at it as a long term average will say 'no, on average he only has 1,090 so we can't lend it'. He would wait until the savings have been untouched for 15 years before touching the cash. And all the time the situation is changing. By year 15 Mr A's long term average for savings is 1,333.

There is 2,000 in the account but commentators will continually state 'Mr A's long term average is 1,333 so he currently has too much money in his account'. It cannot be believed.

Now a more bullish clerk comes along and knows of a client that wants to borrow 2,500 in 5 years time. He looks at Mr A's account and says, 'Ah, Mr A - on average - deposits 1,000 every 10 years so I can use his money to lend to my client.'

Both clerks are using sound data and both are drawing incorrect conclusions.

Using property we can also produce meaningless information. According to the Nationwide the average price of a UK home at the end of 1999 was 74,683 but the average for the 1990s was 56,713. So it should follow that house prices would decrease back to their long term average but they didn't.

Summary

Modelling the market in order to make predictions has proved unsuccessful for even the professionals and much of this has come from the issue that the property market is not based on the data must people assume it should be.

An increasingly mobile and demographic population makes any future ability to do this accurately even more difficult.

See Also:

Making House Price Predictions

The Media and Property Prices

Finding a Property Hotspot

The Media and Property Prices