Are house prices really too expensive?

The Office for National Statistics’ measure of house price inflation has caused quite a stir this morning. There has been chatter aplenty on Twitter and the Treasury has even issued a statement responding to the numbers [you can find them here (pdf)]. Why? Most probably because of its most eye-catching datapoint: that house prices are now at their highest ever level across the UK, exceeding even the peak in January 2008.

It’s a striking statistic, particularly since the Government is in the midst of attempting to pump even more impetus into the housing market through its Help to Buy scheme, which will help guarantee homebuyers’ mortgages. However, it also masks some striking regional variations. You can see the full picture in the chart below. This takes house prices in each different part of the UK. The numbers are from the ONS.*

Now this chart (and you can click on it for a bigger version) shows you how prices in each different region of Britain have fared over the past decade and a bit. In case it’s a little overwhelming, here are a few highlights. House prices across the country as a whole are up by 0.3% since January 2008. They are up by 1.3% in England and by a whopping 17% in London. However, they’re down by 5.4% in Wales, 9% in Yorkshire/Humberside, and by a disturbing 44% in Northern Ireland, in comparison, again, with January 2008.

However, simply comparing prices in cash terms fails to reflect the impact of broader inflation. Spending £100,000 on a house in 2008 is, technically-speaking, not the same thing as spending £100,000 on a house in 2013, because the value of each of those pounds has been eroded away by inflation. Inflation (in other words the cost of all goods and services) increased by 19.8% in the same period, so what £100,000 bought you in 2008 could buy you £119,800 today.

Which begs the question of where house prices are, adjusted for inflation. The answer may surprise you.

This chart again shows you house prices in each region, adjusted for inflation (to be precise, the CPI). Again, you can click on the chart to see a bigger version. The simple take-away is clear, however: in every single region of Britain, house prices are below the 2008 peak in real terms. The strongest region, London, still has house prices  2.5% below their pre-crisis peak. In Northern Ireland prices are still 54% below; across the UK as a whole, prices are 16.3% below their 2008 peak.

Here’s how prices today (or to be precise as of the latest data in Aug 2013) compare with their Jan 2008 peak, in both absolute and real terms.

But before you assume that because real-terms prices are still lower across the board, that means homes are still undervalued, a note of caution: back in 2008 house prices were overvalued by most measures (whether comparing them to incomes, mortgage payments or rental yields). Most economists believed that they were due a fall. But because earnings have been rising far slower than inflation, while in real, inflation-adjusted terms, house prices are still well below their peak, in wage-adjusted terms, they are back up at their peak across the UK. And in many regions, they are well above their peak.

As you can see from this chart above, which compares house prices to earnings across the UK (data can be found in Table 15 of this Excel chart from the ONS) house prices across Britain are today worth about 4.3 times the average wage. That is significantly higher than they were throughout almost all of the 1990s, and about the same level as at the peak of the pre-crisis boom.

However (and I promise this is the final statistic) while house prices are as expensive as ever, this doesn’t necessarily mean the necessary mortgage payments are too high. In fact, because interest rates are currently at the lowest level in history (at least, the Bank of England’s official rate), monthly mortgage payments have fallen sharply compared to where they were before the crisis. The chart below, from the Council of Mortgage Lenders, tells the story:

So there you have it. House prices are higher than before the crisis in absolute terms. They are lower in real terms. They are about as high in terms of sheer price affordability. But interest payments are still very much lower. The upshot is that both those who warn we’re facing a potential housing bubble and those who disagree can quite easily marshall the necessary facts to back up their argument.

What seems indisputable is that if the Bank of England were to increase interest rates it would cause a monumental crunch for many homeowners, who are only able to afford to buy because borrowing costs are down at historically low levels.

* In order to get this figures I’ve taken the most recent cash-terms price for each region – again from the ONS – and extrapolated it back using the ONS’s index of house prices by region. This slightly roundabout method is necessary because the ONS’s own mix-adjusted price measure isn’t comparable year-by-year, since it is rebased each year by transaction activity. The upshot is that in the past few years it tends to have been overinfluenced by activity in London. And a final health warning: no house price index is perfect.