Here on The Value Perspective, we enjoy chatting about house prices as much as the next person although, when the subject does inevitably crop up at a dinner party, we are usually to be found approaching things from a completely different angle to the other guests. When it comes to buying and selling houses, it seems, there are some psychological hurdles people find tricky to clear.
Take this example – say you are looking to trade up to a bigger home next year, should you be hoping house prices go up or down? To judge from countless newspaper headlines over the years, any fall in prices would be the end of the world as we know it. Yet, if you stop for a moment to think things through rationally, it becomes clear you should want house prices to fall.
Not convinced? Well, say your current house is valued at £200,000 and you have aspirations to buy a bigger house worth £400,000 – if house prices were to fall 5%, then your house would have dropped £10,000 but the house you are after would have dropped £20,000. So, despite what certain elements of the press would have you believe, falling prices can be a good thing.
In a similar vein, our eye has been caught by the coverage of proposals announced by the Bank of England on 26 June that are intended to put the brakes on riskier mortgage lending. Most of this coverage has focused on banks and building societies not being allowed to lend any more than 15% of residential mortgages at more than 4.5 times a borrower’s income.
Now, clearly nobody – not even in the land where one’s home is one’s castle – has an inherent right to spend more money than they have to buy a house. Furthermore, ensuring people do not borrow more than they could ever realistically repay seems a sensible precaution. But why was so much less attention paid to another proposal that – at least to US – potentially carries far greater significance?
This is the requirement that lenders ensure mortgage applicants can cope with a three percentage-point rise in rates – “slightly tougher than current affordability checks”, to quote the BBC. But let’s pause again and reflect on just what that three percentage-point rise would mean for most house-buyers – particularly given another pronouncement that emanated from the central bank less than 24 hours later.
For it was the morning of 27 June when Bank of England governor Mark Carney told radio 4’s today programme that, once they begin to rise, the “new normal” for UK interest rates is likely to be about 2.5%. Just to be clear, this level, which Carney suggested could be reached in early 2017, is two percentage points above – or, if you prefer, five times as high as – their current all-time low of 0.5%.
returning to that “slightly tougher” three percentage-point requirement, while such a jump would still leave UK interest rates below their long-term average, it would effectively represent a doubling of most people’s mortgage payments. Here on The Value Perspective, we do not think it is unfair to suggest most people will have neglected to factor that into any calculation of their household finances.
In fact, they are unlikely to be factoring in rates going up at all and that is because, in behavioural terms, human beings struggle to see beyond the recent past. They have seen interest rates drop down to 0.5% and then stay there for the last five years and so it has become the ‘normal’ state of affairs. But of course, by definition, there is nothing ‘normal’ about an all-time low.
People seem to have forgotten – or maybe they do not want to remember – it was only five years ago that banks paid 4.5% on deposit accounts. Times do change and sooner or later things revert to their long-term average. Yet you see it all the time in investment – when markets are thriving, nobody can see what could go wrong. When things are bad, there are no buyers – everyone has run for the hills.
Here is one last example of the horrible psychology of house prices from a value perspective – if you told someone they could buy a house tomorrow for 20% less than its market value, they would bite your arm off. But, if that house fell 20% tomorrow, there would be no-one to buy it because they would be worried it was going to fall even further. Times may change – apparently human nature does not.
We will leave the last word on the subject to one of our favourite asset managers, the Boston-based GMO, which makes a habit of studying financial bubbles and has concluded that, sooner or later, they all pop. Back in 2010, it suggested the London real estate bubble was arguably the biggest of all time but had yet to pop. Four years on, prices have only risen further…