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House prices outside London are fair-value

We question whether the correct data is being used to establish house price affordability and if that means house prices are indeed over-priced.

11 Jul 2017

Simon Adler

Simon Adler

Fund Manager, Equity Value

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This is an extended version of a post first published on The Value Perspective blog.

Here on The Value Perspective, we are as happy as anyone to indulge in the national pastime of house-price discussion although, as natural contrarians, we tend to approach the subject from a different angle.

In Home truths, for example, we suggested anyone looking to move to a bigger place should be hoping house prices fall rather than rise while here we will argue there is not enough house price data around these days.

To be more precise, while there is of course no shortage of data on UK house prices in existence, it is not the right kind of data – and thus any attempts to draw meaningful conclusion on the relative affordability of houses is, we would suggest, doomed to failure.

Sure – house prices in some parts of the country do feel pretty expensive but how might we best go about demonstrating that is objectively the case?

Illustrating the affordability of UK property

A good way of illustrating the affordability of UK property is to calculate the ratio of house prices to people’s income.

The trouble is, most house-price-to-income ratios you are likely to see will have a number of flaws – not least that they tend to be based on ‘mean’ (the sum of all the numbers in a set divided by the amount of numbers in that set) rather than ‘median’ (the middle point of a set of numbers) data.

Other common flaws in house-price-to-income ratios is that the income part of the equation tends to be average individual income, not average household income; even though the UK economy is so varied, the ratios tend not to be calculated on a regional basis; and the data series are usually too short – often only covering a period of 10 years.

No problem, you might think – just use median household income and house prices for the last 50 years and then give us a nice little chart of the resulting ratios on a regional basis.

Unfortunately, that is easier said than done as nobody offers a median house price data series and the people with the underlying data – the Office for National Statistics (ONS) – seem disinclined to make the appropriate adjustment to their spreadsheets.

On the bright side, somebody has been happy to go the extra mile and we are grateful to analysts at Morgan Stanley for pulling together the best available data, the first piece of which is three-year average median household income numbers, courtesy of the Department for Work and Pensions. For the record, these figures are pre-housing costs and needed reflating, so Morgan Stanley used national average inflation for that.

This set of figures should ideally be combined with three-year average house prices.

Here, the closest to a median we can find is the ONS’s house price data, which uses the methodology explained in the notes accompanying the chart below, so that will have to do.

Furthermore, there is no data on median incomes dating back before 2000, so – again – we will have to live with that.

Approximate average (mix-adjusted) house price to median household income by region, GBP

UK house price model
Source: Morgan Stanley. The UK HPI is mix-adjusted to allow for differences between houses sold (for example, type, number of rooms and location) in different months within a year. House prices are modelled using a combination of characteristics to produce a model containing around 100,000 cells (one such cell could be old dwelling, one-bedroom flat purchased in London). Each month, estimated prices for all cells are produced by the model and then combined with their appropriate weight to produce mix-adjusted average prices. The index values are based on growth rates in the mix-adjusted average house prices and are annually chain-linked.


Still, with that caveat that this is clearly not long enough to constitute a meaningful time period, the following chart would indeed suggest house prices outside London are about fair-value whereas those in the capital look very expensive indeed. You may well have reached a similar conclusion yourself but now you have the best available data to back up that view.

Of course for those seeking to invest in property it is always seen to be ‘safe as houses’. However given the chart above you can see that London prices are incredibly expensive.

Continuing to plough money into these assets may be suitable for some, but we feel that it is nothing short of a speculative, over-priced investment built on hope, fed by herd behaviour and could be ready to pop at any moment.

Whilst past performance is not a guide to future performance, investing in a value strategy over the same period as the chart above, for example, would have returned 116% (MSCI World Value) against a 99% rise in average property prices in London*. Investing in our own Schroder Recovery fund would have returned 175.3% (net of all charges).

*Property prices before stamp duty, maintenance costs, council tax, insurance…and house warming parties.