After falling for 18 months is the housing market finally starting to recover?

For the first time since the crash began, both the Nationwide and the Halifax house price indexes are showing a price rise in the last quarter (2.6% and 0.8% respectively).

Prices down 20%

While this is seen as good news by many in the housing industry the overall picture still looks far from rosy, with Halifax showing an overall fall of 20.1% from the market's 2007 peak and Nationwide showing a drop of 14.6%. Meanwhile, figures from the Land Registry (which should be the most accurate) suggest that the fall is somewhere between the two at 17.74%.

In other words, despite the recent rises, a house that was worth £250,000 at the market's peak is still only likely to be worth between £199,750 and £213,500 today. Nevertheless, has the past quarter seen the start of a recovery or are we looking at an upward blip in an otherwise downward trend? The Royal Institute of Chartered Surveyors (RICS) certainly seems to think things are picking up. They've ditched their previous forecast of a 10 to 15% drop in prices this year and are now predicting a slight rise. Not all agree, however. According to Seema Shah of Capital Economics: "it is impossible to say what is going on from Nationwide and Halifax data because their samples are so small as there are few properties on the market"

Recent price rises

Understanding what has driven the recent price rises may help to predict whether they may be sustainable over the coming months. Martin Gahbauer, chief economist for Nationwide, suggests that the explanation may be a short-term supply shortage. He cites the sharp decline in transactions in 2008 (down 43% compared with 2007). This produced a large pool of prospective purchasers who, while in a position to buy, were put off by the uncertainty generated by last year's banking crisis. Some of these buyers have now re-entered the market - encouraged by increased affordability and very low interest rates. Though the resulting rise in transactions has been modest it has been enough to produce a short-term rise in prices as it has coincided with very low levels of supply.

This may explain the price rises of the last three months, however, if Mr Gahbauer is right we should not expect this "recovery" to last. This is because the circumstances he describes are likely to be temporary and do not point to a change in underlying market conditions, which remain poor. We've also seen in previous crashes that prices don't always go down in a straight line. In 1993 the Halifax house prices to earnings ratio (a measure of housing affordability) rose temporarily, just as it did in May and July this year, only to then fall back steadily for the next two years.

Predictions

The website housepricecrash.co.uk has helpfully put together a table of over 20 UK house price forecasts from leading industry analysts. And while the average prediction is for an overall drop of around 21%, nearly half the forecasts predict a drop of between 30 to 50%. The fact is that forecasts vary wildly with a variety of factors creating both upward and downward pressure on prices. We look at the likely effect of some of these factors below.

Unemployment

By far the biggest threat to house prices over the coming months will be rising unemployment. The consensus amongst commentators is that it will rise from its present level of 2.44 million to over 3 million by early 2010, with some forecasters suggesting it could get as high as 4 million. When unemployment rises this fast house prices fall as people fail to keep up their mortgage payments and are either forced to sell their homes or have their homes repossessed. In other words, history does not support those who predict that the crash is over despite the coming onslaught of redundancies.

Wages

Already, as unemployment rises we are seeing pay freezes and lower wage inflation. Since in the long-term house prices tend to rise in line with wages this is another reason they may be slow to recover. Worse still, houses remain overpriced relative to wages according to the Halifax whose price to earnings ratio stood at 4.36 in July. While this is down significantly from its July 2007 peak when the average house was worth 5.84 times the average wage, it is still above the long-term average of 4.0.

To put this in perspective, during the last crash the price to earning ratio fell as low as 3.09 after which it took nearly 7 years to recover to 4.0. Bear in mind also that as a result of globalisation - which has increased international wage competition - we are unlikely ever again to see the kind of wage inflation that helped house prices to soar in the 1970s and 1980s: A time during which the price of the average house in the UK rose 1450% (CLG).

Lack of credit

Another constraint on price recovery will be the continued lack of mortgage availability. The days when banks lent for buy-to-let portfolios are over - they will now only give money to the most credit worthy and those with large deposits. Nor does it look like this will change any time soon. In the Bank of England's August inflation report Mervyn King stated that: "the banking sector is still in a very bad way, and it will take several years for it ... to get back to the point when it will be ... in a position again to lend normally" Without a recovery in mortgage lending it is difficult to see how prices can be sustained once sellers (whether forced or otherwise) begin to return to the market.

Repossessions

So far, historically low interest rates have helped to limit the number of repossessions. However, according to the Council of Mortgage Lenders (CML) things may be about to change. For all of 2009 the CML is predicting there will be 65,000 repossessions - the highest level since 1992. Yet during the first six months of the year there were only 24,000. If the CML are right that means we'll see another 41,000 before the end of the year. Such a spate of repossessions would not only damage market sentiment it would send a flood of cheap houses onto the auction market. And the signs are ominous - already the number of mortgages in arrears by three months or more stands at 270,400.

Silver linings?

Are there any silver linings amongst this gloom? The answer is "yes", although they may be of little help in the short-term.

Interest rates

The first of these is that interest rates may not rise as fast as expected. The Bank of England's latest inflation projections suggest that while interest rates may have to rise during the next two years they will probably not rise as much as predicted, helping to keep mortgage costs down. Additionally, if (as expected) taxes go up and government spending falls following the general election then the Bank may become even more reluctant to raise interest rates.

A banking recovery

One of the reasons the rate of mortgage lending is currently so low is that banks are trying to repair their shattered balance sheets. As they eventually do recover we should see an increase in mortgage lending, which will help boost prices. However, as Mervyn King stated, this is likely to take place gradually over years rather than months.

A property shortage?

In the short-term the supply of properties for sale is largely determined by sellers' confidence, the need for workers to relocate and whether or not financial pressures are forcing people to sell. In the long run, however, supply is determined largely by the rate of housing construction relative to the rate of household formation. Expected demographic changes together with projected high levels of net migration into the UK suggest that over the longer term there will be a significant undersupply of homes. The government expects the number of new households in England to increase at a rate of 252,000 a year between now and 2031. Meanwhile, rates of construction have fallen to record lows with only 75,000 homes expected to be built this year (RICS) compared with 175,000 in 2007.

2010 crash and 2013 boom?

It seems then, that there are two distinct pictures - one short-term and one long-term. In the short-term it seems likely that prices will continue to fall, despite recent rises. Our prediction at http://www.YouMove.co.uk is for a further price fall of 10 to 15% by early 2011. We would then expect prices to stabilise (though they may continue to fall in real terms) until around 2013, before a shortage of supply causes them to rise in the longer term. And, if the shortage of houses turns out to be as acute as some projections suggest we may be on course for another serious boom in house prices in about four years' time.