The end of the house price boom is what will finally sink Brown

15 December 2007

Like Wile E Coyote, the cartoon character who stays aloft long after he has run off the edge of a cliff, the British housing market has constantly defied gravity.

The second set of statistics to give Mr Brown nightmares is that gross rental yields on buy-to-let properties are about 5.3%, before costs are deducted, when mortgage rates are at about 6%. So this market is set to crash. Gross yields were 10% in October 2001. Excluding inflation, JPMorgan estimates rental yields have fallen below those on 10-year gilts for the first time since 1992. Some estimates show net yields to be a mere 2.5%.

With house prices starting to tumble and mortgages costing far more to service than rental income, the buy-to-let market, which accounted for 11% of mortgages last year, is a train wreck waiting to happen.

While the Bank of England has kept rates on hold since July, market interest rates have spiked as the crisis in the sub-prime housing sector forced lenders to tighten their belts, making fixed rate mortgages far more expensive. Lenders have tightened their lending criteria, demanding larger deposits and better documentation of income; wholesale lenders – who are neither banks nor building societies and more likely to take on sub-prime risk – are fleeing the market.

HSBC this week warned that house prices are about 30% over-valued. JPMorgan, whose housing model is based on data going back to 1973, estimates house prices are overvalued by 24% – surpassing the 23% at the peak of the late 1980s bubble. The International Monetary Fund last month calculated that homes in Britain were overpriced by up to 40%. Goldman Sachs calculates that if rents do not go up, house prices would have to fall by 20% for yields to return to their historical level. Morgan Stanley is predicting a drop in prices next year.

Dresdner Kleinwort, the investment bank, says the last time British property was as expensive as it is today was in 1948, when homes were in short supply after the war. In analysis updated for The Business, David Owen, Dresdner’s chief European economist, says the price of the average home is 7.23 times average household disposable income. That is higher than previous peaks of 1973 and 1988. The ratio has only been higher in the late 1940s when it hit a record of 9.16 in 1948. No wonder first time buyers, at least those under the age of 30, have almost died out and that Nationwide says first-time buyers’ mortgage payments are now worth 50% of take home pay.