House prices set for shake-up

The UK housing market, buoyed by a "bubble" of speculative investment, is poised for a shake-up, leading economists have warned.

First-time buyers face a higher risk of falling into negative equity, where the value of their home falls below that of their mortgage, researchers at think-tank Cambridge Econometrics said.

The current bout of house price increases is likely to be reversed in the long-term

Cambridge Econometrics

The sustained rise in house prices, particularly in London and the south east of England, makes a market slowdown "increasingly likely", Thursday's report said.

"The current bout of house price increases is likely to be reversed in the long-term," it said.

Nightmare scenario

The document outlined how housing markets in and around the capital could fall into "crisis".

"That would require some kind of trigger, such as resurgence in inflation coupled with increase in interest rates or a sharper global slowdown resulting in heavy job losses in the City."

London: Especially vulnerable

But researchers said more likely was that prices in the "currently overblown housing markets" would mark time.

"The slowdown in [economic] growth in the coming year, and reduced activity in the City, is expected to lead to stagnation in the London housing market," the report concluded.

The report comes two weeks after Nationwide Building Society, one of the UK's top mortgage lenders, warned that strong growth in the housing market was "unsustainable".

A separate survey by property firm FPD Savills last month warned that weakening consumer demand, and growing fears over job prospects, were set to undermine the market in the second half of the year.

Key ratio

Cambridge Econometrics based their conclusions on an analysis of how far house prices have risen in relation to salaries.

While the overall UK ratio of prices to earnings remains below the level hit in 1989, ahead of the last housing market collapse, in London the ratio is "rapidly approaching its 1988 peak", the report said.

"Speculative demand has boosted London house prices especially in the last few years and pushed them strongly out of line with incomes in the region."

Economic transformation

The think-tank also warned that homebuyers have failed to take account of the UK's transformed economic climate, characterised by low inflation and low interest rates.

We doubt whether households will be prepared to stretch their finances to the same extent as they did in the late 1980s

FPD Savills

While today's homebuyers benefit from low borrowing costs, a lack of inflation makes the struggle to meet mortgage payments a protracted affair.

Borrowers can no longer rely on inflation to raise their salaries significantly, and make monthly mortgage payments considerably more affordable over the life of a loan.

"Debt service payments will remain substantial," Thursday's report said. "Over the full term of the loan the cost is still high."

The implications of a more drawn-out battle to meet mortgage payments will eventually dawn on buyers, and affect prices, Cambridge Econometrics said.

"In a low inflation economy, housing values will need to reflect the level of real earnings.

"Divergence from such real economic comparators cannot continue indefinitely."

Industry view

The validity of the indicators seized on by Cambridge Econometrics is challenged by some other analysts, including the FPD Savills researchers.

"The complexity of housing finance means that other factors and measures need to be considered," they said.

But the firm agrees that growth in property prices is, nonetheless, set to slow.

"We doubt whether households will be prepared to stretch their finances to the same extent as they did in the late 1980s," Savills said.

"This may well act as a natural break to runaway growth in average house prices."