As you may know, I’m a big exponent of the 18 year property cycle.
And it looks as though we are in the last leg of the property cycle where the market ‘loses its mind’ and prices accelerate.
To give you context on the property cycle, you can see the chart below shows average property prices in the north-east of England over time.
Source: ONS Housing data
The question I’ve been pondering: how high can prices go?
Ultimately house prices are a consequence of access to borrowings and cost of debt.
As with 2008 to about 2011, interest rates were very low but ability to obtain finance was extremely difficult. Therefore the housing market went into decline. As access to cash improved and interest rates remained low, so property prices began to rise.
This following chart shows average cost of borrowings as a proportion of average income.
Source: https://www.economicshelp.org/blog/7564/housing/cause-of-falling-house-prices/
Original source of data: https://www.nationwidehousepriceindex.co.uk/download/35new-watn5-ati50-zzznn-n48pr
At the peak of the last property cycle, mortgage payments were approximately 45% of total take-home pay. And you can see from the previous peak in 1989, mortgage costs were nearly 50% of take-home pay.
What about interest rates?
The chart below shows inflation and interest rates in the UK from 1900 to 2015. Between 1933 and 1951, 16 years, interest rates remained low as the economy was recovering from the 1920s boom and World War II. Arguably we have similar circumstances, with recovery from the 2008 financial crash and now recovery from Covid. As you see, in World War II and in the 1950s, there were bouts of seriously high inflation.
Let’s assume history never repeats itself exactly, but it does rhyme. We can say the next 10 years will bring cycles of high inflation and moderate increases in interest rates.
Whenever government debt is extreme, Interest rates remain relatively low.
This article from University of Liverpool goes into interest-rate forecasting in some depth.
Note the peak in government debt around 1945 And low interest rates continuing to 1953.
Source: https://www.courtiers.co.uk/news-and-insights/barclays-equity-gilt-study-2016/
Upshot: My bet: Continued low interest rates for at least another 8 to 10 years. I assume interest rates will rise when:
Obviously all of this leads to a couple of big questions:
– how much more will the market rise?
– how big will the property crash be?
Let’s assume:
– mortgage debt is approximately 30% of average income
– that it’s likely to rise up to 40% as shown in the peak periods in 1989 and 2008
– that base interest rates will rise to 1.5%
This means in theory prices could rise by another 25% to 35%, not adjusting for inflation, before market peak and mortgage costs become unaffordable.
Assuming general historic averages, the non-inflation-adjusted capital decline in a crash will probably be in the region of 10% to 15%.
Since your mortgage debt won’t increase with inflation, it means in a crash scenario, you will be relatively unaffected assuming you buy in an area with decent capital growth and robust demographics.