The UK housing market…’speculation’ and ‘froth’

History shows that as affordability becomes an issue buyers get cold feet, demand drops and sales fall.

The UK housing market is susceptible to bubbles. Through the eighties we saw growth, slow decline, stagnation and recovery.

Today, even with house prices rising, the real value of housing is below the peak of 2007 and only at the same levels as 2003. Far from suggesting a housing ‘crash’ many are predicting that house prices will continue to rise on the simple basis that supply is outstripping demand.

In this blog we consider the question which everyone seems too scared to answer.

Stepping back twenty years

1995 was the bottom of the last cycle so it’s a great place to start. The average real earnings (inflation adjusted) in 1995 were £19,944, the average real house price was £87,012 (Q4 1995).

Comparing to 2015, this data tells us:

  1. Average real earnings have increased by just under 10% over the last twenty years
  2. Average real house prices have increased by just over 115%
  3. Affordability in 1995 was between 3 and 4 x earnings, in 2015 this had risen to between 6.1 and 12.2 x earnings
  4. Deposits have risen by just over 100% during this period (based on a 10% deposit)
  5. Mortgage payments in 1995 were just under 20% of earnings, these are now above 30%. They are expected to rise above 40% as interest rates rise

This time is different

This time is different…because of supply.

There is a shortage of homes which means that demand is outstripping supply; the solution is to build more homes. During this time house prices rise rapidly as people try to get on the housing ladder, and speculators look to make easy money. Combining this with ultra-low interest rates we can see why journalists consider this time as different.

However, the eighties were not dissimilar in terms of demand and supply with the average real house price peaking at £138,790 (Q3 1989). At that time no-one predicted prices would fall. Demand was still there, but interest rates were rising. In May 1988 they had fallen to 7.38%, but from that point they began to rise and by the peak of the housing market interest rates had increased by over 85% (to 14.87%).

History shows that as affordability becomes an issue buyers get cold feet, demand drops and sales fall. At the lowest point in Q4 1995 house prices had dropped nearly 60%, and interest rates had fallen just under 15%. At that point we saw a steady rise in house prices peaking in Q3 2007 (of course this was also helped by a freer lending environment). Since then house prices have dropped and are only now at the same level as they were in Q4 2003.

At the same time average annual real earnings have fallen since 2007 by nearly 10% (from £24,041 to £21,857) and since 2003 by nearly 5% (from £22,843 to £21,857).

Japan and USA

It is also worth considering the case studies of Japan and the USA. In the 1980s there was a similar boom in house prices in Japan but for 14 years from 1991 they fell (at a time of ultra-low interest rates). The US suffered similar problems from 2007, although this is now starting to correct.

It could happen in the UK.

Interest rates

In 1988 mortgage payments were 35% of income by 1989 as prices were falling they had reached over 50%, falling to below 20% in the tough (1995). In 2007 they peaked at over 50% dropping to just above 30% by 2014.

An increase in rates of 1.5% will increase mortgage costs by 20%. It is expected that mortgage payments as a percentage of income will edge above 40% as interest rates rise.

A housing bubble

Housing bubbles are often created through herding behaviour. The rise in demand driven by market sentiment creates ‘froth’ and ‘speculation’.

People take risks to get the house they want on the basis that the price will continue to the rise. For example, over 1 million people in the UK have interest only mortgages to enable them to buy the house they want; some of those have no means of repaying capital.

Additionally consumer borrowing in the UK remains stubbornly high; even a modest increase in interest rates could have an impact on consumer confidence and spending.

House prices can fall even with limited supply – in the UK and Japan in the late eighties, and more recently in US have all shown this. History shows that even a slight pullback in demand can cause significant price falls. We saw this from the peak of 1989 to the trough of 1995.


House prices could continue to rise as interest rates go up. We saw as interest rates rose from May 1988 to the peak of the market in Q3 1989 house prices rose nearly 15%. However, after that prices started on a downward path. In that period interest rates went up 85%. Ii is worth reflecting that interest rates in the UK could go up to 1.0% next year (100% increase) and 3.00% over the next five years (500%).

Compared to history these rates are still relatively low but history shows that as affordability becomes an issue demand drops and prices fall (even when there is an apparent lack of supply). If we see a similar pattern we could expect house prices to peak at around £216,000 (same level as Q3 2006) and then a slow decline; if this was similar to the last crash a 60% decline could see the prices fall to £86,000 (the same level at the trough in 1995).

Unlikely to be at these levels but worth considering.

Source: The information for this blog has been sourced from various places. The key sources include; Bank of England Interest Rate Database and Inflation Calculator, Earnings Database, Independent Article ‘Interest Only Mortgages A Million Face Payment Problems Yet Lenders Are Still Pushing Them’, York University Research on Rent, Government Data Statistics on Dwelling Stocks and Private Rental Market Statistics, data on housing market. Telegraph article ‘Buy to let returns beat all other mainstream investments’, indices from Nationwide, article comparing Stocks and Shares to Buy to Let

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