In nominal terms they may only be down 12.8%, however adjusted for inflation (RPI) UK property prices are down 26.2%, and adjusted for the value of real money, i.e., gold, they are down a staggering 67.5%. And this article shows why UK property prices have much further to fall.
The chart below shows the price of the average UK home in both nominal terms, and adjusted for inflation (RPI). It also shows the price of the average home adjusted for the value of real money, i.e., gold.
A 22 year (monthly) chart of UK Property prices adjusted for inflation (RPI) & real money (gold) (Click on the chart for a larger version)
Notes: Inflation data from Office for National Statistics (RPI all items index). House price data from Nationwide (Nationwide House Price Index – UK Monthly Indices). Gold data from World Gold Council (London PM fix converted into GBP using the foreign exchange rate closing price on the same day).
Since reaching a peak in October 2007 the value of the average UK home has fallen by 12.8%. But that is in nominal terms. When the official loss of the purchasing power of the British Pound (thanks to inflation), has been factored in, we can see that the average UK home has actually fallen by 26.2%.
However, the official RPI (and CPI) indices underreport the true dilution/ devaluation of our currency. If, rather than using RPI to reflect the loss of purchasing power of the Pound, we use gold, we see that property prices have actually fallen a staggering 67.5%.
The fact is, when priced in real money, the value of property (and just about every other asset) is declining rapidly. In October 2007 it took 490 ounces of gold to buy the average UK home. Today it takes just 159 ounces, and this is a trend we see continuing. In a few years time it is possible, perhaps even likely, that it will require just 50 ounces of gold to buy the average UK home.
Why UK property has much further to fall
The primary factor influencing the property market in the UK is the cost of borrowing. Bonds are in a multi-decade bull market, and because prices and interest rates move in opposite directions, the cost of borrowing has been falling for around three decades.
The Bank of England’s benchmark lending rate is at its lowest level since records began back in 1694, and the yield on 10-year UK government Gilts is still close to 300 year lows. These ultra-low rates are providing a lifeline to property owners and therefore are preventing prices from falling. They are the reason that the Economist describes UK property as the “unfinished bust”.
The reality however, is that bond prices are now in a huge bubble, and sooner or later the bubble will burst. When it does bond prices will fall and interest rates will rise (probably quite sharply), something that will prove particularly damaging to property prices that float on a sea of debt. More on this in a future article.
How much more will UK property prices fall?
This is the $64,000 question. The Economist thinks property prices in the UK are still 20%-28% too high, while ratings agency Fitch estimates them to be 25% over valued. Others, such as Deutsche Bank and the IMF put the number higher still at 34% and 30% respectively.
Our view is that prices may not fall by much in nominal terms due to the massive wave of inflation we see coming. However, in real terms, i.e. adjusted for inflation, they will continue to fall at an accelerated rate. By around 2018, in real terms, UK property prices are likely to have fallen by around 60% from their 2007 peak, and perhaps by as much as 90% when priced in gold.
The bottom line
To quote Peter Schiff, both bond and property prices “are a bubble in search of a pin and they’re going to find one”.