After a 13-year experiment with near-zero interest rates, this key driver of house prices has at last returned to historically normal levels and, with a bit of luck, this could be the pin that finally pops the UK’s 20-year property bubble.
“A 20-year bubble? Impossible!” I hear you cry. But it’s true.
The seeds of today’s bubble were sown at the end of the 1980s bubble. Back then, the average UK wage was a dizzying £9100 and the average UK house cost a whopping £63,000. That put the UK house price-earnings ratio at just under seven, far above the five-times average of the previous four decades.
Such high valuations are only stable if the environment remains perfectly still, like a tall vase on a wobbly table. If a clumsy child bumps into the table then the vase will fall over and shatter into a thousand pieces. In the late 1980s, the clumsy child turned out to be the Bank of England, which raised interest rates to 15%. That caused the economic table to wobble and, inevitably, the housing market crashed, shattering thousands of lives in the process.
By 1995 the crash was over and house prices had declined by 20%. Over those same five years, average earnings had risen to £13,100 and the average house cost just over four times the average wage. Let that sink in for a moment. In the mid-1990s, the average person could buy an average house for four times their salary. Today, the average wage is £34,600, so that would be like buying an average house today for £138,000. However, the actual cost is almost double that, at £260,000.
The low prices of the mid-1990s attracted lots of buyers, so prices started to climb. By 2001, the average house had increased in value to £89,000, which was a historically normal five times average earnings. At this point, houses were neither expensive nor cheap, but the advent of the dot-com crash and 9/11 caused the Bank of England to panic and cut interest rates to 3.5%, their lowest level since the 1940s. I think we should pause again to let that sink in. In 2003, interest rates of 3.5% were shockingly low and lower than most people had seen in their lifetimes. Today, most people seem to think 3.5% is high.
Those super-low interest rates were the match that lit the fuse of the current 20-year bubble, and the fuel was a combination of reckless lending by banks and a manic belief that house prices would keep going up by 10% or more every year forever. By 2007, average earnings were up to £21,600 but the average house price had skyrocketed to £184,000, leaving the price-earnings ratio at an all-time high of 8.5. This was a bubble of epic proportions.
But as I’ve already said, high valuations are like a tall vase on a wobbly table, waiting for the next clumsy child to come along. In 2007, the clumsy child was the banking industry, which had overindulged in excessive lending to the point where the global financial system almost blew up. The resulting financial crisis caused a huge contraction in lending that wobbled the economic table and the tall vase of lofty house prices crashed once again.
But this time the crash was short and shallow as the government aggressively intervened, leaving no stone unturned in its crusade to protect the housing market, along with, of course, their chances of be re-elected.
The first move was for the Bank of England to cut interest rates almost to zero. That unprecedented decision supported house prices and the crash was swift and small, with average prices falling a mere 15% in 2008. But the economic environment remained terrible, and even with near-zero interest rates, house prices went nowhere for the next few years. By 2012, they were still down about 10% and relative to inflation or wages, house prices were in steady decline.
Unfortunately, the housing bubble’s slow deflation ended prematurely with the arrival of Help to Buy in 2013. This was the government’s nuclear option where it lent up to 40% of the purchase price to wannabe home buyers. This idiotic scheme worked like a charm and house prices headed back into the stratosphere. As if that wasn’t enough, the government then introduced a stamp duty “holiday” during the pandemic to protect a housing market that didn’t need protecting.
That fuelled the final leg of this 20-year bubble, with average house prices reaching an eyewatering peak of £275,000 in 2022, according to Nationwide. That was 8.5 times the average UK wage, a figure that almost exactly matches the peak of the 2000s bubble. As always, high valuations are only stable if the environment remains stable. In 2024, I would not call the environment stable.
After 13 years of near-zero interest rates, and a decade of Help to Buy madness, these artificial stabilisers have been removed and today’s sky-high property prices have little to support them other than a deeply ingrained belief that rising house prices are as reliable as gravity. Interest rates at 5.25% are now back to historically normal levels, and if they remain close to historically normal levels then I would expect house prices to also revert to historically normal levels.
Over the last 70 years, house prices were, on average, six times the average wage. With average wages now up to £34,600, that would give a historically normal average house price of £208,000, compared to the 2023 year-end average of £259,000. Of course, the average house price isn’t going to drop to £208,000 by the end of this year; that would be a decline of 20%! Instead, I hope we see strong, above-inflation wage rises over the next decade, combined with little or no house price growth.
For example, if inflation stays at 2% and if wages grow at 3%, the average wage would reach £46,500 in 2033. If the house price-earnings ratio fell to six over that period, house prices would grow by just under 1% per year to £279,000, keeping most people out of negative equity and making housing much more affordable. That would be as close to a win-win as we’re likely to get, but I suspect the odds of achieving such a soft landing are, unfortunately, very low.
