Housing Bubbles Are Universally Destructive

Ever since this column started in 2000, I have been writing that British house property is hopelessly overpriced. There is no question this has been spectacularly bad investment advice – Londoners who owned a home in 2000 have at least trebled their money since then, doubling it in real terms. Nevertheless, it is possible for an asset to remain overvalued for decades, and I would like to examine the damage that overpriced real estate has done to Britain’s economy.

The initial impulse for the column arose when I discovered that my grandparents’ very modest semi-detached house in Bristol, where I spent six months of my childhood, was now valued at £740,000 (just under $1 million at today’s exchange rate.) The house was in a fairly nice part of Bristol, near the cricket ground, but it was no more than skilled-artisan housing from the 1900s, with small rooms (3 bedrooms) and a driveway shared with the house next door. Needless to say, my grandfather; a retired Major, could no more have afforded that house at today’s prices than he could have flown to the Moon, At today’s top salary for a Major of £62,132, his maximum borrowing capacity would have been only about £250,000 at most, and he would never have stretched his finances that far.

A recent Dallas Fed study compares house prices from 1899 to 2012 across a number of countries. In the United Kingdom, house prices in real terms fell by 1% per annum from 1899 to 1938, then jumped during World War II (presumably reflecting destruction of part of the supply) and began a moderate real price increase thereafter, which accelerated to a mad spiral in the 1990s and 2000s. Real house prices across the UK are now roughly double their 1990 level, (1990 being itself at the peak of a bubble) four times their 1970 level and eight times their level in the blissful days of 1938.

Two factors account for part of this increase. First, there is a modest hedonic improvement in the quality of the item known as a “house.” Houses built in 1899 quite often had outside privies, although my grandparents’ house, built a little later than that, had modern plumbing, albeit not very much of it by modern standards. The Dallas Fed estimates that the hedonic factor accounts for about a 0.2% per annum price increase. Second, there is an increase in real terms in the wages of construction workers, and hence in the construction costs of houses. This factor has been minor since 1980 or so, but was very important in the decades after World War II, during which in Britain blue-collar wages shot ahead while professional wages stagnated or declined.