June 16, 2008 | posted by Michael Baxter in House prices |

Mistakes were made in Japan.    Mistakes could have been avoided, they weren’t and that’s why the economy of the Rising Sun suffered ten years of economic sunset.    

Now policy makers in the UK, US and Eurozone need to ensure those mistakes are not repeated here. 

So what were they?  After the bursting of an asset price bubble, the government and Japanese banks went into denial, for years.     Asset write downs were a drip drip affair.  Banks refused to admit, maybe even to themselves, how bad things were.  Eventually, the government had to step in and bail out a number of Japanese banks, it had a series of Northern Rock style moments – over a prolonged time frame.

A similar, but not identical, problem sits in the UK today.  This time, though, the dangerous denial of reality relates to the price of land. 

It is still profitable to build houses.  Any losses that may be incurred by builders relate to the cost of land.     The trouble is, builders have already paid for this land.  Even though they could sell property on this land for less than the cost of build, they dare not, because then they would be forced to admit the true scale of capital loss.      

Fear is pushing builders into trouble.  At the time of writing, the Barratt share price is just 85p, down from over 1,200p 18 months or so ago.    Its market capitalisation is actually less than the projected profits for this year.

Meanwhile, HBOS has made the headlines, after whispers grew over the weekend that retirement homes specialist McCarthy & Stone is struggling with its £800 million debt, mostly with HBOS.

Meanwhile, the House Builders Association is making grave warnings.  It is worried about a building slump creating an even bigger shortage of properties in the future. 

Remember all that talk last year about a shortage of new homes leading to even higher house prices?  Well, some believe that predicted rise is merely on hold.  That once the credit crunch ends, house prices will rocket up.

But we are not so sure.   The truth is that house prices will need to fall a lot more, a lot more, before it ceases to be profitable to build, but right now, builders and banks are reluctant to realistically value land – that is to say, give it a value that is in line with historical precedent.  

Once they do, then house building will begin again.  Prices will fall to a realistic level, the credit crunch will inevitably come to an end, and a gradual and sustained pick up will be under way.   If they refuse to do this, if they develop the same habit which permeated Japan ten years ago, then not only the housing market, but the UK economy in general will limp along the bottom for many years.

The House Builders Association says only 110,000 homes will be built this year, less than half of Gordon Brown’s 240,000 target.      In 2009, it warns, building could fall to just 80,000.

Roger Humber, from the House Builders Association, said, “We’ve not seen anything like this post-war… It’s essentially a financial crisis, more like 1931 than anything else that we’ve seen.   House builders are not going to be starting new sites, they’re going to be laying people off, they may even be mothballing sites.  It really is on a scale we’ve not seen before.”

Yet a survey among the Society of Business Economists conducted for the ITV programme Tonight, found that 56 per cent of those interviewed reckon house prices will fall by 20 per cent, with another 20 per cent of that number predicting 30 per cent falls.

Almost two-thirds of the interviewees said house prices will not recover to the 2007 peak until 2012, but nearly 15 per cent said it will take until 2015.

So, on the one hand, you have got some saying a shortage of housing will mean that prices will soon shoot up again.  On the other hand, you have predictions of a slump lasting 8 years.

Who is right?

The shortage of houses in the UK is exaggerated.  As was told here on May 28, according to the Survey of English Housing, no less than 47 per cent of existing owner-occupier dwellings – that’s 6.8 million homes, are under-occupied.  Capital Economics described it like this: “Many owner-occupiers are engaged in a form of speculation, in that whether, when, and how much space they buy is heavily influenced by their beliefs about the future course of house prices.”   In short, they buy bigger houses than they need because they expect the price to go up.

So as prices fall, the speculative motive will disappear in a puff of smoke.     Space will be freed up, prices will fall some more.

But, the cost of build relative to average house prices is so low, that the market can afford big falls; it will still be profitable to build – it will still be profitable to convert biggish properties into two smaller properties.    But at lower house prices, it will become profitable for buy-to-let landlords, not because of the hope of capital growth, but because rental yield will be much higher than costs.  It will be tempting for first time buyers to move back in, too. It will be with realistic pricing that the recovery will begin.

The challenge will be to find a way of providing finance to those with negative equity.

The danger lies in the banks and builders who fight this trend, who refuse to admit to the inevitable; the longer they do this, the worse it will get.