Housing: still a dead cert?

Homeowners spooked by their rising monthly mortgage bills may try to seek some solace in the very big picture. Now that the Bank of England is hiking base rates, some consolation may come from immigration, family break-ups, and Britain's inability to build houses. Perhaps.

For the optimists, the housing market is still a one-way bet simply because of those long-run pressures that are increasing demand for homes far in excess of a relatively static supply. The Bank has shown some support for this argument.

'Over the longer term, demographic changes were working to increase the demand for housing, and hence for mortgage debt relative to the population of working age,' said an analysis in August's Inflation Report . There has been a steady increase in the number of owner- occupiers, but a dramatic increase in the number of households. This reflects very long-run changes to Britain's economic and social fabric chiefly based on family break-ups, and therefore an increasing trend for one-person households.

The recent census showed that there were 6.5 million one-person households in the UK. This represents 30 per cent of Britain's 21.7 million households, up from 26 per cent a decade ago. Just over a third of that total (2.4 million) are female pensioners. Among the 3,376,000 non-pensioner one-person households, male occupants outnumber women by three to two.

So, from these facts, optimists deduce that the housing market will be buoyed up by, for example, demand from increasing numbers of divorced men.

Similarly, immigration, particularly in London and the South East, will inevitably increase demand for housing. Government projections show Britain's population increasing from 59 million to 65 million by 2025, with two-thirds of that caused by net migration.

In America, currently in the throes of a housing boom, Federal Reserve chairman Alan Greenspan has singled out immigration as a principal reason why the boom is sustainable and not a specu lative bubble. 'Census data suggest that one-third to one-half of new household formations in recent years result directly from immigration,' he told US bankers earlier this year. 'The overall level of new home construction appears to be well supported by steady household formation.'

So even the most conservative of central bankers have given their seal of approval to this sort of analysis of the housing market's long-term future. Where Britain parts company with the US is on the supply of housing - which in the UK has remained alarmingly static over the past decade and failed to respond to the growth incentive provided by rocketing prices. Greenspan says this is a geographical matter. 'There is no national housing market in the US. Local conditions dominate, even though mortgage interest rates are similar throughout the country. Home prices in Portland, Maine do not arbitrage those in Portland, Oregon. Thus, any bubbles that might emerge would tend to be local, not national, in scope,' he said.

But the medicine man of the global economy is also on record as saying that a bubble 'is easier in England because it's a smaller geographical area'.

The US market functions better, because there is space and comparatively few limitations on allowing housebuilders to respond to high prices. The US is also more diversified.

But the UK's comparative lack of supply is no reason for ever-increasing prices. HSBC's UK economist, John Butler, specifically points to the inconsistency between arguments about housing shortages and recent regional trends in prices.

'The northern regions have led the charge up over the past few years, while the South - where the greater housing shortage exists - has lagged well behind. That is the opposite to what you would expect if housing shortages were the main reason for the boom. Everyone cites supply problems, when demand is booming,' he warns.

International precedents show that supply restrictions will not stop a bubble bursting. Japan has even greater pressures on space than Britain, and broadly comparable long-run population trends. Yet prices have been falling for more than a decade. Hong Kong's real estate is still worth only half of what it was five years ago, yet the territory is not exactly overflowing with building space. Nor could that crash (or the preceding boom) be attributed to demographics.

'In the long run, these trends are important - but anyone saying that a few thousand households could stop a housing market crash has forgotten about the late Eighties,' says Gavin Cameron, an economist and property market specialist at Oxford University.

Academic economists are scathing about the suggestion that strong growth in migration or continuing family break-up will support Britain's housing habit.

'These factors are slowly evolving over time and are supportive to house prices over the long run,' adds Cameron. 'But demographic changes are sufficiently smooth that they won't explain year-to-year shifts or even the boom over the past five years.'

Ed Stansfield, property specialist at Capital Economics, agrees: 'Look back to 1988, house prices were ticking along at 30 per cent and then, without any change in demographics, inflation was negative. Short-term valuations are driven by earnings and affordability,' he says.

But surely the huge rise in single person households will have pushed up prices in a housing market with about 1.5 million sales per year?

'It is a big rise, and housebuilding has been weak, but you start from a position in the Seventies, where we had healthy surpluses. The demographics have been tightening the market, but only at the margin,' says Stansfield.

'Ultimately, it is what people are earning and what banks are prepared to lend them that ties prices down in the long run - and that's what we think is happening now.'

And for the truly heroic optimist there are other pitfalls to relying on demographics. Trends tend to change almost as soon as they are identified. Immigration may be a factor bolstering demand now, but it is not unlikely that politicians would limit it. The overwhelming shortage of housing in the South East stands to be at least attenuated by John Prescott's housebuilding plans. But there is some anecdotal evidence of professionals giving up on the expensive, congested 'grim South' and heading for other parts of the country.

'These ex-post rationalisations [of very high house prices] seem reminiscent of those arguments used to justify the surge in corporate debt during the late Nineties,' says Butler - and we all know where that ended.

faisal.islam@observer.co.uk