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2009 Outlook plus House Price Outlook (24 Nov – 31 Dec 2008)

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2008: A Year in the Markets

This Month's House Price Crash Developments


> Nationwide: UK house prices fell 2.5% in December, down 18% (£33k) from their peak of £186k
> Nationwide: UK house prices fell 0.4% in November, down 15% (£28k) from their peak of £186k
> HBOS: UK house prices fell 2.2% in December, down 20% (£40k) from their peak of £200k
> HBOS: UK house prices fell 2.6% in November, down 18% (£36k) from their peak of £200k
> Halifax and Nationwide have decided not to release house price forecasts for 2009 – I wonder why!
> Rightmove: home asking prices down 9.9% (£24k) at £218k since last October's peak
> Hometrack: house prices fell 0.9% in December, now down 9.3% from their Aug 07 peak
> Hometrack: home prices falling in 63% of the country - largest falls seen in London & East Anglia
> Hometrack: buyers now only pay 88.6% of the asking price, time on market rose to 12 weeks
> Land Registry: house prices down 1.9% in November, 12.2% for the year, driven by South East
> Land Registry: houses in Richmond fell by 3.8% in November, while those in Ealing fell by 3.2%
> Land Registry: huge drop in sales seen of properties valued at £250,000 to £300,000, - down 71%
> Knight Frank: London rents now fallen for three consecutive quarters, down 12%
> RICS: Estate agents sold less than one house a week in 3 months to 30 Nov – lowest since 1978
> Countrywide holds £1.7bn end-of-year sale - 7,500 property prices slashed by as much as 30%
> Creditworthy borrowers refused mortgages as surveyors give lower-than-expected valuation
> Glut of BTL properties will hit housing market - borrowing difficult, landlords struggle with payments
> BBA: Mortgage approvals in October fell by more than half from a year earlier
> UK commercial property prices have already fallen by 25% and the falls may accelerate
> Office rents in London, Manhattan & Tokyo fall for the first time in almost seven years

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> S&P/Case Shiller reported US home prices down 2.2% in October, 23.4% off their peak
> S&P/Case Shiller reported US home prices down 1.8% in September, 21.7% off their peak
> NAR: Existing home prices down 13.2% in past year to $181,300, fastest annual decline on record
> NAR: Sales volume fell 8.6% in November to a seasonally adjusted annual rate of 4.49 million
> NAR: Inventory of unsold homes up 0.1% to 4.2 million, an 11.2-month supply at current sales pace
> NAR: Fall driven by large number of distressed sales & foreclosures selling at much lower prices
> Commerce Dept: The price of new homes is down 11.5% for the year at $220,400
> Commerce Dept: Sales declined to lowest level in 17 years, down 2.9% in Nov, 35.3% for the year
> Commerce Dept: The inventory represented an 11.5-month supply at the November sales pace
> Commerce Dept: U.S. home builders slashed construction of new homes in November - new starts    dropped 18.9% to a seasonally adjusted annual rate of 625,000, worst level seen in 50 years
> RealtyTrac: November foreclosures up 28% - 259,085 households received foreclosure notices
> Homeowners are re-defaulting on their mortgages even after getting aid
> Fed cuts rates to record low – to keep them between 0-0.25% “for some time”
> Fresh $800bn from US Fed raises bailout to $1.7 trillion, further $500 billion of tax cuts to come
> FDIC, regulators seize Sanderson State Bank, the 25th to fail this year

Rest of World

> Ecuador is first country to default on sovereign debt since credit crisis began – others may follow

Section Index

House Prices & Housing Market Review >
A Very Quick Recap on 2008 >
The All Important Outlook for 2009 >

House Prices & Housing Market Review

In the final weeks of 2008, as Santa readied his sledge and crossed Gordon Brown and Alistair Darling of his list of those who had been well-behaved during the year, the fall in the price of gingerbread houses continued unabated.

Nationwide reported a 0.4% fall in prices in November, followed by a hefty 2.5% fall in December. For the two months combined Nationwide’s average house price fell £5,300 or 3.7% to £153,048. According to Nationwide, since reaching their peak in October 2007, house prices have now lost 18% of their value or £33k.

This picture was mirrored at Halifax where a fall of 2.7% in November was followed by a further fall of 2.3% in December. For the two months the average house price fell 4.9% or £8,280, now down 20% or £40k from their August 2007 peak.

The largest price falls over the last couple of months have been recorded in London, East Anglia and the South-East.

The fall in house prices is a result of the ongoing decline in buyer activity. The housing market generally slows in the run up to Christmas, but this year’s fall in activity came on the back of an already weak 2008, meaning that estate agents had to take drastic action in order to keep the market ticking over. Agents across the country launched “Christmas Sales”, offering up supposed bargains at cut prices. Where agents were able to convince sellers to cut prices, reductions of up to 30% on the original asking price were seen.

Housing Market at Psychological Turning Point

I sense that we are now close to a turning point in the psychology of the market, with buyers pulling back to assess their options and sellers panicking. Until now most participants in the housing market believed that the correction in house prices was temporary. Following a decade of stellar house price growth it became generally accepted that house prices always rise. Hence, the arrival of the credit crunch was interpreted as a temporarily problem which, once resolved, would allow house prices to resume their upward trajectory. However, it is now 18 months since the sub-prime crisis started to emerge and house prices have fallen almost every month since.

People are now starting to wake up to the reality that house prices don’t always rise and that the current crisis is very real and very serious. The economic problems we face are a long way from resolution, despite the dramatic actions taken by monetary powers and governments around the world. I believe that this is becoming clearer to the general public.

Buyers Will Disappear

The first implication of the above is the disappearance of buyers from the market place. With house prices falling 2% per month, the incentive to wait a year and see what happens becomes extremely compelling. The flood of high profile businesses going into administration each month will highlight the need for caution. Economic volatility, job security and mortgage lending restrictions will continue to weigh on the market.
The latest survey from the Royal Institution of Chartered Surveyors revealed that the volume of home sales plunged to a new low last month, with estate agents selling an average of only 10.6 properties per firm in the 12 weeks to the end of November, the lowest level of sales since the data started being collected in 1978. Mortgage approvals continue to fall and even creditworthy borrowers who put down big deposits are being refused deals because cautious surveyors are giving their homes lower-than-expected valuations.

Many buyers who agreed deals earlier in the year and now choosing to walk away rather than complete their purchases, either because they have been made redundant and can no longer afford to proceed, or because they sense bargains further down the line.

Sellers Will Panic

On the other side of the equation, the behaviour of sellers may become irrational, with vendors scattering off in different decision-making directions. Unlike buyers, whose purchasing decisions will become more analytical and finance-driven as the correction continues, sellers begin to let their emotions take over. If you want to sell something in a falling market you normally have to lower the price. If lowering the prices is emotionally unacceptable, you might choose any number of other actions…

A number of buyers have stuck their heads in the sand and simply refuse to cut prices. They still wish to sell at prices achieved near the peak of the market and many have psychological barriers which prevent them from reducing the price, notably homeowners who purchased in the last couple of years, for whom the desire to least break even on their properties is an overriding factor.
Other buyers may decide to take their properties off the market entirely, refusing to accept the fact that the correction will continue. Unfortunately, a quick recovery will not be forthcoming.

A small number of hugely overconfident sellers have even been raising prices, marking up the value of their homes so that they achieve their desired sales price once the buyer’s discount is factored in. In the current environment this is a highly risky strategy.

Owners of properties in need of modernisation also face a psychological barrier. Previously such properties would have achieved good prices as buyers believed that they could add significant value by renovating them. However, with so much inventory swelling the market, buyers can take their pick of a wide selection of properties and will tend to go for homes which need no further work. As a result, homes in need of modernisation must be reduced in price if a sale is to be achieved.

And, as reported in previous months, the trend towards putting properties on the rental market when they don’t achieve the desired asking price continues to gather steam. In my opinion this ranks alongside some of the worst financial decisions of all time. Why would you hold onto a property that has every chance of losing half its value in order to receive a small rental income each year?

Rental Market Remains Good for Renters

The rental market continues to be flooded with properties. Prime Central London rents fell by 9.6% over the last three months of 2008, according to Knight Frank's latest index, by far the largest drop since it was set up in 1995. Rents are down a total of 12% over the last three quarters. The increased demand for rental property, as buyers delay purchases, has been outweighed by the sheer amount of new stock coming onto the market, much of it from ‘forced landlords’ unable or unwilling to sell. Knight Frank said it has three times as many rental properties on the market than this time last year.

As the rental market weakens, buy-to-let landlords face increasing financial pressure. The homes most affected by the recent slide in house prices have been new-build flats and apartments which were designed to be sold as investments to buy-to-let investors.

Meanwhile, borrowing for these types of loans is becoming harder and harder to obtain - the collapse of Bradford & Bingley, the country’s biggest buy-to-let lender, has accentuated this problem. In the months ahead we are likely to see a glut of buy-to-let properties come onto the housing market, putting further pressure on house prices and rental income. Many landlords will struggle to pay their mortgages out of rents, leading to a new wave of defaults and repossessions.

Bargain Hunting?

One word of caution about the spin used in news stories by various vested interests. There has been a lot of talk recently designed to artificially buoy the market. One example is the stories of bargain hunters who are apparently out in record numbers, snapping up properties at basement prices. Do not be tempted to follow suit. Ask yourself what makes these bargain hunters so good at picking the right time to buy why almost nobody saw the crash coming in the first place. With house prices falling 2% per month there is no sense in stepping in. Why try to catch a falling knife?

Commercial Property Prices Plummet

UK commercial property prices have already fallen by 25-30% since last summer, but there is now clear evidence is that the UK property market has entered its so-called “double dip” phase as falling rents from struggling office and retail occupiers began to accentuate already dropping prices.

This is bad news for their lenders and it is forecast that Britain's banks will soon face up to £70bn of losses on commercial property loans, enough to force some of them into a further round of taxpayer bail-outs. UK banks are particularly exposed, having fuelled the commercial property sector boom by lending as much as 95% of a property’s value to private investors. Investment bank Close Brothers forecasts massive write-downs because of an estimated 50-60% slump in commercial property values by the end of 2009.

Back to Section Index >

A Very Quick Recap on 2008

I won’t spend much time looking at last year, it is more important to look at what is coming in the year ahead.

As you can see from the table at the top of the page, unless you invested in the precious metals it was probably a bad year for your money. House prices were down 16%. The FTSE 100 index had its worst annual fall in 24 years, since its creation in 1984. The FTSE All Share index had its worst annual fall in 34 years. Across the pond, US stocks had their worst year since the Great Depression of the 1930s. Commodity markets suffered their worst year since modern records began, as demonstrated by the Reuters-Jefferies CRB index, which began life in 1956 and fell a record 36% in 2008.

Even if you stuffed your money under your mattress you would have lost 20-40% of its value against the world’s other major currencies. The pound fell 24% against the Euro, 28% against the Dollar and 42% against the Yen.

So 2008 was an epic year. As we start to look towards 2009 we find ourselves at an interesting vantage point.

The first cracks of the sub-prime crisis emerged in 2007 when over-leveraged homeowners started to collapse under the weight of their own debts. At that point a chain reaction of mortgage defaults and home foreclosures was initiated, which resulted in the collapse of a number of major banks and mortgage lenders. Those which survived had to cope with massive loan losses, writing off around $1 trillion of bad debt to date.

As financial institutions wrote-off these loans, which were assets on their books, their capital became quickly eroded, threatening their solvency. Favouring self-preservation financial institutions were no longer willing to lend out money and the credit markets dried up.

Governments and central banks around the world stepped in, slicing interest rates and pumping vast sums of money into the banking system in order to alleviate the contraction of credit. So far this has not worked.

Businesses which had become reliant on the easy availability of short term funding began to fail, unable to fund their working capital and operations. We have seen numerous high profile bankruptcies recently and such failures will continue in the year ahead. At the end of 2008 we saw the effects start to feed through to the high street - Woolworths, MFI, Zavvi, Whittard, Officers Club, Adams and USC went into administration, and many thousands of job losses, store and factory closures were announced.

It is at this point we can pause to acknowledge the past before realising what comes next…

Back to Section Index >

The All Important Outlook for 2009

So the first half of 2008 was characterised by the seizing up of the credit markets, which caused banks to re-trench rather than lend out money. In 2008, house prices fell because of a lack of money – people could not borrow enough to pay for the houses they wanted.

In the latter half of 2008 we saw the impact of the credit contraction spread from the financial sector onto the high street, leading to the bankruptcy and administration of big name businesses. In 2009, house prices will fall because thousands of people lose their jobs, and either default on their current mortgages or won’t be able to obtain a mortgage to make a new purchase. In 2009, it will make more sense for prospective buyers to wait and see what happens - to wait for lower house prices.

House Prices

With house prices having fallen around 18% from their 2007 peak (Nationwide down 18%, Halifax down 20%), I have chosen to maintain my target for a total peak-to-trough drop of 50%. So I am looking for a further drop of 32% from peak level. This equates to a fall of 39% from current market prices.

For example, Nationwide house prices peaked at £186k in October 2007. A 50% fall from this level gives us a £93k fall and a £93k target value once the correction has worked itself out. The current Nationwide average house price is £153k, so we still have to drop £60k to get to the target value, which is 39% below current levels.

It is difficult to predict how quickly house prices will fall in 2009. Picking the top of the market is easier – you can look at when the majority of mortgages are due to reset and at what interest rates they will reset at. This gives you a reasonable window in which the rate of defaults and repossessions will accelerate – and in such an overleveraged world the collapse of the housing market takes care of itself. But once that collapse has started it is difficult to estimate its pace.

My feeling is that the majority of the predicted falls will likely to come in 2009. Until recently the impact of the credit crunch has only been experienced by the public in a remote capacity, through news stories about exploding Wall Street firms, or government coordinated bailouts. Now the contraction of credit has fed all the way through to the high street and to corporate Britain. Job losses will begin to accelerate and those lucky enough not to be directly impacted by layoffs will become more concerned, conservative and financially sensible.

The housing market will remain extremely vulnerable in 2009. It may be that we see house prices fall 2% per month every month for the whole year. Or we may see a weak spring bounce which accompanies a temporary stock market rally. But any such bounce would then just be followed by even steeper price falls in the later stages of the year.

We are still only about half way through this crisis – at best. It will only be over when all of the excesses of the last 30 years have been flushed out, which is not this year, or next. It is some way off.

But we don’t have to wait for the very bottom of the market in order to buy. Decisions should be made relative to their alternatives. I can say that right now it still makes significantly more sense for me to rent than to buy – approximately half the monthly cost, plus I am not exposed to falls in the value of my home. But if by year end house prices have fallen 40% from their peak, at that point it may be cheaper to buy a home than to rent. I may decide that I am happy to accept the risk of further price falls so that I can give my family some stability, a castle of our own (not literally, although that would be nice!).

So, depending on the extent of price falls we see this year, some of you might wish to take the plunge. And boy will your patience have paid off!

I recommend you familiarise yourself with the Which Way Home Buy vs Rent calculator which can be found here and may help you to compare different courses of action when the time comes.

With respect to US house prices, I have increased my target from an expectation of a 30% fall to a likely 35% fall. This reflects the severity of the ongoing developments in and out of the financial markets.

Stock Markets

In 2008 UK and US stock markets fell almost 50% from their peaks. It was a pattern mirrored around the world. They have since recovered a little and currently stand around 40% off their highs.
Have we seen the worst of the falls? Absolutely not.

The stock market will most likely consolidate for the first few months of 2009, taking some time to digest last year’s sharp falls. The consolidation may emerge as extended period of sideways action in which big rises one week are offset by big falls the next. Or it could take the form of a relief rally as market participants “hope” that the worst is behind them and presume that there are profits are to be made by stepping in at this level. Trading such a relief rally can be risky as any number of catalysts could set off the next sharp dislocation.

It is my opinion that any consolidation or relief rally will be a secondary movement within the ongoing primary downtrend. It doesn’t make sense that the economic fundamentals which resulted in the obliteration of some of the biggest, most prestigious financial giants in the world, can be over in one short year and a modest 40-50% stock market correction. The timeframe is laughably short and the magnitude of the correction too comfortable.

The fundamental picture which deteriorated and set off the chain reaction of financial collapse and government bailouts is unchanged. In order for the market to find a healthy footing it will correct further from these levels. Prices must fall below their recent lows, flushing out the remaining weak-hands from the market. As the market falls we will see the return of forced sellers, a topic covered in some detail in the last outlook, which will take the market down even further.

I believe that 2009 will see stock markets head toward a correction of around 60% from peak levels. Whether we reach the bottom in 2009 is another story - one which is too difficult to call at present.

Interest Rates

The US Federal Reserve lowered rates as expected in 2008, dropping them to the range of 0-0.25%. It is the first time I remember the Fed quoting an interest rate range, rather than an absolute value. It indicated that it will keep them at these low levels for the foreseeable future.

I expect the same pattern to be followed in the UK, although the Bank of England appears to be taking a little longer than the Fed to put through the cuts. In the first days of 2009 the Bank of England was reduced to the current 1.5%, the lowest level since its creation in 1694. That the base rate will continue to be lowered is without question. The British Government will try everything in its power to end the current crisis and to stimulate the economy. If rates were not cut further the monetary authorities would come under extreme pressure to explain why they had not done as much as their US counterparts.

As a result I have lowered my target for UK rates down to 0-0.5%. I would be extremely surprised if we did not see these levels reached in 2009.

Commodities (excluding gold)

The outlook for commodities should be very favourable. I use the word “should” for good reason.

The fundamental picture for commodities is very strong. Supplies of many commodities are at historically low levels, and as prices have dwindled there has been less incentive to invest in further commodity production. This suggests that at some point the supply will reach such low levels that prices have nowhere to go but up.

Take oil for example. The supply of oil is depleting each year, reducing the amount of oil which can be shared out around the world. This is one of the main reasons we saw the price of oil rise in the first part of last year. Massive investment is required in order to minimise the rate of depletion by bringing more supplies onto the market. However, as the price of oil plummeted in the closing months of 2008, it no longer became commercially viable to make such massive investments, meaning that the depletion of oil supply will only worsen. The price of oil has currently fallen so far that, rather than drill for it, many oil companies are going out into the market, buying oil and putting it in storage, waiting to sell it when prices begin to rise once more.

Furthermore, as governments around the world pursue their dramatic bailout strategies, flooding the world with printed money, the value of that money will one day start to fall in equally dramatic fashion. As the value of money falls, the price of real goods such as commodities will increase.

So commodities have two extremely fundamental upward price drivers on their side – dwindling supply due to lack of investment and increased tangible value due to the fall in the value of money.

The reason I use the word “should” above is because other market participants may not interpret the picture in this way, temporarily sending the price of commodities in a different direction. Many investors currently believe that the price of commodities will fall due to “demand destruction”. This is the reduction of demand brought about by slowing global economic growth. I agree that there will be some demand destruction, but this has probably already been reflected in the price falls of 2008. There may also be some forced selling.

As a result of the above it is difficult to determine what will happen to commodity prices over the short term. But as inflation picks up and people realise the tightness of supply, prices will begin to rise - the medium to long-term outlook for commodities is very strong.

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Longer Term Macro Picture (including gold)

As I described in the last outlook, it is often difficult to see the wood from the trees, especially at times like this when the markets move quickly. Headlines about bailouts, financial collapse, plunging asset values and the onslaught of recession fill the newspapers and TV shows daily. It’s certainly hard to keep up. It is also difficult to know what to focus on.

Good investing is all about focusing on the big picture – the tide is far more important than the swimmers.

When big picture developments are identified ahead of time it allows us to shape our financial strategies in the best possible way. A clear picture is unfolding which is crucial to our vision of the years ahead: massive bailouts = massive money creation.

At present the monetary powers are completely focused on bailing out the financial system. Central banks are pumping truly vast sums of money into financial institutions and into the economy.

In the UK

In the UK the Treasury’s figures show Britain’s debt rising to £1.1 trillion by 2013-14, over 60% of our GDP. This is more than double the amount of debt we had last year. Doubling our country’s debt in just 5 years! Where is this money going to come from? To put the figures into perspective, in the current year alone we will borrow around £78 billion - more than we borrowed, in today’s money, to pay for the Second World War!

It comes as no surprise therefore that Britain’s credit rating has plunged in recent weeks and that the risk of Britain defaulting on its bonds has increased dramatically. Investing in UK government debt is now twice as risky as buying MacDonald’s corporate bonds, demonstrated by the price of the credit default swaps which provide insurance to buyers of such debt.

Think about that. If your whole family worked at MacDonald’s, if you re-invested all of your savings back into its shares and bonds, it also administered your benefits like healthcare and your pension, and it had the power to cut your salary at any time – would you feel secure and comfortable?

Yet, we live in a country that has taken ownership of our banks, administers our healthcare, our benefits and our state pension, a country which is raising taxes, printing tonnes of paper money and is racking up huge debts.

The markets are telling us that the burger chain option carries half the risk.

We the public are not much better, with around £1.5 trillion in mortgages, credit cards, store cards and personal loans.

In the US

It took around 200 years for the US to accumulate its first $1trillion of debt, 20 years for the next trillion, and now at times it is expanding at a rate of around $1 trillion a month. The acceleration is truly terrifying.

The US bailout alone totals $1.7 trillion (and counting…). $158 billion of tax rebates last May, $700 billion bank rescue fund created in October, $100 billion to buy the debt of government sponsored mortgage enterprises, $200 billion to support consumer finance and $500 billion to buy mortgage securities backed by Fannie Mae and Freddie Mac and Ginnie Mae.

Plus a further $500 billion of tax cuts are still in the pipeline, which takes the total to $2.2 trillion!

Macro Outlook

Your job as an intelligent reader is not to get bogged down in the details of the current developments. The housing market is crashing, we know that! Put a reminder in your calendar to buy a home in 1-2 years time and let prices fall in the meantime.

Don’t get caught up in all of the bailout hype and government spin. The authorities are trying their best to provide a financial fix, however the problem is too much debt, and by focussing very intently on adding more debt they inadvertently create bigger problems for themselves further down the line. Conversely these are big picture opportunities for us.

I would liken current events to the monetary powers focussing on diffusing a candle in one corner of a room, while a time-bomb situated on the other side of the room ticks down towards zero.

We know what governments are going to do – they are going to keep adding debt and will print more money to pay off their loans. This is a neat trick that only a government can pull off. “We are going to write bad cheques and you can take them or else”.

The risks of hyperinflation, a complete loss of trust in our currencies and a currency default grow stronger by the day.

In the years ahead, as the value of our money decreases I see the price of gold and silver rising. Gold performed well in 2008 and the fundamental factors which lead to its gain remain intact. Both metals may suffer from market volatility over the short term, but longer-term their destiny has already been set out by the actions of government today.

Back to Section Index >

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Market Outlook
Nationwide U.K. House Price Index
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Case Shiller U.S. House Price Index
FTSE All Share Index
S&P500 Index
US Dollar Index
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