Home, no longer where the money is

There will be a sigh of relief across much of the country now that it appears the slump in house prices is really over. With both important surveys of prices - from the Halifax and Nationwide building societies - showing some buoyancy and the Bank of England mortgage lending figures showing a sharp increase in the number of mortgages approved in October, the message is pretty unambiguous: the British housing market is coming back to normal.

But what is 'normal'? Now that the cyclical slump is over, it is time to ask questions about the long-term trend. While most people agree that in the absence of a return of the very rapid inflation of the 1970s and 1980s it is highly unlikely there will be another runaway housing boom, there is less agreement as to whether housing will be 'a good investment' in the future in the way that it has been for most of the post-war period.

There are two alternatives. The first might be called the conventional view. It starts from the position that there has been an enduring relationship between house prices and earnings for at least 40 years. During this time, home prices have fluctuated between three and four times average earnings, with just occasional peaks above the four times mark at the top of the successive housing booms. At present, prices are between three and three-and-a-quarter times earnings, which puts them towards the bottom of the traditional range. In that sense, homes are more 'affordable' than they have been for some years.

Looking ahead, even without runaway inflation, homes might move back some way up the post-war range, say to three- and-three-quarter times earnings, before falling back again. So, the view would run, we should expect quite a decent market for homes over the next four or five years. Even with inflation averaging about 2 per cent, earnings might rise at an average 4 per cent. So over five years, one could see house prices increase on average by perhaps a quarter without any change in the relationship between earnings and prices. Allow for some shift in that relationship and house prices could rise by 50 per cent. That should clear all negative equity.

The alternative view is more radical. It would be better news for home-buyers, but worse for those with negative equity. It is that there are structural changes taking place in the supply and demand for housing that will break the post-war relationship between prices and earnings.

These include the changing age structure of the population (fewer young people forming families), the decline in the tax advantages of investment in housing (the growth of alternative tax-efficient savings media as well as the shading down of mortgage interest relief), and the fact that at some stage quite soon the proportion of homes in owner-occupation will cease to rise further (because the natural demand will be satisfied).

In addition to these practical changes, there is a possible psychological one. As older people leave the value of their homes to their children, the habit of acquiring financial assets, rather than physical ones, will grow.

Add one further factor. If inflation trends towards the bottom of the Government's range of 1 to 4 per cent, not because of any particular commitment by the Government but simply because world inflation continues to fall, then earnings might rise at only 2 per cent, rather than the 4 per cent noted above.

If most of these points are correct, the gradual but sustained rise in house prices envisaged in the first case above might prove wrong. Instead of prices rising by between 25 and 50 per cent over the next five years, they could stay much the same. This would be very good news for people forming households, but it would not help those with negative equity.

Which scenario is the more plausible? Or will the outcome be somewhere in between? It is very difficult to call big turning points in markets, and the British housing market is no exception. It was quite easy to see that the market had become overblown in the late 1980s. It is also reasonably easy to predict that there will be no further collapse in house prices now. But the second, more radical, sketch of the future is surely just as likely as the conventional one.

The moral is that people should think of houses as an item of consumption, not something on which they should expect to make a profit.