... but here comes the night

Douglas Wood warns that investors can no longer use bricks and mortar to build up wealth; The chance of a sustained boom is small

After a long convalescence from the excesses of the late-Eighties, housing is in some sort of shape. But present efforts to talk up the market simply confirm how short memories are. As recently as 1995 house prices fell 5 per cent in real terms. But on the strength of recent predictions by the Halifax of rises of 6 per cent in 1996 (around 3 per cent above inflation), some commentators are already talking about rises of 15 per cent in 1997.

If rises of this size do occur, it is a tribute to the credibility of expert pundits who have steadfastly predicted a recovery in prices for the current year, to be followed by massive gains the next year, for almost a decade of housing stagnation. It is the accepted wisdom that house price increases are a good thing, so we tend to ignore the fact that many of these forecasts are made by employees of firms that benefit from rising prices.

Although a house purchase is probably the biggest financial transaction in most people's lives, none of the health warnings that govern smaller financial deals seem to apply. It is not surprising, then, that people are so easily stampeded into the market for fear a bonanza is passing them by. But the Nineties are nothing like the Seventies and Eighties and the chances of a sustained boom, unless galloping inflation reappears, are small.

The main claim now is that prices will rise because homes have never been so affordable. But while interest rates have fallen, so has inflation; the real cost of housing finance has actually increased, especially after reductions in mortgage tax relief.

The housing experts and the Government statisticians may pretend that paying 6 per cent after tax with inflation at 3 per cent is cheap. But compared with 7 per cent and 12 per cent, the typical equation in the Seventies and Eighties was much kinder.

The only consequence of current affordability is that initial payments absorb a lower proportion of salary. But, assuming continued low inflation means lower pay rises, homeowners will devote a higher proportion of their longer-term incomes to buying their "affordable" house and will be less able to trade up.

It is also often overlooked that capital gains and income tax privileges have been switched to Tessas, PEPs and pension plans. These financial products do not require the heavy investment in central heating, double glazing and fitted kitchens that is conveniently forgotten by house owners in calculating their capital gains and by building societies in calculating the rise in average house prices. All these costs add at least 2 per cent to the annual financing costs of home ownership. If a PEP grows at a modest 4 per cent above inflation, and even if house prices retain their historic link with earnings at 2 per cent above inflation, someone buying a pounds 50,000 rather than a pounds 100,000 house and investing the savings in a PEP could expect to be pounds 27,000 wealthier after 10 years.

There are other reasons for doubting the optimists. Without the prospect of big gains in value, people will buy the house they need rather than a larger one. With a massive release of MoD and railway land and the conversion of offices and factories rendered obsolete by computerisation, there should be little shortage of land for residential property. And the claim that more than 4 million new housing units will be needed only reflects more people living alone.

In practice the demand will be for much the same housing but in smaller units. Indeed, the truth is that better productivity in house construction can be expected to produce better houses for stable or falling real prices.

q Douglas Wood is Professor of Banking and Finance at the Manchester Business School. Last year on 'Panorama' he predicted that, given low inflation, house prices would fall in real terms over the next 20 years.