Yesterday HBOS stunned the market when it reported a 2.6% rise in UK house prices; the biggest monthly rise since October 2002. Was this a rogue number or is there really life in the housing market?

In my article A Guide To Trading UK House Price Surveys we looked at the mechanics of the various indices and what data they used in calculating their prices.

Today I’ll start by comparing the indices, then I’ll set out to explain why I’m not buying into the good news story yet.

What Are The Indices Telling Us?
Collectively the best these indices can tell us is that last month appeared to be ok, that prices are still well down on a year ago, but that there’s been a gentle move away from the worst levels.

Rightmove is predictably showing the biggest jump in prices (the data used for this index is the original asking price for a property, which takes no account of the average 10% mark down for a sale).

The Land Registry and FTHPI indices don’t yet show much improvement; their data comes from completed transactions so have a greater lagged effect.

The Hometrack index is based on opinion rather than hard data so is less likely to conform to the median.

There’s not too much to choose from the two mortgage providers (or the CLG) on the annual figures. The chart shows the HBOS number before yesterday’s monster gain, which was overdue after 3 consecutive monthly falls and was at odds with improving data from the Nationwide.

There’s a similar pattern for the average price of a house; Rightmove’s average price at £227,441 is a whopping £75,000 more than that offered by the Land Registry. The mortgage providers are fairly close at around £155,000, but the interesting exception is the FTHPI. Despite showing a larger annual fall it still manages to show an average price of just below £200,000. This index is the only one to use all UK transactions so perhaps it paints a more accurate picture.

Are These Numbers Credible?
Even those with a vested interest don’t fully buy into the hype. Both the big mortgage lenders accompanied their recent shock rises with a note of caution. There’s no denying a brighter mood in the housing market, or the rise in buying enquiries. However two factors are consistently mentioned by those in the industry:

1) The information is distorted by the low level of interest in the market. The Bank of England mortgage approvals number is probably the best measure of transactions. This number has increased for three months in a row, fanning the flames of rising house prices.

But take a look at the volume; April’s improved figure of 43,200 is still way below the trough of the previous collapse in house prices (this chart doesn’t go back that far). As traders we’re well aware that when there aren’t many transactions a small amount of business can distort prices.

2) Although there’s been a rise in buying enquiries, it’s the supply side of the equation that’s causing the rise in prices. The RICS survey noted the average stock of houses per surveyor was down to 69 in May compared to 75 in June and as high as 80-90 last year.

New instructions to sell continued to fall. The (eventual) introduction of HIPs in April was thought to be partly to blame, but also the ‘reluctant landlord’ syndrome where people who move are opting to rent out their original property in the expectation (or hope) of selling it when prices improve.

What Else Matters?

Affordability
The House Price Earnings Ratio for the first quarter of 2009 was 4.35; that’s down from a whopping 5.8 times in July 2007. But the long term average only takes 4 lots of your salary to buy a property and during the last housing slowdown the ratio slid to 3.35 times.

The Halifax index showed that the proportion of disposable income spent on mortgage repayments by new borrowers dropped from a peak of 48% in the third quarter of 2007 to 31% in the first three months of this year. Last downturn saw the number drop from an astonishing 65% at the peak of the bubble to the low 20s during the mid-1990s. This was partly due to lower house prices requiring smaller mortgages and partly down to interest rates falling from 15% to 5%.

Finance
OK, so lets assume a couple, both on average salaries of around £24,000, can afford to buy an average house of £160,000. The mortgage rate of between 3-4% isn’t a problem, but where the hell are they going to find a £40,000 cash deposit from?

There are in the region of 1600 mortgage deals on offer today, but two-thirds of those insist on at least 25% up front, and a quarter of all deals want a 40% deposit. We’ve already seen that mortgage approvals aren’t far off record lows. I don’t see how this housing market can really kick into action until the banks get more realistic with the size of mortgage offers.

The trouble is they’re in such a mess with their own finances that they’ve little appetite for increasing loan capital-especially if they fear a further deterioration in property prices.

Unemployment
Granted, this is a lagging indicator, but it’s still rising and likely to keep rising for some time yet. Unemployment hits the housing market on two fronts; many households have been bailed out by the fall in their mortgage payments-so long as they keep working. But as more people lose their jobs they could be forced to sell their home, or face repossession.

Secondly, the fear of unemployment will deter many potential buyers, and this time job losses are spread right across the industrial and financial sectors; even Members of Parliament are suffering!

Arrears
The Council of Mortgage Lenders recently toned down their prediction of a further 75,000 repossessions this year after the first quarter yielded only 12,800.

But more worrying was news of an increase in prime mortgages falling into arrears. The figure of 1.66% being more than 90-days behind with their payments won’t raise many eyebrows –except that these are the prime, high quality mortgages; these people weren’t supposed to get into trouble. At the moment lenders are apparently taking a sympathetic approach to loan arrears, but I wouldn’t count on that continuing if the bad debts mount up.

Last Time Around
Here’s why I’m sceptical of the rally. Take a look at what happened during the last house price crash.

After the Lawson-inspired housing boom of the eighties, house prices collapsed towards the end of the decade. When house prices started to pick up, people feared that they’d miss the bargain of a lifetime.

They needn’t have worried though as prices slumped for the next two years. Now, admittedly that government tackled the recession by raising, rather than cutting, interest rates (due to a historical cock-up called the ERM).

But this time around there’s a double-edged sword; either the green shoots wither under the summer drought and house prices fall. Or the economy continues to expand, in which case interest rates will rise and put pressure on a still heavily indebted nation. Rising mortgage rates will force the hand of the ‘reluctant landlords’ and house prices will fall.

Conclusion
So there it is; the indices give different answers because they’re using different data over different time spans. They’re conveying a general message of an improving market, but the data’s distorted by a lack of business. Things might improve for a while longer so I’m not placing bets yet. I’m already bearish on equities and reckon Sterling would take a pasting on signs of a downturn. And I’m holding off from buying my second home in Westminster.