The Guardian yesterday reported that traders were pricing in a 50% drop in house prices over the next four years. Firstly and personally, I think prices may fall quite deeply. But I don’t think they will drop by 50% in “real” terms, unless the economy takes a pretty freaky turn for the worse. Then all bets are off.

I’ll come to why a 50% drop in “real” house prices is unlikely later, but first (and I seek help here if I am being a chump) I can’t make the Guardian figures stack up.

The Guardian article takes as its base the Tradition Future HPI – a monthly index for the future price of an average UK house using derivative prices quoted in the over-the-counter residential property market using the HBOS (Halifax) index as its basis.

In May the index four years out was £154,671, set against a quoted May 08 figure of £190,952 and a peak in August last year of £201,081.

Taking the Guardian’s inflation assumption of 4% that means roughly five years out from peak (doing the compound interest sums) you’ll need about £1.22 to buy what you could buy for a £ today. So that £154,671 in today’s terms is worth, say, £127,128. I make that a drop of 37% (Please tell me if I have cocked up the figures here), which oddly enough is in a similar region to the “real” house price drops in the early 1970s and early 1990s.

Now for some loose thoughts on why a 50% drop in “real” house prices looks highly unlikely…
In the 1970s and 1990s inflation was much higher than today. We can argue about the measures and the fact that prices are on the way up now, but broadly rising prices assisted in correcting “real” house prices while house prices in cash terms continued to rise in the 1970s and fell by 14% between July 1989 and Jan 1996 (using the Halifax figures). This helped aleviate the problem of negative equity in the 1970s, and although it was very painful for some in the 1990s the inflation did burn out some of the debt.

Meanwhile, “real” house price corrections in both cases were between 30% and 40%.

The Tradition Future HPI shows a fall in cash terms of about 23% to 2012. That is going to be hard to swallow and, if it happens, it would push huge swathes of homeowners into negative equity. Those that don’t need to sell out of the market will probably wait for better times to come. The market would most likely suffer a partial freeze.

Rents may be squeezed, but if house prices fell by a half in real terms over the next four years even a fairly hefty drop in rents would change the equation for residential investors favourably and the long-term prospects (30 years out) for house prices remains buoyant according to the Tradition Futures HPI. Much rests on interest rates, but ask a housing association if it think the sums stack up for buying homes at half the current price.

And while interest rates may rise, they are (from what we can see now) unlikely to hit the levels of 13% as seen in the early 1970s and 14% as seen in the late 1980s. Not that they will not or cannot.

Similarly unemployment will almost certainly rise, but will it rise to levels that create a swell in distressed sales that will prompt an unprecedented collapse in house prices? Not so sure there.

The post-War experience has been that over time house prices rise above RPI at about 3% depending, obviously, on what measures you use. An effect in large part down to increasing wealth, better homes and a relatively constrained supply.

So at current rates of RPI we are looking at trend growth of about 7%. Over five years assuming that trend has any meaning, we will see a “correction” in house price around the trend of about 40% if house prices stand still.

Finally, I wouldn’t base my life choices on the futures market. A year ago it was predicting steady albeit unspectacular growth in the housing market from here to eternity.

Anyway and just for the amusement of how dramatically views can change, it’s worth looking at a prediction made in 2006 about how house prices would grow 50% over the following six years, also incidentally reported in the Guardian, so you can’t accuse it of bias.