Is there really a new bubble in UK house prices?


  • Author: John Fry
  • Date: 18 Nov 2013
  • Copyright: Image appears courtesy of iStock Photo

Television programmes, websites, newspaper articles and a range of popular book titles all reflect one inescapable fact - ours is a nation obsession about house prices.

This fascination has been further stoked of late as price rises in recent months have raised fears of another property bubble.

Everybody seems to have an opinion about house prices. A variety of so-called economic experts have also seemed all-too-willing to enter the debate. However, as these experts clash the situation appears increasingly confused.

thumbnail image: Is there really a new bubble in UK house prices?

The BBC News website recently quoted one high-profile economist as stating that recent house-price rises would “fuel concern” about a new housing bubble. However, the same article quoted a second high-profile economic advisor as stating that “the chances of another housing bubble are ‘extremely slim’” (1). Taken purely at face value both viewpoints have some merit but do omit important considerations – and anybody who enters the debate, especially academics, needs to tread carefully here. There are thus two major issues that remain to be resolved:

1) Are recent house prices a harbinger of the next bubble?
2) What are the chances of another UK housing bubble?

A cursory look at the Nationwide house-price index suggests that the price of a typical house has increased from £162,722 in the first quarter of 2012 to £170,918 in the third quarter of 2013 – the most recent data available. This corresponds to a nominal price increase of 5% over eighteen months. Against an uncertain economic backdrop this may well look like a natural candidate for the next bubble. However, as students of empirical econometrics may recognise, the important thing to look at here is real prices rather than nominal prices. The Office for National Statistics (ONS) produces a Retail Price Index (RPI) which enables the conversion between observed nominal prices to so-called real prices so that a fair comparison can be made once the effects of inflation are taken into consideration. In real terms these figures equate to a price increase from £170,382 in the first quarter of 2012 to £170,918 in the third quarter of 2013. So, in short, this price rise is nothing like as dramatic once we take into account inflation. Over the last few years nominal price rises are insignificant when cast against the backdrop of inflation. Rather than house-price bubbles the important policy debate would hence appear to be the issue of a declining material standard of living. The figure below shows real (inflation-adjusted) UK house prices from 2009 onwards.

Figure 1

Thus, the absence of a housing bubble clearly does not mean that everything is hunky-dory! The above raises difficult questions about inflation and a reduced standard of living. Housing affordability (the level of house-prices to wages) and marked regional differences in wealth also raise important ethical concerns.

Thus, inflation-adjusted data suggests that there is currently no evidence for a bubble in UK house prices. However, when it finally arrives (yes, that is 'when' not 'if'!), the next bubble will also raise difficult equity issues. This is particularly true if more people lose out in busts than gain in bubbles. Viewing another UK housing bubble as impossible misunderstands crucial aspects of both housing markets and about how financial bubbles form. The rich and varied historical evidence, combined with an understanding of the underlying financial mechanisms involved, only points to the inevitability of the next bubble. The only difficult question remaining is the timing of the next bubble.

Historically, house prices, both in the UK and worldwide, have been subject to various bubble and antibubble (bust) episodes over the years. Using a stochastic model I developed, we have recently found formal statistical evidence for a speculative bubble in UK house prices over the years 1983-89 and from 2000-2008 and evidence of an antibubble from 1983-89 and from 2008-2011. This historical perspective clearly shows us that UK house prices are intrinsically volatile – an inconvenient truth that all too easily forgotten in the midst of a speculative bubble but something that has clearly rung true over recent years.

...being based on consumption, rather than investment, market inefficiencies mean that house prices are particularly prone to bubbles and more so than say stock markets. It is not just the UK. Academic studies have also found evidence for house-price bubbles in many different countries throughout the world and at various periods in time.

History shows us that bubbles occur time and time again across different assets, cultures and periods in history. In their evocatively titled book, This time it’s different: eight centuries of financial folly, Carmen Reinhart and Kenneth Rogoff forensically sift through various booms and crashes that have occurred as far back as the default of Dionysius of Syracuse in Greece in the Fourth Century B.C. An unfortunate fact of economic life is that during boom periods, many people are over-confident and over-estimate the true extent of the returns available – neglecting the risks implicitly involved. Sadly, these new developments are rarely “as different” as previously thought and the bubble eventually bursts. Financial booms and busts doubtless go even further back into human history. Linked to evolutionarily stable human preferences for risk, return and over-confidence, it seems that financial bubbles will always be with us. Thus it appears that seemingly “universal” market mechanisms may explain the ubiquity of financial bubbles over the ages.

Whilst modelling bubbles is fraught with economic and statistical difficulties, a key theme that has emerged from the literature over the last 30 years is that, despite clear instances of mass hysteria, there is no requirement for mass irrationality in order for bubbles to occur. Under so-called rational bubble models, most market participants take a “calculated risk”. Investors may thus be drawn to a risky market for the possibility of future rewards. However, whilst doing so most people are probably over-confident. During the internet bubble, people correctly recognised that the new technologies afforded genuinely profitable opportunities but over-estimated the extent of the potential rewards. Similarly, during the housing bubble, people rightly recognised that housing represented a good financial investment in ways previously under-explored. However, collectively, the market exaggerated the scale of the potential gains available. Whilst finance is inherently quantitative, these bubbles all have important social dimensions – note some of the mass hysteria of the 1920s prior to the Wall Street Crash, the obsession with Internet technology in the 1990s and the recent proliferation of property-based TV programmes and the fascination with house prices in contemporary media.

Now, bubbles occur in all sorts of different markets but it turns out that housing markets are actually a great place to look for bubbles. This is partly because the risks and rewards associated with housing are so great. Furthermore, being based on consumption, rather than investment, market inefficiencies mean that house prices are particularly prone to bubbles and more so than say stock markets. It is not just the UK. Academic studies have also found evidence for house-price bubbles in many different countries throughout the world and at various periods in time.

Global economic history, past UK house prices and the fallible human beings that make up all housing and financial markets all point to one unassailable truth. The next housing bubble will come. The only question is when! Current evidence from inflation-adjusted house prices suggests that there is no bubble. Perhaps the next bubble is about to start – only time will tell! With mortgages recently described as “unusually affordable” perhaps prices will rise and continue to rise for some time? In the absence of a bubble the more pressing issue for policymakers hiding behind the headlines is the declining standard of living brought about by inflation. Equity issues related to the affordability of housing and marked regional differences also remain as important challenges yet to be resolved.


(1) BBC News, Bubble warning as house prices rise again, 31st October 2013,

Dr John Fry is a Lecturer in Finance at Sheffield University Management School.

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