23-12-2008

In what ranks as the gloomiest forecast for the UK property market to date, LGIM economist Tim Drayson has predicted that house prices will "fall another 10pc-15pc next year followed by four to five years of stagnation as incomes catch up with house prices".

"It will be at least 10 years before we see prices return to their 2007 peak levels," he said. LGIM, part of the insurance giant Legal & General, has been remarkably accurate with other economic predictions in the past year.

The crash in prices he is forecasting will take the total fall from the August 2007 peak to 30pc. Although his prediction is among the bleaker of economists' outlooks, the market – through property derivatives – is pricing a 50pc fall from peak to trough.

Mr Drayson said the long-delayed recovery would be a result of changes in banks' lending practices. He expects a return to the more conservative practices of the early 1990s, when banks would lend less of a property's value and on lower multiples of a borrower's income.

Three times income used to be considered racy but banks like Northern Rock were in recent years often lending six times income, justifying the loans by arguing that low interest rates made mortgage costs more affordable.

Mr Drayson: "Banks will not price off affordability in future. It has been a mistake of the last several years to price off interest rates, which can move monthly. They are more likely to return to more cautious income multiples."

With rates now at 2pc, and LGIM expecting them to fall to 1pc next year, a relatively small increase could see a homeowner's monthly interest payment double. Banks have tightened up lending standards so only the most creditworthy, with deposits of close to half a property's value, qualify for the cheapest rates.

Mr Drayson's forecast is even gloomier than perennial property market bears Capital Economics, which expects prices to fall 35pc but for the market not to start growing again until 2011. Barclays chief executive John Varley expects prices to fall another 15pc next year while Lloyds TSB chairman Sir Victor Blank is predicting a 10pc decline.

Lenders also continue to withdraw from the mortgage market, research from Credit Suisse shows. The number of mortgage deals available last week was 2,336 – 86pc less than what was available in June 2007. In addition, banks are increasing their relative pricing. Although interest rates are falling, "banks' risk aversion has continued to increase with a widening spread between 75pc loan-to-value mortgages and 95pc LTV", Credit Suisse said.

Mr Drayson said that measures taken by the Government and banks, such as the Homeowner Mortgage Support Scheme and delaying repossession orders until borrowers have missed six monthly payments, will only help people remain in their homes during the downturn and not help prop up house prices. He believes the market will only recover as incomes rise.