A new report concludes that house prices could fall by around 10-15% over the next few years, but this is unlikely to lead to a repeat of the early 1990s recession, say the authors.

The report also says that speculative ‘frenzy’, currently evident on the part of buy-to-let investors has been a recurrent theme in past housing booms.

The analysis, which is published today in PricewaterhouseCoopers regular UK Economic Outlook report, notes that the housing market has shown surprising strength over the past year, with the result that the ratios of house prices to both disposable incomes and rents have moved further above their long-run average values. These measures now suggest overvaluations relative to historic norms of around 20-40%.

The analysis suggests that a significant part of this divergence from historic norms can be explained by reductions in real interest rates and slower growth in the housing stock since the early 1990s, but a significant degree of unexplained overvaluation remains.

Historic evidence suggests that speculative ‘frenzy’ has been a recurrent theme in past housing market booms and some such effect seems evident at present in the buy-to-let sector of the market, which appears to be increasingly driven by hopes of continued capital appreciation as net rental yields (after deducting finance costs) have fallen to low or even negative levels.

The report notes that is impossible to predict the precise timing and extent of any future housing market correction, but argues that it would be prudent for both potential homebuyers and businesses in the most affected sectors (such as mortgage lending, estate agency and household durables) to consider the potential effects of a future fall in the level of house prices.

John Hawksworth, Head of Macroeconomics at PricewaterhouseCoopers, said:

“House prices do seem overvalued at present, although part of this is explicable by lower real interest rates and supply shortages. Based on our analysis of evidence from previous housing market cycles, prices could decline by around 10-15% in cash terms, or around 20-30% in real terms, when measured from the peak to the trough of the current cycle.”

“A house price decline of this magnitude might reduce consumer spending by around 1.5-2.5% over the next few years, relative to normal trends. But the impact on GDP would be significantly less, so this would be unlikely to lead to the kind of recession seen in the early 1990s.”