Where to now for the British property market?
John Stepek Dec 06, 2012
What next for British property? Will the gap between London and the rest close? John Stepek discusses with our panel of experts what lies in store for Britain's housing market.
John Stepek: A year ago, the general conclusion was that the British housing market would fall a bit. Outside London it has, though not by as much as most of you thought. What’s next? Will the gap between London and the rest start to close?
James Ferguson: Logically speaking, the downside risk in London property is way higher than elsewhere. At the peak, in summer 2007, you’d have said house prices in the regions were most vulnerable. The slump would hit manufacturing hardest, so manufacturing counties would suffer, then maybe areas reliant on government spending.
But now London is being propped up by bizarre factors, like people trying to escape the euro crisis, rather than fundamentals. So I would expect property in London and the South East to underperform prices elsewhere from here.
James Wyatt: I agree. Take Hartlepool – prices fell by more than 35% from the peak in inflation-adjusted terms. And at the Bank of England, Mervyn King has basically said the currency is still too high. So he is likely to print more money, debasing the currency, which should benefit exports and manufacturers.
Jeremy McGivern: But surely London benefits more than most from currency debasement, because of overseas buyers?
James W: Say you are an overseas investor. You pick up the FT and see King saying: “We are going to debase the currency”. Would you buy today? Or would you wait for a year for the currency to be debased?
Our Roundtable panel
Jeremy: But that assumes people are logical, which they patently aren’t. They know there is going to be money printing the whole way through. They just take the opportunity when it fits their particular currency.
Henry Pryor: London’s housing market is detached from the rest of Britain and will remain so – I don’t have queues of international buyers asking me to buy something in Manchester or Norwich. There doesn’t seem to be a ripple-out effect any more – those selling in London are not then going and buying in the shires.
I expect this frozen market to continue – the domestic buyer with an ability and motivation to buy is almost extinct. Away from the gated community of the M25, the nation’s housing market is hanging off its hinges.
Jeremy: For Britain as a whole there is still an awful lot of downside. London is in danger too, but the country’s demographics are shocking. The majority of the housing wealth is owned by our parents’ generation. Unfortunately, they aren’t immortal and once they start dying, our generation does not have the wealth to pay for its houses.
James F: A 10% deposit on the average house today would account for around 60% of the first-time buyer’s annual take-home pay. So it is no wonder the average age of a first-time buyer is 37, and in London it’s 42. The younger generation has been priced out altogether.
The only thing keeping the market afloat is the fact that we have the lowest interest rates in 320 years. As soon as we remove this support – which is an emergency response to the financial crisis – then all the other things will normalise.
Lead indicators for Britain's economy
Stuart Law: But this is why there’s such high demand for residential rental property. We are seeing Far Eastern investors beginning to fly more into Manchester, and we’d expect a general diversion of capital over the next year away from London and into better priced, higher-yielding quality residential markets outside London.
Ed Mead: I have my doubts about quality money moving out of London – our clients are very concerned about protecting the value of their investment. But it’s fairly obvious that fewer people will be able to afford to buy their own property. Mortgages are no easier to get. We will be in this crisis mode for years to come. But what’s wrong with renting?
John: It’s pretty expensive.
Ed: Yes, but it is coming down a bit. A lot of property owners simply don’t know what to do with their money, so if they move, they are keeping their old properties and renting them out. So the stock of available property to rent in London is going up, while the number of people with good jobs is falling. Therefore rents are falling. I don’t think they will fall a lot further, but they are definitely lower. If they get too expensive people simply won’t pay.
Stuart: Landlords are renting at a market rate, and there is lots of room for pushing it up. When that stops, it stops.
John: If I were desperate to buy a house to let out in Britain, where should I look?
Stuart: Remember we’re not pre-credit crunch anymore. Pre-credit crunch, 100% mortgages for people with no jobs meant the whole country rose to a generic level. Now, you’ve got to have good employment in the area. If you haven’t, and it’s not going to come back for years, that property market is stuffed. But most of Britain is fine – Newcastle might be in the top ten. Manchester, Birmingham – all the main cities.
John: What yields are we talking about?
Stuart: Gross, 8%. Net 5% or 6%.
Ed: Would that asset be saleable, Stuart?
Stuart: As our investors would say, why on earth would I want to sell the thing? I’m trying to find somewhere safe to put my money that gets a return.
James F: But it can’t be safe at 8%. It must have fallen for the previous seller, if you can buy it with an 8% yield.
Stuart: Only partially, because the rental growth has been pretty substantial. Manchester has seen a couple of years of near-10% a year. There is zero supply in Manchester centre. Tenants are terrified of losing their flat because they know they won’t get another one easily. Speak to an agent in any half-decent city centre within reason, you’ll get the same message. There are certainly distressed sellers in every single city. But not many.
James F: The whole point of Bank of England policy has been to take distressed sellers out of the market. There was very little unemployment, which is why productivity has gone through the floor. And there is very little burden on mortgages, especially for people who own the mortgage that they took out pre-crisis. So you’ve got an extremely – and unrealistically, in the medium-to-long term – under-stressed property market from the seller’s point of view.
Stuart: Which is why very few of those in the buy-to-let world have been stopped out of their investments.
James F: Absolutely. But what we are really saying here is that we have artificially created a very supportive environment, which – being artificial – is also to some extent temporary.
Stuart: But you have to look at why we have the monetary policy we do now. If we didn’t, the UK housing market would have collapsed, which would have destroyed UK plc. The security behind all the banks would have gone. So it is not an accident that base rates are at 0.5%. They will never admit it, but protecting the residential market was more important than the commercial market. And they’ll continue with that unless they are forced to change – perhaps by some sort of collapse in the bond market – but that’s a sort-of 2% risk.
James F: It’s not 2% – it’s guaranteed. We are only talking about timing. It comes down to when the banks are fixed enough to go out and lend again. That is probably three or four years away. What is not normal is what’s happening today.
In 317 years prior to 2008, the lowest level that bank base rates ever got to was 2%. We are currently at one-quarter of the lowest level in 317 years. That has to normalise at some point. What happens when base rates go back to 5%, the long-run average? Mortgage rates would be, say, 8.5%. What would house prices be then? Given that rates right now are about 4% – so less than half that – then all other things being equal, house prices would halve.
If you look at what has happened in other countries, it’s not unreasonable to think that house prices in Britain need to come down about 30% to be more realistically valued. And even with interest rates at this unprecedented level, house prices are still falling.
James W: In real terms, since the peak in 2008, prices are down 24%-25%, according to Land Registry (see chart).
Stuart: Why is anybody bothered about real terms? Mortgages don’t change. Inflation is fantastic for property owners. Real-term house-price figures are not relevant to most people.
John: If the end game – as we suspect – is that inflation makes a horrible comeback, should you hold property?
Jeremy: A lot of people think they own property. But in fact, they own a tiny bit of property and an awful lot of debt. Around 75% of properties with a mortgage are on variable rates. So if you do get huge inflation, you’ll be in trouble.
James F: Don’t forget, debt is good to have in inflation. Property is not – but debt is good because it can inflate away.
Jeremy: Not if you are on a variable rate – you get carried out.
James F: Not necessarily, as long as wage inflation keeps up with rising mortgage costs. But while house prices do go up nominally during times of inflation, they won’t necessarily keep up with inflation – so they are not necessarily a good hedge against inflation in real terms.
Henry: But if you own a house to live in, its value relative to other investments is irrelevant – you are just going to trade up to another. Most of the 24 million householders in the UK take part of their yield as the privilege of having somewhere to live. Whether the man on the Clapham omnibus understands that they are 25% down in real terms or not is irrelevant.
Ed: That’s a hell of a lot better than dropping 30% all at once. Stuart is right, if that had happened in one go we would all have gone to hell in a handcart. The banks would have called everything in. Are you seriously saying this is bad news?
James F: But if we’re not dealing with this in the short term, we’ll have to deal with it over the medium to long term.
Ed: How many years is that?
James F: The most extreme points are the 1930s in the US and in Japan today. In both we are talking 20 to 25 years.
Ed: I call that long term.
James F: Yeah, but we’ve done about four or five years, and the average is six.
John: Do you think there is a point at which electoral pressure to do something about prices builds from those who feel...
Henry: ...dispossessed? No.
Ed: I rented for 20 years and never once felt like a second-class citizen. It enabled me to invest in my business. Why is there this thing about renting?
John: Could we get to the point where we have a rental market like Germany’s?
Ed: Quite possibly. Why not?
Jeremy: We do need legislation where we can take out long-term rental contracts much more easily, though.
Stuart: I accept that. Short-term contracts are very destabilising. They really upset tenants. I’ve turfed some out to do renovations or just to up the rent, and they get really upset.
Jeremy: For me the issue is still – will people have the earnings to pay the rents landlords are expecting?
Stuart: I keep saying, year after year – sell your retail shares. In the end, this is all going to come home to roost on the high street. Because I will keep putting rents up, and I will find tenants who will pay the rent, and they will stop buying handbags and stop going out for expensive meals. I will have that money. I will decimate the high street. So sell the retail shares.
Jeremy: You’re becoming a slum landlord.
Stuart: No. Fantastic quality property – but stop spending money on discretionary luxury goods and services.
James F: I find it extraordinary that you don’t have the imagination to see what would happen to your scenario when interest rates go up.
Stuart: But my model is different to your model. Forget base rates – they’re irrelevant. What matters is payable rate [mortgage rate]. The Bank of England could not get away with 8% payable rate. The banks need to rebuild their balance sheets – so the goalposts will be moved constantly until they are massively capitalised, so they have to get a big profit margin.
An 8% payable rate off a 5% base rate, say, on current profit margin, isn’t going to happen, because it will hold back GDP growth and tax take and the rest. We will go back to 3% base rate when we are stabilised, to allow the banks to make better profits. That will allow a 5% or 6% payable rate, which is traditional territory, and that’s fine. They are not going to kill the golden goose.
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Ed: You are talking specifically about the investment side. An awful lot of the readers are concerned about their own house prices. James – you said things wouldn’t return to normal until house prices had halved. But [James W] pointed out that in real terms they’ve already fallen by 25%. Can’t we acknowledge the possibility that via aggressive management of interest rates they manage to get this halving in value in real terms without anyone even noticing? It’s like killing someone quietly with arsenic.
John: OK – what’s the end game? Hard or soft landing, and why?
Jeremy: Hard landing. Because anybody under the age of 25 is stuffed. They are coming out of university with pointless degrees, loads of debt, they can’t get on the housing ladder, and they can’t get a job. So I think social unrest is going to be a big issue.
Ed: I think we will see a long, very boring and relatively soft landing. I don’t see much changing over the next three or four years.
James F: We are having a landing – all it comes down to is whether it is fast or slow. It is slow at the moment because the monetary policy response to the crisis is “working”, if that’s what you want it to do. But just because we’ve had a soft landing so far, it doesn’t guarantee we will get a soft landing all the way through.
James W: I think soft, because the Bank of England will do all it can to engineer inflation. In the meantime, the percentage of people renting will go up, and will continue to do so for some time, and that will eat into people’s actual standard of living, because, as Stuart said, landlords are going to want a return.
James F: Stuart is going to keep pushing up rents until people starve.
Stuart: No. But they can buy food at the supermarket and cook their own meals. On the end game we’ve already seen a soft landing. If you look at house prices in nominal terms, we saw the over-shoot on the downside, a very sharp recovery, and after that we saw 18-to-24 months of stability.
We’re not going to see another wobble on the downside in all likelihood. What we will see is a gradual increase over the next five years, as lending improves bit by bit. We’ve seen the worst that can be thrown at the market.
Henry: I think we’ve had the correction already. There are artificial constraints on lending, but while I think that’s shameful and wrong, the fact is that prices will be where they are for the foreseeable future.
John: And what could mess things up for each of your scenarios?
Henry: The biggest risk to my view is that the government decides we should be building homes over another 15,000 acres. But I don’t see that happening.
John: Is there any physical shortage of property?
Ed: There is a shortage of properly developed useable accommodation. But there is an awful lot of rubbish around that is not utilised properly. I don’t think you need to build hundreds of thousands of new properties if you develop the stock that’s there.
Jeremy: For me the risk is that nothing changes. But the scenario I am describing will play out over three or four years.
Ed: For me it’s the euro. If Europe goes down and a lot of countries around the Med go back to their own currencies, then people with three or four properties in London will start selling to reinvest in bargain assets in their own countries.
James F: I think the euro is about to fall a lot. So far it hasn’t, because the euro hasn’t been diluted through quantitative easing (QE), whereas the US dollar and sterling have. But the euro will not hold parity once the US stops doing QE, which I think will happen in the next 12 months, and when the euro starts doing QE, which I also think will happen in the next 12 months.
Henry: So what could go wrong with your prediction, James?
James F: I expect the housing market to mean-revert downwards – fast or slow. The only way prices could go up from here is if interest rates went lower than 0.5%, which is technically just about possible but highly unlikely.
James W: In London, everyone underestimates the power of the government to screw things up. Our clients like London. Why? Because they educate their children here. They all go to Oxford, Cambridge, LSE, Bristol, wherever. That won’t change. But more taxes could hurt and dissuade some people from buying, as could higher rates of stamp duty, or even rent caps.
I don’t think that’ll happen, but don’t forget that Labour could easily get back into power. Nationally, the big risk is that something else goes wrong – maybe further debasement through QE tips the currency over the edge, food price inflation zips up, and interest rates have to rise.
Stuart: My main worry would be a mistake by the Bank of England. Mark Carney was an interesting choice to take over as governor. The fact that we’ve gone international might make him feel able to move away from decisions made by Mervyn King.
John: You think he might turn around and simply say: “Let’s raise interest rates now”?
James F: With Canada, Carney was in charge of a country that didn’t have a banking crisis. So he doesn’t understand what QE has done. Many people think that QE did nothing, because the visible impact was very limited. But look at, say Ireland, Greece or Portugal where they couldn’t do QE – they’ve gone deep into a 1930s-style deflation depression.
So there is the danger, and I find myself agreeing with Stuart, that by having a governor who avoided the crisis, we also end up with a governor who doesn’t understand the crisis. So he may feel that QE is unnecessary and dangerous and he might cancel it. If you do that too early, the broad money supply could shrink, and we might go into deflation.
Stuart: It’s all down to whether he gets this basic principle – which he probably does – that money supply was protected by QE. Otherwise money supply would have just imploded.
James F: You’re 100% right.
Stuart: So to me the biggest risk is that he might make a mistake here then run off back home to Canada.
Ed: Except that while Carney might have avoided the banking crisis, he did allow Canadians to run up the highest personal debt in the world.
John: Not to mention a massive housing bubble. Thanks, everyone.