8 December 2016
The property bubble has a slow puncture
Low supply may not negate a buyer’s market.
by Frank O’Nomics
The bull market in residential property has now been running for almost 8 years, which, if we take the average age of a first time buyer in the UK as being around 30, means that most people under the age of 38 have not experienced a falling market. Indeed, conversations around just how difficult it is to get on the housing ladder would suggest that the general view is that prices only go up. This view has been entirely reasonable through a period of stable employment, exceptionally low interest rates, strong demand and limited supply. However, there are signs that a number of these supportive factors are either turning or will have less influence, and that the scope for a further extension of the bull run is limited. In particular, the availability and price of credit, which has been so key to perpetuating house price rises, look as if they are about to turn for the worse. There are a small but growing number of commentators who believe that the house price bubble will in fact burst, and the chances of this are not statistically insignificant. However, given a solid economic outlook, the more likely outcome would seem to be an extended period of mildly declining prices, particularly when looked at in real terms (excluding inflation).
It is worth taking a look at the current situation. Recent data from the Nationwide (the UK’s second largest mortgage lender) showed prices still rising at an apparently healthy rate of 4.4% year-on-year. However, this rate is the lowest since January, and the monthly rise of just 0.1% suggests that progress is halting. If turnover is a driver of prices then the data for transactions gives a good pointer to why price growth is slowing. In general, the rise in prices has been driven by two factors, house price inflation at the top end of the market, and a ripple effect out of London. The problem is that expensive properties, particularly those in London, are not trading. Since the start of the year, of the 60,000 £1 million+ properties for sale in the UK, only 6,000 have sold, and in London, of the 14,000 £1 million+ properties for sale at the start of October, only 313 sold. Overall, property transactions between July 2015 and July 2016 were down 43%.
There are a number of reasons why price growth has been slowing, much of the slowdiown being down to government policy, which itself was partly driven by the desire to undermine both the bubble and the dangerous growth in credit. The increase in stamp duty on higher value properties put paid to activity in richer areas of London (transactions in Kensington and Chelsea are down by 50%, with prices having fallen some 15%), while the combination of an additional 3% stamp duty on buy-to-let properties and the impending wind-down of the tax incentives for buy-to-let mortgages, is starting to have a real impact on activity further down the chain. In addition to this it seems as if the Bank of Mum and Dad might be either be finding its resources seriously depleted, or might be becoming more cautious. A buying agent cites an example of a couple looking to downsize to free up cash to get their two children started on the property ladder. Their house was valued at £3.3 million by several agents but, when they tried to sell, the best they could get was £2.5 million – effectively negating their ability to buy at least one of their children’s flats. 40% of property transactions are sales for cash – if this cash becomes much more cautious then demand will fall very quickly. That there is scope for caution is not to be doubted with uncertain growth forecasts (please see last week’s article: The Futility of Forecasts) given the unknowns surrounding Brexit.
At this point many of you property bugs will dismiss the gloomy outlook as being short term. The shortfall in properties in the UK is a long-term phenomenon that will not go away quickly given the current level of building programmes. However, it is here that we come back to the point about the price and availability of credit. Recent events in the US suggest that, the 32 year-long trend in falling bond yields may be coming to an end. A rise in the inflation outlook occasioned by a strong labour market, the expected policies of a Trump government, and last week’s OPEC agreement on oil production, have meant that 30 year bond yields have risen back above 3%, from less than 2.5% a month ago. The UK is not the US, but a lot of the drivers will be the same, and the inflation outlook has been similarly pushed up, as have gilt yields. US interest rates are expected to rise three times over the next 12 months and, while the MPC seems committed to a lower for longer approach for base rates, a rise in longer-term yields is likely to have an impact on mortgage rates. With higher costs of funding, property investment becomes less attractive and, with UK household debt having risen to 133% of household income, from 90% 20 years ago, there is not only very little scope to take on more (1/4 of all new mortgages are of at least four times salary). If interest rates revert to their historic norms, there could be forced sales. Rising bond yields will make investing in safe assets such as gilts, which can be sold in seconds, much more attractive than buy-to-let property, unless rents rise (which seems unlikely), or capital growth can be reasonably expected. Property needs to yield much more than bonds and equities to compensate for the high transaction costs and the danger of being a trapped holder.
The prospect of a higher cost of capital may well be coincident with a fall in availability. Already borrowers are being forced into longer mortgage terms, typically 30 years+ rather than the traditional 25 years, and lenders are insisting on significant deposits from those that want to lock into the more attractive fixed rate deals. Recent Bank of England stress tests will leave all UK banks looking to manage their risky loan portfolios very carefully, and it seems that mortgage availability is only going to get tougher.
I have stopped short of suggesting that property prices are about to implode, and that does seem unlikely given that there is a wall of cash waiting to be invested. However, it is a very cautious wall, with investors and borrowers needing reassurance that they are not going to suffer capital losses or onerous debt servicing costs. With such a backdrop it seems right to be very cautious about buying a property, although there should be considerable scope to negotiate attractive deals if you can find an eager seller.
If you enjoyed this article please share it using the buttons above.
Please click here if you would like a weekly email on publication of the ShawSheet
