11 June 2020
Property Market Standoff
Who will win?
by Frank O’Nomics
In the blue corner stands the property market bull, confident that prices will hold up whatever the economic weather. In the red corner, the predatory bear, arguing that a global pandemic can only mean lower prices and they will not hold up. Surely only one of them can win? Not necessarily – it may all be down to motivation and timing.
First, we should mark-to-market. The most recent data from Nationwide showed house prices falling 1.7% in May, their greatest monthly decline in a decade. Nevertheless, on a quarterly basis, prices were still up 1.2% and the data released by Halifax only showed a 0.2% monthly fall. There are 2 problems in looking at this data. The first is that it only includes mortgages actually agreed by the lenders and, more importantly, they cover a period when transactions are only running at 20% of normal levels due to the enforced shutdown. Since the market reopened, some online monitors actually report an increase in asking prices and, while one estate agent said that 79% of buyers had tried to negotiate already agreed prices down, very few achieved more than a very small discount. Larger properties are now being discounted (Savills report 5%) but the talk of 10-15% discounts suggested at the start of the crisis have yet to come to appear.
Has the gloom regarding house prices been overdone? It is too early to say. There is a great deal of pent-up demand that needs to wash through (Zoopla reported demand in May up 34% from March with prices holding up), and the ultimate outturn in job losses, a key determinant of prices, remains very unclear.
How far could prices ultimately fall? Oxford Economics believe that a 3% fall will only occur if the unemployment rate rises from 4% to 6%, while the Centre for Economics and Business Research has adjusted its forecast for 2020 to a fall of 8.7%, from a previous 13%. Some remain much more negative, however. Lloyds Bank have central forecast of a 5% fall this year, but see a risk of a 30% fall over 3 years. The uncertainty is well illustrated by the wide range of outcomes that Halifax foresees: down 5.6-15.7%. The Bank Of England, when setting its stress tests for banks, asks them to model a fall of 33%. This may seem extreme given that in 2007-09 the fall was 19.7%, but the outturn for unemployment could be worse than in the financial crisis.
The wide, and rapidly changing forecast range suggests that, like most aspects of the current crisis, no one has a clue. On the supply side this is understandable, the perennial shortage of available housing stock could be reversed if there is a wave of forced sellers, but if we come through a relatively quick V-shaped recession the housing market may barely miss a beat. However, on the demand side there may be elements that are being missed. Yes, affordability is a factor -we went into the crisis with prices at a high multiple of earnings (just under 8) and if earnings take a big hit the level would be unsustainable – yet the factor that seems to get less of a focus is the value of housing relative to other asset classes. A buy to let investor, after costs, may be facing rental yields barely above 3%, and even this may be hard to maintain, with the Joseph Rowntree Foundation reporting 37% of furloughed private renters as worried about being able to pay their rent after lockdown. Is there a sufficient risk premium (margin over the cost of borrowing) to justify tying up money in such an illiquid asset? Nationwide are offering buy to let loans at a historic low of 1%, but that is only fixed for a year. If rates go up you are going to be relying on some healthy capital growth to justify the trade.
Compared to equities, with the historic dividend yield of the FTSE All Share Index at 4.75%, domestic property returns look unattractive. Despite many firms cutting their dividends, one could argue that equity yields should be lower than those for property given the much easier facility to sell. In addition, the vast amounts of central bank support, via quantitative easing, is proving to be much more supportive of equity values. If we think that property should yield 1% more than equities (as a liquidity premium), even if the forward looking yield on shares is only 3%, either equities need to rally by 33%, property prices fall by the same amount, or some combination of the two. If that sounds excessive, ask those in Ireland, Spain and Greece, whose homes lost (respectively) 55%, 35% and 40% in value between 2007 and 2012.
There will be no shortage of those pointing out some of the undoubted flaws to this reasoning. However, the extent to which either side of the property bull vs. bear argument might be able to claim victory depends on their investment time horizon and motivation for buying. If you are looking to buy a place to live, that is likely to be your primary residence for some years to come, there may be little point in waiting – as long as you can minimize the risks of getting into a 1980’s situation of negative equity, and assuming that the right property is actually available. If you are a first time buyer this rationale may be even stronger as, if you think that you will be trading up to a bigger property in a few years time, in a bear market that property is likely to have fallen by a greater amount than your first purchase in absolute terms. On the other hand, if you are looking to buy for investment, there seems a strong justification in waiting and then playing hardball when negotiating. The short-term pent-up demand resulting from the market closure suggests that prices may take some time to fall. However, once economic reality bites, furloughs end and unemployment rises, housing “bargains” may become apparent.