The housing market in the UK is a true polar market. On the one side you have England, with house prices in slow decline as the recession grips the population. On the other is London, a city where the average property price has exceeded even the pre-crash highs (in some cases). The big question to which every Londoner has an opinion is where is the property price going next! Exposing the bias of this article I can tell you that I am a property hawk.
In my opinion there is only one way the market can go, up!
”How have you come to that conclusion? Surely it’s only a matter of time before a second crash occurs and takes the overvalued property market with it.”.
The average London property
In my opinion the property market is not over valued, sure if you take the UK average wage of £22k the average propery is worth around 15x annual salary. However in order to truly assess the affordability of the London property market, we have to compare apples with apples. After all, people working in Coventry do not live in London and so in order to gauge affordability, we have to look at the average wage within London which is in fact £46k per annum, making property prices 7x earnings, or slightly above the long term UK average of 6x.
Furthermore, as my astute property friend points out, the purchasers of property now tend to be couples rather than individuals (increase in the number of career women) and so for a couple, the average house price is in fact only 3.5x earnings…….bargain!
Growing Demand but Limited Supply
With a 10 million increase in population forecast in the UK over the next 10 years (15%), homes will be increasingly demanded as everyone needs a place to live. The problem (at least in London) is that because of the city’s age and stringent planning laws, there is a limited amount of supply. We will never (at least for a few hundred years) see London turning into a concrete jungle like Hong Kong and so people working within London will have to pay up for property or live further out.
Of course projects like crossrail as well as improved infrastructure will reduce commute times and make it more feasible to live further away from London, but the amenities near these homes will never match those offered within London.
The Overseas Invasion
*GBPJPY courtesy of Yahoo finance
*GBPCNY courtesy of Yahoo Finance
In terms of Japanese Yen, London property prices have halved in real terms whereas for the Chinese (Yuan) they have dropped 33% These significant drops make ownership of London property extremely attractive and it is in fact foreigners that are making up a majority of London property purchasers. If we take into account the attractiveness of London properties and the amount of cash rich people in these countries, we can see straight away that property prices have a long way to go
Property as an Investment Rather than a Home
One of the biggest scourges of the Londoner is rental prices which have increased 30% in the past year! . Forget the third rent, third spending, third saving rule – 2009 onwards is home to half rent half spend, save later. As rental prices increase, the attractiveness of a property as an investment increases too. For a safe(ish) yield play, an investor could by govt bonds for between 1% and 1.5% yields, or corporate debt yielding 4%. But with property yields of 4% in prime, 10 – 12% in less desirable areas, and near 20% in council estates the London property scene becomes attractive for yield investors.
With billions of pounds actively purchasing property, the price increases and will continue to do so until the yield drops to a point where alternative investments begin to offer better rewards. In the not too distant future, the London property market may develop into something resembling the German market, where the majority of people don’t even own.
Low Interest Rates
With the UK interest rate curve not showing any increase to rates until the end of next year, 3.5% fixed mortgages and between 2 – 3% (currently) make property purchase a bargain for those who have the money to pay the deposits. Let us assume you put 25% down on a flat at the London average price of £350k. Your mortgage will be £262k and interest only repayments would be 7.5k or £656 per month! You can’t even rent a decent place in London for that amount.
As the world grows and while each central bank keeps the printing presses buzzing, inflation will always be present. The erosion of nominal cash makes saving a nightmare (saving rates of 0.5% vs inflation of 5% = real savings rate of -4.5%) and so many people will look to transfer their money in an asset class instead. For regular people who cannot and don’t want to purchase gold bars in order to avoid the debasement of currency, properties become an attractive store of value.
As announced this week and commented on by yours truly: The governments new buy scheme will allow first time buyers a 95% mortgage for new builds up to a value of £500,000! This offer extends to 100,000 buyers which would equate to an average estimate of £25bn in housing stock (more than all UK housebuilders combined). If you want to see what effect a stimulus like this does, just look at the stock market after the government injected liquidity via QE
Bank of Mum and Dad
Being blunt, if your parents bought a flat or house in the late 90′s to early 2000′s for £300k or more, they are asset millionaires by now. Furthermore, enjoying their prime working lifetimes in one of the largest credit bubbles in the 20th century, they are likely to have some form of savings. As a result more and more people are using their parents for loans, or even going through the Lend a Hand Schemes, where mortgage companies give 95% mortgages if parents hold X amount of savings in the parent banks.
Obviously all the arguments presented above are pro-property and it is always prudent in a piece like this, to look at why people may look to avoid property as an asset, so I will start countering my final point.
I realise it may be naive to assume that everybody parents are asset millionaires. After all, making money is one of the the hardest things in the world to do. Barclays wealth research tells us that in London, there is only 2.12 millionaires per 1000, which is 287,000 but obviously not a huge number considering the population. On thop of this, some parents would be against the idea of giving such help to their children as they believe it doesn’t offer a valuable life lesson. If the children grow up with everything provided, they may not fare well when the parents are gone. Regardless of the reason, there are plenty Londoners whose parents aren’t capable of giving their children a helping hand on the property ladder. With youth unemployment above 20% (less so in London but still high) and rents at all time highs, it is difficult to envisage how youngsters can save enough for a property given the stringent lending criteria on mortgages.
This would be my second worry when looking at the problems with this market. Prior to the crash, mortgages were available for up to 125% of the property value. A house with not one penny down! Fair enough, I am embellishing the ease of credit back then as first time buyers didn’t have access to these ridiculous mortgages but I can safely state that leverage was easy to come by and the application itself was much simpler.
In order to apply for a mortgage the bank needs P60′s, payslips, bills, and surveys, while incomes are evaluated more critically. For example, those who rely on bonuses to make up the majority of their earnings will find themselves unable to get a 5x mortgage using their bonus as the mortgage companys have understood that bonuses may be less in consequent years.
Of course, bonuses these days aren’t even 50% cash. The standard structure of a post 2009 bonus comprises maybe only 25% of the total value in cash, the rest being in shares, deferreds and bonus/malus systems. This means that the power of financiers (a major foundation to the property market) has markedly reduced. Couple this with the fact that there is now less jobs in finance and less ways to make money, you could argue that this foundation is crumbling. Even if foreign buyers have increased, they may not fully replace the loss of domestic buyers that has occurred in this downturn.
On a more important note, what if we haven’t seen the worst of it? This worry is one of the largest arguments against property ownership. We are in the midst of the biggest credit contraction in modern history. How do we even know if we have seen the worst. Should other countries go through a disorderly default or if another big bank has to be bailed out, natural purchasers of propertys may spook and pull their money out of all markets with even limited elements of risk (property) and place it elsewhere.If this was to occur, there is no telling just how far things could fall.
There you have it, the property market summed up in 1500 words. What side are you on?