Will UK House Prices collapse in 2013? Part 1
One thing which has been very resilient in the face of
adversity is the UK housing market. Nationwide reckons that UK prices are down
by more than 12%. This may not be stunning but, when compared to other
countries, it is not too bad a result. As a comparison, the average cost of a
house in Spain is down 31%, in America it is down 34%, in Ireland it is over 50%
off its peaks of a few years ago.
Let’s face a few facts here. The UK has not exactly set the world alight with
its economy. It is basically in a recession, unemployment stubbornly refuses to
drop and the family earners have been hit hard with a combination of higher
taxes, poor wage increases and inflation - a triple whammy.
This begs the question why has the housing market not crashed? The main reason
is money is now cheap. Interest rates are very low, in fact they are as low as
they have ever been. Up until the end of the Conservative government in the
early 1970’s, UK rates remained no lower than 2% and no higher than 10% with an
average of around 5%.
Then in 1973, global inflation forces UK rates up to almost 13% and it kept
going higher until reaching its peak in 1980 at 17%. Inflation was gradually
brought under control and rates slowly came down to around 5% in the mid-1990s.
It stayed at about this figure for well over a decade and then things started to
get interesting as the Global Financial Crisis took effect. The Bank of England
(BoE) took action in early 2008 and cut rates from 5.5% in January 2008 and kept
cutting until they were at 2% by December of the same year. Things did not stop
there, though; three months later rates were down to 0.5% and that is where they
have stayed ever since. To put things into perspective, rates never dropped this
low during two World Wars or the Great Depression. The lowest they went down to
was 2%.
However, the BoE view things differently these days and, according to them, we
are in more economic pooh than we ever were in the first half of the last
century. But at least in those days we were in charge of our own destiny whereas
now we just seem to copy what the Fed does.
If this is so then why haven’t we suffered as much as them when it comes to the
cost of buying or selling a house? Well, the fact of the matter is, there are
more forced sellers in America than there are in the UK. Over the last couple of
years the amount of home repossessions runs to just over thirty thousand per
annum. This is a lot less than levels incurred during the property crash of the
1990s.
In America, things are a lot worse. Almost 100,000 homes are seized every month.
There is a good reason for this number and that is much of the property
financing is done via ‘non-recourse’ loans. This means that if the borrower can
no longer afford to pay the loan then he/she just ups sticks and walks out. The
lender then takes over the property but that is it and cannot make any further
claim against assets or earnings. This cannot happen in the UK.
However, not everything goes the borrower’s way in the US. One of the more
common mortgages is ‘long term fixed rate’. Compare this to the UK where it is
much more usual to take out something which is more akin to short term variable
rates. Thus, any cut in the base rates is of far more benefit to the UK
borrowers than their counterparts in America. Despite this the UK is still in
the metaphorical pooh and all this means is that it has prolonged the inevitable
but necessary correction. The simple fact is that property in the UK is not
exactly cheap.
Let’s look at some recent history. In the ten years that followed from 2001 the
average cost of property rose by 94% whereas earnings only went up by just less
than 30%. To put it in plain English, you do not need to be Einstein to see that
when the former has risen by more than three times the latter then see that
something is not quite right. If you look at the history of property prices then
you will see that, eventually, after any large increase then they ‘revert to the
mean’ and make the necessary adjustments.
It is interesting to note that The Economist reckons the prices of the UK
property market are as much as 28% too high. They are not alone: Fitch - 25%;
Deutsche Bank - 34%; Morgan Stanley - 25%; International Monetary Fund (IMF) -
30%. It must be said that the very low interest rates over the last few years do
distort things and, as such, are keeping property prices well over where they
should be. This can be seen by looking at the average rate of the UK Consumer
Price Index (CPI) over the last couple of decades - this has been at around four
percent. The present rate is just over 2.5%. The implication is that the correct
base rate should be about seven percent per annum. However, the lenders have to
make money too and will add on between 1% and 2% for themselves and this is why
many mortgage rates are approximately a couple of percent over the base rate.
To put things another way, the Standard Variable Rate (SVR) should be about
double of where it is now. This would mean that your mortgage payments would be
double what they are now and nobody would be walking around saying there is a
recovery or “the market is stabilising”. Whilst prices are not volatile at the
moment it must be recognised that there is a massive underlying weakness. The
amount of completed purchases is almost half of what it was five years ago.
Theoretically, this is ridiculous as potential purchasers should be able to take
advantage of lower prices but the lenders have been tightening their purse
strings - they have returned to the pre-sub-prime era of high deposits and lower
income mortgages. (Maybe they have learned something after all?)
Buyers are not the only ones with problems. The drop in the average price means
that many people who bought when near the peak of the housing market cannot now
afford to sell as it would mean they would get into negative equity and so sell
the house for less than they paid for it. This not only affects the sale of the
present property but also, potentially, any new one they want to buy since they
would have to find money for the move and also cover the deposit for the next
property. Not an attractive proposition when you have just had to take a hit on
what you have just sold.
The problems do not stop there. The re-mortgaging of present property has
dropped by more than a quarter in comparison to what it was last year. This may
not sound too important but what it does do is tell us that there is not enough
equity in the property to be able to re-mortgage it.
Even property owners who do not have a mortgage could be affected as prices are
invariably linked to available credit so if the price of property heads south
then so does the value of what you own.
To be continued…
The above data and research was compiled from
sources believed to be reliable. However, neither MBMG International Ltd
nor its officers can accept any liability for any errors or omissions in
the above article nor bear any responsibility for any losses achieved as
a result of any actions taken or not taken as a consequence of reading
the above article. For more information please contact Graham Macdonald
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