How high-risk are UK house prices?
UK house prices.
Few old chestnuts are more certain to wind everyone up.
Opinions are highly polarised…
Some people say that British residential property values will never drop far because the government and Bank of England won’t let them.
Others are convinced that a crash is just around the corner.
My recent focus in the Daily Reckoning has beenfinancial market risks, in particular how the rebound from the 2008/09 Great Financial Crisis (GFC) has created some very over-extended valuations.
On this score, UK house prices certainly fit the bill. And three topical pieces of property news could be warnings of trouble ahead…
London’s on the slide
House prices in the capital dropped year-on-year for the first time since the GFC eight years ago, according to last month’s Nationwide survey.
The average London house price is now £471,761. That’s down by 0.6% in this year’s third quarter compared with the same period last year.
Indeed, London values have been slipping steadily for a while. Asking prices in the capital fell by an average of £18,000 in just one month, said online property site Rightmove in September. Areas such as Kensington and Chelsea were hit very hard.
Now, “weakness that began with London’s most expensive homes in central London appears to be rippling through to the capital’s outer boroughs”, notes the Guardian.
Of course, a 0.6% dip is peanuts compared with the capital’s house price surge over the last decade. And housing market fans were quick to point out that on a national basis, UK home values still rose 2.2% in September to an average of £210,982. While London sets the trend, property bulls will claim that the overall market is still fine.
Let’s be clear. Buying a house isn’t the same – for most of us, anyway – as investing in shares or bonds. Unless you’re big into buy-to-let, it’s often as much of an emotional call as a monetary one. But there are still parallels with financial markets.
Look at affordability. Right now, we’re talking significant valuation risk. And from this standpoint, residential property could become a very hazardous investment over the next few years.
First-time buyers are the bedrock of the housing market. There’s always a natural stream of sellers for a wide range of reasons. Without new entrants, the property scene would completely freeze up.
Nationwide has also produced a first-time buyer p/e ratio (price versus earnings, i.e. it’s similar to the calculations made on shares) since 1983.
When it started, the average first-time buyer’s purchase was 2.7 times income. By the mid-1990s, the ratio had dropped to two. Fast forward to 10 years ago, just before the GFC, and the p/e climbed to 5.4. Following the financial crisis, it dipped again.
But do you know where it is now?
Correct. Back at 5.4.
Britain’s houses have never been more expensive in first-time buyer terms.
Scary. And it’s not just first-time buyers who are paying top whack for their gaffs.
Earlier this year the Office for National Statistics crunched some 20-year numbers. The findings were startling.
At the end of 2016, UK house prices stood at an average 7.6 times the average annual salary. That was more than double the level of 20 years ago.
The ONS said that the median home price soared by 259% over this double-decade period while median annual earnings increased only by 68%.
Back to Kensington and Chelsea: the ONS survey said that house prices here were an astonishing 38.5 times annual earnings!
Greater fools at work
As with US equities, this feels like the ‘greater fool’ theory. Buyers have acquired properties they know to be stupidly expensive in the hope of selling on to even more gullible purchasers down the line.
Yet some pundits say we shouldn’t worry about shrinking residential property affordability. Tumbling mortgage costs post-the GFC may have fuelled the housing boom, they say, but as interest rates will never again reach their previous levels, valuation isn’t a problem and UK home values are set to keep on climbing.
Don’t believe it. UK pay packets are currently growing more slowly than the cost of living. That’s already putting the squeeze on home buyers’ disposable incomes.
When interest rates dropped post-GFC, no one forecast they would stay down as long as they have. When rates rise – as they will again one day – the increase could be just as dramatic as the fall. In fact rate hikes could soon happen.
Even ‘dovish’ Mark Carney, the Bank of England boss, has just warned that the UK’s central bank could soon raise bank rate, which sets the tone for mortgage costs.
Taking out fixed-rate mortgages will protect many borrowers from higher rates – for now. But fixes don’t last forever. What’s more, the cost of arranging such loans has already started to increase, according to the BBC last week.
“If the Bank of England, as has been intimated, put rates up before Christmas I am in no doubt that the market will take a dive”, says John Phillips, sales operations director for Just Mortgages and Spicerhaart.
RICS rocks the boat
The third piece of the jigsaw is the latest RICS survey, one of the best barometers of future UK housing trends.
And it was bad. The new buyer enquiries balance plunged to -20 in September (its lowest level since July 2016 and below any point between 2009 and 2015) from -4 in August.
The balance of surveyors forecasting rising prices over the next quarter has declined to -8, the lowest reading since the Brexit referendum. And expectations of prices one year ahead dropped to their second-lowest point in more than four years.
This all “points to an extended slowdown in the housing market”, says Capital Economics.
The bottom line is that for property, as with other markets, valuations matter.
When these are low, buyers shrug off rate hikes because they’re acquiring cheap assets. But when valuations get ever-more overstretched, the risk factor rises sharply.
It may not take much bad news to unnerve both mortgage borrowers and cash purchasers. Brexit, politics, poor economic data…all could be the catalyst for a house price fall.
In the meantime, Brexit negotiations will be continuing for many months, and while there’s likely to be plenty of pitfalls to come, here at the Daily Reckoning we’ve identified what could be a major opportunity for our readers to profit in the form of what our researcher calls ‘Brexit Severance Cheques.’
But to find out how to claim your share of a potential £57 billion giveaway, you must act before Wednesday 18th October.