How a Market Works
By definition a market cannot recover until it shakes out the last seller who has been holding off waiting for a price recovery. Until this happens at each recovery the pent up “demand” of sellers appears and offloads stifling any recovery. Currently in the Property Market that picture is crystal clear – a very small number of buyers are taking whatever comes to market, which is very little. There is no structural demand so ultimately prices must trend downwards.
The recovery will start when there is a buyer in the market who can’t find what they want to buy, and has to put their price up and force someone who wasn’t going to sell to make an offer. I wasn’t expecting that until Easter, but am beginning to wonder whether I was being too optimistic. Because the market has been talked up and supported over the summer it hasn’t been able to exercise its natural decline, so that dip is waiting to happen. Probably the end of the Stamp Duty holiday in January will be the trigger for the next fall, hopefully just another 10% and over by Easter so that the market can return to normal conditions.
Technical Analysis and the Head and Shoulders
UK Property Prices
Anyone who has used technical analysis to trade equities will know that volumes are as important as price. The current recovery means nothing because it is not accompanied by a significant volume. TA would suggest that the current increase in prices is the second Shoulder in a classic Head and Shoulders formation – made famous by the 1929 Stockmarket Crash.
Head and Shoulders
Whilst I agree with that analysis, even I wouldn’t sign up for the classic TA prediction that we are on the edge of a 70% drop in house prices.
TA is widely used on Options, Commodities, Equities and Gilts (every financial investment there is except property), but there is an argument that with other investments the buyer and the seller have little they can do with the investment other than buy, sell or hold, and when they hold they get little value. The argument runs that with a house, the pricing for the market is dominated by the 70% who are owner occupants, and most of these owners are buying and selling for personal reasons, they are unsophisticated as property investors, buy/sell for status reasons ’Oh, honey I really like the place. We have to buy it.’.
The market of Equities, which saw the birth of TA, is every much as imperfect as the housing market. Only 1% of Equities are actively traded. Most Equities are held under the mattress, or sold through intermediary instruments – Investment Trusts, Unit Trusts, Pension Funds, Employee incentive schemes. The equivalent of ‘Oh, honey I really like the place. We have to buy it.’ comes from the major industry of newsletters and tips which is tell readers that they have to buy on the basis of a myriad of reasons such as “Penny Shares”, High Tech, Venture Stocks right through to – yes TA! A market is a market to TA, whatever the rational behind the trades.
In a way all of that is irrelevant – remember that it is impossible to make money trading a perfect market. You can only make a profit if the market is wrong in some way, whether you are a fan of Benjamin Graham or Charles Dow your profit comes from recognising the Extraordinary Popular Delusions and the Madness of Crowds first described in 1841.
I think that it’s an entirely reasonable to take a position that TA doesn’t work, I’m quite tempted to myself as I have proved to my own satisfaction that I am not sufficiently talented in TA to stake money on my analysis. However I also know that there are hundreds, if not thousands of analysts who earn their daily crust by its application. What I find most interesting, and the fundamental reason for this commentary, is that most people don’t believe that house prices can fall far, they believe that property has some intrinsic value which, like a sky hook, will hold prices at within 10% of their current values. So I would ask you these 4 questions:
The 4 Questions
1. Do you think it possible that rents will return to the level that they have been at for the other 90 years of this century?
It is only in the last 10 years that residential property yields came anywhere close to mortgage rates. The business model of making a yield from Property is a fairly recent, and maybe transient phenomenon. Historically a property investment was about Capital appreciation and an inflation hedge. The reason BTL portfolios swept all before them was that the idea that you might be able to cover a 90% mortgage payment from the rent was a novel idea, probably never seen before, and as such a number of investors made a spectacular fortune from exploiting that new idea.
2. Do you think it possible that Banks may adopt a more conservative approach to lending?
Is the Pope Catholic? We are experiencing it. Historically lenders required a salary cover for a loan of 2.5 times salary, but in the last decade this has crept upward until we stand at 5 times salary. A return to the norm could nearly halve house prices.
3. What do you think holders of highly geared BTL portfolios will do when property prices fall, and interest rates rise?
Some such as the Wilsons are already restructuring in order to be able to withstand such events. Under the circumstances described those who haven’t anticipated the possibility will be forced into fire sales into a falling market.
4. Is the 1988 Housing Act perfect?
The law on renting changes quite regularly 1968, 1977, 1980, 1988, 1994, 2004 …… the biggies being 1977 & 1988. Is it time for another big change? The government has been considering removing the Landlords’ right to possession – basically a return to all the pre-1988 laws. Shelter has been lobbying for this change, and historically what Shelter asks for Shelter gets. Prior to the 1988 act and BTL phenomenon tenanted houses were valued at 50% of those with vacant possession.
The Million Dollar Question
Now TA never claims or tries to understand the fundamentals behind market moves, in fact most practitioners believe that considering fundamentals impairs the TA. TA predicts what the market is doing, and where the market is going. The reason for asking those 4 questions is to illustrate that a dramatic crash in property prices is fundamentally a possibility. Too many people have an almost religious belief that the price of property cannot fall. Answering those 4 questions will explain what is possible – but of course the million dollar question is whether the BTL phenomenon of the last decade really is a structural change in the economics of this country, or just a 10 year aberration? I guess we will found out fairly soon!
This article was inspired by a discussion on the highly regarded Property Social Media Site Property Tribes
Particular thanks go to UK Property Expert Lyndon Forshaw & International Real Estate Expert John Corey for their thoughts and questions which have been incorporated into this article.
Interesting take on the market.
Question 2 the answer has to be yes although I suspect there will be a middle ground to be found. I do not believe banks will have any desire to be as risk averse as some way wish. Shareholder and market pressure will push banks again in the longer term. Government too will not want to strangle the market as then, we will end up in more difficulties. That said lending must be more controlled – 125% mortgages should never again appear and self cert. mortgages should be gone forever. I don’t think the multiplier was the main problem.
Question 4 – Surely Shelter must lose out this time? We had/have a thriving housing and rental market, which turned other niche suppliers into mainstream companies (tenant referencing, insurances etc.) I work for one of these companies and while I sometimes curse at how tenant friendly some of our laws are, from a neutral’s perspective we seem to have a good balance where fairness prevails and UK companies in this market grow and prosper.
As a country our economy is intrinsically linked to the housing market. If a collapse in prices was to occur our banks and entire economy would no doubt swiftly follow. Ergo they will not be allowed to fall to the degrees you suggest are possible. If they do, well I guess we’ll all have bigger concerns.
[...] you read my “4 Questions to answer before the 2010 Property Crash” and moved on, then I suggest that you look at this picture, and then if you have stomach for [...]
Question 1:
Your point tat no point takes into account the growing population of the UK and the limited space. OF COURSE rents will return to previous levels and WILL go beyond.
The movement of people & trade accross borders is higher now than at anytime in human kind’s history. The internet works further to even remove the limits of geography…all we can say is looking into the past is no longer going to provide us with resonable comparisons. We are living in unparalleled times.
Why not make a new set of stats?
Question 2:
I think your point is over simplified and somewhat misdirected, only a small minority of people were using 5x mulitplier. Returning to the previous “norm”(ambiguous distinction at least!) should also factor ‘property value increases during that time’ and albeit small wage increases in the interim before assessing new values.
This point should also look at some of the creative purchasing methods currently providing some updraft in the market(lease options for one).
Question 3.
See last point above. Selling a property with negative equity doesn’t necessarily mean you loose money. Agreed, those willing to take on the risk of managing a property over time and take on existing lending commitments may eventually profit but there is opportunity for both parties to benefit.
Question 4 is stupid.
NOTHING is perfect.
http://www.macro250.com
Nick,
I am not sure we can have a useful debate in this format. Let’s give it a go.
1. Return to the level of 90 years? Rents do not live in a vacuum. In other words, the interest rate, inflation rate, the access to capital and the legal framework matter a great deal. BTL was triggered by a legal change. The interest rates during the growth years were at a 40+ year low and the UK government gave up interest rate control.
2. We have computers now. Using a fixed ratio between gross income and the price of a property is a very bad way to evaluate the risk. The ratio is largely blind to interest rates. A credit history matters in terms of the borrower risk assessment. It is so much easier now to look at factors that were not even measured back 20 or more years.
3. Spot on in terms of this question. How investors handle the present to prepare for a higher interest rate environment is very important. Granted investors only make up 10% of the UK housing market. When a survey was done at the 10 year anniversary of the BTL sector, the average LTV was 60%. Obviously the LTVs are likely higher now. Some investors will get slammed. Some might do very well as they hover up bargains. Hard to say with little data as to who owes what.
4. Shelter might be the boggy man or a red herring. The 50% discount that you noted is mostly because lenders could not count on the eviction laws if they took back a property. Setting tenants stop a sale to the largest segment of the market at that time, the owner occupied buy. The private rental sector was almost non-existent.
John Corey
Hi John,
Thank you for taking the trouble to try and have the debate here, as it’s always nice to have choices, I have set up an alternative here http://www.pimlico-flats.co.uk/forum/viewtopic.php?f=3&t=1435
Also – if you do sign in, I would be interested to know how you set up such a nifty Gravatar, Rich asked me earlier, which is how I know what you have done, I just need to learn how to do it.
1) Is to question whether the last decades circumstances are unusual.
2) Sounds suspiciously like the way Banks used computers to securitise Mortgages and make Sub-Prime Lending “safe”. GIGO. However you dress it up, what we earn pays the mortgage.