Property prices on the move again
Relevant to: investing in uk property; understanding economic trends; Your “ideal” equity portfolio
It has been clear for some years that the UK residential property market has been substantially supported by a huge increase in properties owned by buy-to-let landlords. But now it may be owner occupiers who will increasingly be making the running again, thanks largely to cheap government-driven lending. But does this mark the return to a normal property market, or is this just another bubble which may burst the moment the cheap government money ends, as it surely will?
Recent years have posed a cruel irony for aspiring home owners. Interest rates have been the lowest for a generation, and – according to the Halifax House Price Index – house prices dropped more than 20 per cent from the 2007 peak. The deposit needed to buy a house leaped from zero per cent to up to 30 per cent.
Average house prices are currently the highest they have been for 3 years, since the false dawn of Autumn 2010 when prices recovered briefly, prematurely, from the April 2009 low, before retreating again in just eight months to an average of 20 per cent discount to the 2007 high of £200k, as shown in Figure 1 overleaf.
But in the last 12 months, prices are up five per cent again. What has changed is that the government has been pumping out more cheap money to the banks to lend, both to industry and homeowners, while simultaneously making it easier for some customers to meet the banks’ lending criteria. This leads the IMF and the Institute of Directors to fear that the combination is too close to the US mortgage guarantee schemes that in part triggered the financial collapse of 2008, a view even shared by the coalition Business Secretary, Vince Cable. Even the new Governor of the Bank of England has warned against the dangers of a new bubble, referring ominously to “new powers” the Bank has regained to rein in mortgage lending without necessarily raising interest rates.
There are two schemes in place: Funding for Lending Scheme (FLS) and Help to Buy. Currently only for buyers of newly built properties, Help to Buy (HTB) will be followed next year by a similar scheme for which existing homes will qualify. Neither scheme is expected to last indefinitely – not least because the next general election is less than two years away. But clearly the stimulus to the new build market is a major factor in the current price surge, as witnessed by the share prices of the likes of Bovis, Barratt, Galliford Try, Trafalgar, Taylor Wimpey, and Persimmon – as shown in figure 2. Even so, it seems probable that pent-up demand is outstripping supply, and will continue to do so, especially in major cities, further overheating what is already a simmering pot.
The Royal Institution of Chartered Surveyors, the RICS, expects new house starts to rise by 15 per cent in 2013 from 100,000 last year. But it doesn’t think that it will be nearly enough to meet a growing number looking to take the first steps to purchasing a property of their own. The recent enforced pause in home ownership has effectively created a backlog of aspiring potential buyers who are more able to meet the current mortgage lending criteria and are now ready to set foot on the ladder.
According to the Council of Mortgage Lenders (CML), there are now more first-time buyers than at any time since the spike last March when the stamp duty holiday ended, and also the highest since the end of 2007. And more of them are taking out mortgages with lower deposits, even though the average deposit proportion remains at 20 per cent; the government’s 20 per cent contribution to the 25 per cent requirement for a HTB mortgage may contribute to this.
And an increase in the volume of lower deposit – but more expensive – mortgages suggests that mortgage providers are at last making for innovative use of the government’s other stimulus package, the Funding for Lending Scheme. This is essentially cheap money for lenders to make available to borrowers, and the more they loan the cheaper it is for them.
So there is cheap money for home buyers, plus the Help to Buy scheme whereby the government contributes part of the deposit for first-time buyers (FTBs) – effectively joint ownership. Despite the prolonged squeeze on incomes, some would-be buyers have clearly been able to use their period of forced absence from the market to accumulate at least the 5 per cent deposit required of them.
Another factor is undoubtedly the continuing decline in mortgage rates, and probability that this may yet have some time to run. Five-year deals are now below 3 per cent, spurred by the Funding for Lending Scheme, but also by a confidence that the base rate will remain low for the majority of that time, as implied by the governor of the Bank of England Mark Carney. BoE statistics show that average 5 year fixed rates fell from 5.55 per cent in 2011, to 3.4 per cent in 2013. Real rates across the different mortgage types are down by 1 per cent on average. But while rates have come down, some fees have been increased so as to wipe out much or all of the benefit: some arrangement fees now reach £2,000.
A natural result of the recovery in house prices is that the house price to earnings ratio – one standard benchmark of affordability – has risen for eight months in a row. That means that house prices are moving faster than earnings, making home ownership less affordable now than it has been for the last 3 years. The figure stands around 5.7 in August 2013, well below the 7.3 recorded in 2007. This does not indicate that the rises are necessarily unsustainable, since this measure of affordability does not take into account the other currently favourable factor – declining interest rates.
The RICS reported that opinion amongst surveyors in June 2013 was more confident of an increase in house sales than at any time since 1999, the strongest reading since they started collecting data.
There are fears that the stimulus of Help to Buy and the FLS are going to stimulate the market too fast, and see a return of some of the unsavoury practices that periodically plague house buying, especially in boom times, such as gazumping. Yet on anything other than the shortest of horizons, this must be a time when interest rates can only realistically go up – even if it is not for a while. This could leave FTBs and other house buyers potentially vulnerable to any reversal in prices if the market were to cool suddenly.
Figures from the last census show that home ownership, once the goal of every ambitious youngster, fell amongst 25-34 year-olds to a new low of just 40 per cent in 2011 compared to 58 per cent a decade earlier, and is thought to have dropped even lower over the last 18 months. While reversing this decline may seem admirable, there are real fears that the government’s stimulus to the market may only be storing up problems for later.
The housing think tank Strategic Society Centre has suggested that landlords should not be allowed to buy new builds for let for a period of three years, to balance the market a little more toward the first-time buyer. They claim the lending market is too skewed in their favour in that landlords are likely to have greater capital and income. This may explain why BTL mortgages now account for nearly 13% of all mortgages, against under nine per cent in 2007. Whether that is due to an increase in BTL or the decline of private mortgages is not clear, but anecdotally the former seems more likely.
With a limited supply of new houses, and increasing demand, if that stock is taken up by landlords it can only further the trend for children taking longer to leave home and then to rent rather than buy.
Ironically many BTL landlords are small companies, who are therefore entitled to the loans made available from the FLS to further their business. And for lenders they are an attractive proposition, since lending against the security of a house, with a predictable return in a good market, and an asset that is easily valued and saleable if need be, in turn secures them 10 times the amount they have lent at very attractive rates to loan out again.
Could BTL find it has peaked if FTBs maintain their recent momentum? So long as the government is throwing money at lenders to lend, in many cases the landlord is still the better lending risk; and so long as rents continue to rise, it means that there is less disposable income available for tenants to save up for the deposit, suggesting that the time of the landlord is far from over.
So is there going to be a bubble? The Nationwide, still one of the most respected property institutions, does not think so. They think the price rises are supported by lower income tax, and the modest improvement in earnings and job prospects. Prices are still high compared to incomes, but with interest rates at historic lows, borrowers are not yet overstretched. Prices are rising but not yet running away, and it is the government’s Help to Buy scheme that has made a difference. The RICS suggest demand will remain strong, and that will add upward pressure.
The availability of incentivised loans for landlords will undoubtedly influence how this trend continues by reducing availability from a limited stock of properties. This could underpin a continued increasing house price trend.
Either way a side effect of increasing demand is likely to be the increasing share prices of house builders, materials manufacturers and suppliers.
Does investing cost more than you thought?
Relevant to: Unit trusts and the risk factor; trading and investing in exchange traded funds; today’s stockmarket; investing and the internet
A new pricing formula
WHAT THE AUTUMN STATEMENT MEANS FOR INVESTORS
Relevant to: the bulls, the bears, and you; how to play the gilt market; how to understand economic trends; investing in UK property.
At first sight, not much. Although it contained no less than 59 individual policy announcements, only two of them directly concerned individual investors, and neither comes into effect until next April. The full title of the document is the Autumn Economic Statement, but in fact this was almost entirely a political performance, and it is there that the real significance for investors lies.
The two specific investor-related measures coming into effect in April 2014 are:
• the abolition of stamp duty on shares purchased by Exchange Traded Funds, in an attempt to woo some of them out of Luxembourg and Dublin and back to the City
• tax relief on “social investment” – investment in equities or bonds linked to charities, community-interest and community-benefit companies. It is assumed the incentives will be similar to those for Enterprise Investment Schemes or Venture Capital Trusts, but may not be finalised until the full Budget.
The first may give a small boost to an already booming industry – but one which some believe, being derivative-based, is already marketing products with higher risks than many investors appreciate.
The government hopes the second may unleash up to £100m a year extra for charities and social enterprises, to give some more tangible muscle to David Cameron’s “Big Society” concept.
But the impact of both will be small against the overall implications of the broader economic framework unveiled in the Statement.
This is that the independent Office for Budget Responsibility thinks the UK economy will grow at a faster rate than its post war average for each of the next 5 years. It is this which enables the OBR to predict that the national debt will start falling as a percentage of GDP while the debt itself will, by definition, continue to increase each year until the annual deficit is finally eradicated, now hopefully by 2018; three years later than the Chancellor forecast when he first came to office.
BASIS FOR A BULL MARKET?
Investors’ first reaction will be that this should underpin a sustainable bull market. That may indeed be correct but for two factors:
• the sustainability of a debt-financed recovery; and
• the impact of firstly the end, and secondly the unwinding of Quantitative Easing.
The current economic recovery appears to be financed entirely by running down savings and running up debt. Back in the 1970s Labour Chancellor Dennis Healey famously remarked he viewed this phenomenon in the same way he would seeing his mother-in-law drive his car over a cliff.
In its way it is good news: a sign that consumers are once more confident of the economic future and job prospects. But although personal debt levels are not yet back to where they were before 2007, it is not long before the Governor of the Bank of England is likely to be showing the same concern about the effect on the overall economy as he did with the government’s Help to Buy scheme on house prices.
Many economists argue that current asset levels – stockmarkets, house prices – represent a classic asset bubble, artificially inflated by the impact of the billions of pounds of money which the Bank of England has pumped into the banks through QE, and which it thinks it is going to get back one day. That this will mean higher interest rates is no secret, but the inevitable accompanying collapse in gilt prices is something about which current buyers seem in total denial.
What all that may mean for the stockmarket is less clear. Conventionally as interest rates rise, shares are seen as less attractive, though interest rates have some way to rise before they even equal the current yields on many good quality shares.
But intuitively if QE has created asset bubbles, then in some ways the bull market which ought to accompany a strongly growing economy may already have happened, to the extent the market might have stayed a good deal lower for a good deal longer if the QE programme had not been started in 2009; or at the very least, will severely limit the scope of the next bull market.
And there are some worrying harbingers – primarily from the other side of the Atlantic, which still often provides financial writing on the wall for the rest of the world. The feeding frenzy for Twitter shares in November on a valuation reminiscent of those at the height of the dotcom boom was a symptom of a booming and largely undiscriminating market for Initial Public Offerings, reflected to a degree in the UK by the massive oversubscription for Royal Mail shares. The danger is that investors become indiscriminate, and companies which would normally find it difficult to raise money are able to attract investors, simply because the average investor has nowhere else to go except bank cash deposits which yield virtually nothing.
But more worrying is evidence from America, where the rules on disclosure are ahead of the UK, that more founder investors in IPOs are selling some of their their shares during the normal 180 day “lock-up” period. This is a restrictive period normally applied to prevent new investors being taken for a ride.
According to Dealogic, no less than 26 US-listed companies have raised over US$7bn from share sales within the normal 6 month period during which founder sales are normally prohibited. Permission for such sales has to be granted by the underwriting banks who do so if they believe such sales will not affect the price short term. They also have an incentive to do so in the form of fresh fees from often substantial shareholdings which need to be privately placed.
Figure 1 shows that this level is now higher than at the height of the dotcom boom, with the exception of the very low volume year in 2008.
As with the banks underwriting Royal Mail, companies have an incentive to underprice their IPOs so they can convince the underwriters to let them offload more of their shares early. When insiders are looking to dump their shares and cash out, the rest of us should take note: and sooner than most of us did in 2000.
BACK TO POLITICS
The Autumn Statement was the first real shot of the 2015 election campaign. By including action to reallocate some of the Green costs from energy bills to general taxation, it is clear utility companies are going to remain a political football until the election, and possibly beyond. The same may also apply to rail and bus company shares which are also likely to come under pressure in the continuing “cost of living crisis” debate which Labour has successfully highlighted.
The only comfort is that when in office, political parties of either hue realise very quickly that if they want to mobilise private investment for public enterprises such as fuel generation, investors have to expect some predictable return on their capital, and one which is not subject to periodic political interference.
Care Home Fees and Trusts – When not to trust a trust
Relevant to: Keeping it in the family: inheritance tax and trusts; Life assurance as part of your total plan
When not to trust a trust. For most of us our house represents our main asset, the result of a lifetime of labour and love; and inflation. The prospect of losing the family home for any reason, for instance to pay the inheritance tax bill, has produced many schemes designed to remove the asset from the reach of the taxman, most of them ineffective.
But now there is a new threat. Many of us may need long-term care in our declining years, and care has always been a means tested benefit, but means tested in such a draconian way as to make HMRC’s Inheritance Tax look almost benign.
If you need to go into local authority care, they will assess your entitlement to any financial assistance. Under current rules if you live in England or Northern Ireland and your total assets — including the value of your house — are over £23,250, you do not qualify for the benefit and will have to pay in full for your care. They are not required to pay for all your care until you have less than £14,250. These figures are slightly higher in Wales and Scotland.
Since nowhere in the country can a habitable house be bought for less than this, it is clear the house will have to be sold sooner or later. This has spawned a new industry marketing schemes designed to shelter assets away from the grasp of the local authority.
But just as HMRC have always been able to seize assets “put in the wife’s name” if the purpose of such a transaction has been tax avoidance, so local authorities have the power to take the value of any assets into account which have been transferred elsewhere with the main purpose of avoiding them being assessed for benefit entitlement. It is known as deliberate deprivation.
There are ways of removing your assets from the watchful eyes of the authorities, but they require planning, and in some cases can come back to bite.
In the first instance you must consider one choice: if you are resigned to needing to go into a residential care home, will it be local authority care, or would you want it to be private? If private care is your preferred choice, then paying for it from your existing income may be feasible, supplemented either by selling the home and investing the proceeds for income, or renting the house out. An alternative solution might be to release some equity, enabling you to return to the property later or at least maintaining the potential to keep it in the family.
Those planning in advance for the worst case scenario may purchase a care fees annuity, or “immediate” annuity. These assure a continuing amount will be paid however long care is needed, and can be increased by RPI or fixed amounts as needed. But they require a one off purchase, and there are only a couple of providers in the market. Annuity payments are not subject to tax if paid directly to the care provider.
There is then a hybrid situation where you can qualify for local authority funding for care, but actually reside somewhere that suits you better if you can pay the difference. This “top-up” method only works if family foot the bill, since by definition you will not qualify for local authority funding if you have assets above the limit.
As an alternative to requiring you to sell your house immediately, local authorities can instead take a charge on your house to cover the costs of care, an equity release of sorts. They are paid when the estate is sold, including interest. But there are increasing concerns that cash strapped authorities are paying out more for care and deferring payment to a point that they will become overstretched. The increasingly ageing population could soon be making demands that the local authorities just can’t meet.
But in an age of austerity it is natural to want to maximise what you can keep for a rainy day, quite apart from natural resentment by those who have led a thrifty life with the primary goal of passing something on to the next generation, and are now faced with losing some or possibly all of it, while others who have adopted a less conscientious — or less socially moral — lifestyle and spent everything as they go will have their costs covered by the state.
It doesn’t seem fair. But on the other hand, why should low earning tax-payers be contributing to the care costs of someone who actually has the means to pay for it? They may feel they are paying to maintain someone else’s inheritance. Long-term care on the scale now increasingly the norm, at home or residential, was never part of the NHS plans for which we have paid our national insurance contributions, despite the promise of support from “cradle to grave”.
Both political parties have long recognised the problem and established the Dilnot commission to recommend how to resolve it.
The latest proposals are that
• the threshold at which assets will be considered should be raised to £123,000, and
• the total amount that any individual will have to pay will be capped at £75,000.
But as ever the devil is in the detail. The £123,000 turns out to be an upper limit of a sliding scale. The bottom end is likely to be £17,500, so if you had £100,000 in assets then you would still have to pay some £300 per week. And the £75,000 cap applies only to the care element, and not to the residency component of a care home’s charges.
These changes are not scheduled to come into effect before 2017, and are intended to be covered by not increasing the IHT allowance beyond the £325,000 level where it has been for some years. The government hopes that the life assurance industry will rise to the challenge of writing policies to cover the individual’s cash needs, but until the scheme is up and running, anyone owning a home and contemplating residential care will be worried.
These concerns have presented an opportunity for others. Some eager accountants and lawyers claim that transferring the assets into a trust is a strategy which will work to keep them in the family. Some even market their services as “how to avoid care home costs”.
Accountants and lawyers are duty bound to tell you if their schemes are even crossing the intent of the law, but these neatly presented package solutions fail to point out the potential pitfalls.
The problem was revealed as long ago as 2011 by a BBC investigation into a trust package provider which made it quite clear that if a local authority can deny benefit entitlement if it believes that a trust was set up with the intent of depriving assets from assessment, then marketing it as “how to avoid care home costs” almost by definition defeats the purpose of the exercise. The local authority may be able to challenge its validity based solely on the company through which it was set up by or purchased. They can simply disregard the “fiction” of the trust if they deem that you have deliberately undertaken that approach in order to avoid paying for care.
For example, if your move into care is imminent, and you transfer your assets into a trust, you will be deemed to have deliberately hidden them from the assessment, and the authority will include them regardless. They must conclude that the intention to avoid charges must be a significant part of the reason for establishing the trust.
Power to recover
The National and Social Services Social Security Adjustments Act 1983 states that if deprivation occurred in the last 6 months it can recover sums paid out, but authorities have powers beyond that. If they believe that your financial position has been deliberately created to avoid depriving assets from assessment — for example by giving assets away to children — the insolvency laws allow them to look back even further, even beyond the IHT seven year rule.
On the other hand, if as part of prudent planning for your family the assets are in trust, and have been for some time, then they are most likely safe from assessment. History and intent are important. There is case law that supports both sides of the argument. One consideration is that the strategy or action has no IHT benefit, then it could be considered as deliberate deprivation.
And setting up a trust is not cheap. A simple one might cost less than £1,200, though the ones being aggressively marketed to avoid home care fees charge £3,000 or more.
Trusts tend to be seen by HMRC as tax avoidance, and so can have certain immediate tax implications too. Assets such as houses can be transferred in, but shares, including those in ISAs, have to be either sold and repurchased within the trust, or the balance left as cash to be used for other income generation. And if the sum of the asset being put in trust exceeds the IHT limit, currently £325,000, then an immediate tax liability of 20% becomes due. There will be ongoing charges for accountancy and the services of the trustees, and every ten-years an “anniversary” charge is due, a further tax payment up to a maximum of 6% of the value of the trust over the nil rate band. Your trust is subject to income tax too, at different rates for dividends or other income.
“Settling” assets into trust is also subject to the same rules on gifts, in that they are still subject to a tapering rate of inheritance tax if the donor dies within seven years. And any amounts paid out of the trust will also be subject to tax.
But the inclusion of the family home in any assessment of means is not automatic. If for example, your spouse, partner or relative aged over 60 still lives there, then the value cannot be included. Changing the way the assets are owned from joint tenants to tenants in common will also make it impossible for the local authority to claim that your proportion of the value of the home should be taken into consideration: it is as simple as sending a Deed of Severance to the land registry. In addition the property cannot be sold so long as there is another part owner. The proportions of the home owned by each need not be equal. In this way parts of the home could be left to children in trust, or directly and still keeping under the IHT threshold. Changing ownership from joint to common tenancy requires making a will, since “survivorship” — the automatic transfer of jointly owned assets — does not apply with common tenancies.
But trusts can cause some problems. Remember that if a tenancy in common is transferred to a trust, the surviving partner cannot sell or move without getting the permission of the trustees, who may not judge it in the other’s interest. And any capital gain on the house since it was put into the trust will be taxable at the trust’s capital gains tax rate.
In many situations setting up a trust can make sense, and should not be over complicated or expensive. It should however always be done by an expert with knowledge of your individual circumstances.
There is help available from several reliable websites, Saga, and Which? HMRC has explanations of the tax situation but it is complex even for professionals and depends on many variables.
The concerns over protecting family assets are real. And some people are being tempted to undertake increasingly dubious steps to try to ensure that what has been carefully accumulated over a lifetime does get passed on as planned. But your solicitor and/or accountant will be best placed to advise you, and normally for a fee much less than £3,000. A trust may well be the best thing for your circumstances, but such a significant strategy must warrant the use a professional.
For tax and trusts advice contact Jeff Parr at Chesapeake Associates. Email firstname.lastname@example.org