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.