How much further will house prices fall?
After a dismal year in the property market, Merryn Somerset Webb asks our panel of experts where Britain's house prices will go next.
Merryn Somerset Webb: This time last year, we asked you all where prices would be in a year's time. Almost everyone thought they'd be down at least 5%, except Stuart Law, who isn't here tonight, who thought they'd rise 4%. But they've only fallen 2%. So everybody was wrong.
Henry Pryor: But in real terms they are down 7%.
Merryn: Yes, but none of you thought there would be inflation. I mentioned it, but you all disagreed with me. In any case, we are only down 2% in nominal terms so what went wrong? Why haven't prices fallen as far as we'd thought?
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Henry: The average person is still being encouraged by politicians to become a homeowner. They're not making decisions based on the macro-economic arguments. That's why we were all wrong.
James Ferguson: But it's not rational to expect people to take an economics degree to learn all this stuff. Instead, they look at the prevailing interest rates, and assume the future will look the same. The trouble is, at 0.5%, the current bank rate is five standard deviations away from the 317-year mean. In other words, it's way lower than it ever is normally. If these things have a tendency to revert to the mean, then anyone who assumes that rates will stay at this level is likely to be proved wrong. If anything, the authorities should be warning people that they shouldn't assume base rates will stay this low for the duration of their mortgage.
Jeremy McGivern: I agree. People are now happier borrowing £1.3m at 3% than they were half a million at 8%, yet Armageddon could be around the corner.
Merryn: But until it happens, and we don't know when that will be, house prices won't budge?
Jeremy: Well, they will drift outside of London and they will go up in London.
Ed Mead: In London, if someone has found something they think they can afford, they will still buy. Whether that's the case outside London is another matter.
James F: Maybe they can't afford it outside London. The latest batch of quantitative easing (QE) comes to £75bn. For the sake of easy maths, let's say there are 75,000 dealers and bond traders in the City. They will each get £1m of this QE coming through their hands. Also, £75bn is about 5% of UK GDP, so that's going to have a dilutive effect on sterling over the next 12 months, which will benefit foreign buyers as sterling weakens. So if you're a foreign buyer or you work in the banking system, QE directly channels money into your pocket. Outside of London, that's not the case, so that's where you're getting a fairer reflection of the economic reality.
Ed: Yes, the difference is quite extraordinary. I won't say it's never been better in London, but outside London, estate agents are clinging on for dear life.
James F: So taxpayers and the rest of the country are subsidising London for the first time. But the situation in Europe which looks to be approaching an end game could be interesting.
Ed: If the euro falls to something like €1.50 to the £1, then everything in London will stop in its tracks. But in any case, volumes are still way down. A few agents are doing OK, but no one is doing fantastically well.
Merryn: So why are volumes down so much in London?
Ed: A lack of sellers is the main issue.
Jeremy: Around the £20m mark it's almost impossible to buy a property. People just want to hold on to their assets. Yes, they are worried about the euro, but not just the euro they are worried about fiat money in general.
Merryn: So your clients are buying for currency safe-haven reasons?
Jeremy: A lot of them, yes.
Ed: Your average good property in central London is trading now at about 25% more than at the peak. It doesn't have to be particularly expensive, just a good example of what it is. But if you go immediately outside of central London, to the likes of Battersea or Putney, then properties are still trading at slightly below the peak.
Jeremy: That's the difference between 2007 and now in 2007 you could sell anything.
Merryn: So the market is very different now to during the bubble?
Ed: It's changed so much. Everyone has started talking about average rental prices. People have almost stopped talking about average sale prices.
Merryn: Do you mean rental prices or yields?
Ed: Prices. The cost of renting is so high and the cost of mortgages so low that lots of buyers think: we don't really care what happens in the next few years. As long as we don't hold this for five years, we're better off.' If we see five-year fixes at under 3% and I think we will that'll tempt an awful lot of people who have otherwise been thinking about renting.
James F: But that's an interesting point, which goes back to what we were discussing earlier. Central bankers are trying to make people think that 0.5% base rates are quite normal, and so base their buying decisions on that.
James Wyatt: Yes, people are prisoners of their short-term memory and the central banks are manipulating the market. They are pumping in more credit to stave off a depression. If you look at the fundamentals of property the ratio of house prices to earnings for example then property is still overvalued nationally.
James F: Basically, printing money and having interest rates this low is all that prevented the US and Britain from falling into a hole, as Ireland did. But the central bankers are now in a real pickle. Eventually maybe in three years' time or so they are going to start thinking to themselves, now how the hell are we going to get out of this?
Merryn: Hang on, do you think the banks will be fixed within three years?
James F: I think there are American banks that are already fixed and some that are within 12 to 24 months of being fixed. In Britain, HSBC is probably already fixed to all intents and purposes. Give Barclays and Lloyds another two to three years, and as long as all goes smoothly, they should be well out too.
James W: So on that basis the Bank of England has done quite well. It's been buying time to recapitalise the banks.
James F: Except, of course, that it's not necessarily the Bank of England's job to make that choice between having a recession and taking the pain upfront, or hiding it from people and allowing them to make terrible, inefficient economic decisions because they were assuming that things were normal.
Merryn: Back to house prices. Henry, what's happening at your end of the market?
Henry: Outside the M25 they are having a miserable time. There's a huge gap between the aspirations of sellers and what houses are actually selling for. In Newcastle you find whole rows of classic Coronation Street-style houses for sale. They are starting to get boarded up and dilapidation is creeping in and having a serious impact on those still living there.
James W: In the last couple of months I have taken two phone calls from owners looking to sell their West Country properties through London agents because they can't sell to the local market there is just no money. Yet meanwhile, the average first-time buyer's age is going up by a year every year it's now 37.
James F: It's 43 in London.
James W: The market is still so high that it's taking first-time buyers 15 or 17 years of employment before they can buy.
Henry: Added to that you've got a whole load of people who were first-time buyers five years ago, who are now in negative equity. You may be able to take that hit on the chin and sell, but you've got no money to put down for the next house.
Merryn: So when are sellers actually going to capitulate and start selling at something approximating a market price?
James F: Or why don't the people who are waiting for house prices to revert to the mean all get placards and go storm the Bank of England?
Henry: Because the vast majority of people who put out information have an interest in selling a house or selling a mortgage, and that fuels this perpetual idea that rising, or high, house prices are a good thing.
Ed: Hang on a second Henry. We've had four years of people telling us that house prices are going down and they have.
James F: But Ed, wouldn't you have preferred it if house prices had dropped 25% in one year, then we bang the floor, and from now on it's going to go up?
Merryn: Everybody would.
Henry: But that's not realistic.
James F: No it's not, but it does go to show how destructive this policy is. House prices are one area where quantitative easing (QE) is becoming most distorting and dangerous: it's locking us into this idea that house prices now can't go anywhere for the next decade or longer.
Ed: If nothing changes radically, we've got another five or more years of this dirge. Maybe people will get so fed up that they will stand outside the Bank of England and give Mervyn King a hard time, but I think they'll just put up with it.
Merryn: So thanks to QE and low interest rates, the next five to eight years will see prices stay static in nominal terms, and fall by 4% or 5% a year in real terms, before it's all over?
Ed: That's the most likely scenario. Unless the banks get fixed and they suddenly start lending and people start buying.
Henry: Well, I'd say that what Merryn just said is the most optimistic outcome. But it's not necessarily the most likely.
Jeremy: Yes, what if austerity measures kick in and people start losing their jobs in greater numbers? The banks are going to slash jobs and make 2008 look like a picnic. That will have a huge impact on prices. Even with unbelievably low interest rates, people will struggle to pay their mortgage or their rent, which will then cause a lot of problems for landlords.
James F: Already £60bn-worth of mortgages in Britain have been modified to interest-only. If you got modified to interest-only during a time when base rates fell from 5.5% to 0.5%, that shouldn't come under the heading of modified' that should be considered distressed', or even delinquent'.
Merryn: There are more interest-only mortgages in issue now in Britain than there were in 2007, which, given that no new ones have been issued
Ed: It's extraordinary when you think about it.
Merryn: So what's going to spark a sudden flood of forced sellers?
James F: The most likely catalyst is a serious banking crisis in Europe. We are too close to remain unscathed.
Merryn: How will that affect house prices here?
James F: Well, Europe is facing exactly what happened in America, but it's a good three years behind. What we don't know is whether European politicians will understand that, or whether those 17 countries will be able to pull together and agree to do the right thing. The people who have been supporting the London property market are Europeans. If their banks blow up, then that source of demand could dry up.
Merryn: And outside of London?
James F: For the rest of the country, it's about the policy response to any sort of blow-up. If the eurozone ends up doing QE, that will inflate commodity prices.
Merryn: So we have a big banking failure in Europe, which forces Europe into QE, which pushes up commodity prices, which hits disposable incomes in Britain, which in turn hits UK house prices?
James F: Which in turn hits those British homeowners who have already been pushed onto interest-only. There is nowhere to go after that.
Merryn: But your transmission mechanism doesn't hit UK interest rates, does it? Whereas James [W], you think that a European crisis will affect gilt rates?
James W: Yes. We've got inflation at 5.2% already. Let's say Europe does QE. We will import that inflation. So when is the Bank of England going to raise interest rates? Will foreign buyers really carry on buying gilts if they see us printing money and letting inflation rip roar ahead? And at what point will the actual population turn around and say, inflation is too high?
Ed: But isn't the more immediate problem that if the European banks blow up, British banks are exposed to some greater or lesser degree to the European banks, and therefore will be even less keen to advance mortgages?
James F: Well, as far as we can work out, there is not much continental exposure as a whole in the British banks.
Jeremy: Can I just raise another issue? I think we could be on the verge of a mansion tax. That really would hit central London. I'm not in favour of it, but the Lib Dems have been talking about it for some time, and it was reported that several senior Conservative MPs are supporting it too the Tories want to drop the higher rate of income tax, so it would be a quid pro quo. So you could see a mansion tax of, say, 1% per year on anything above £2m.
Ed: They would lose too many votes.
James W: You say that, but Knight Frank and Savills keep on saying that right now 60% of buyers above the £2m bracket are foreign; they don't vote.
James F: And you could change the voting easily by just saying overseas or non-doms.
James W: I'm not in favour of more taxes either. But a wealth tax is very easy to collect, because the District Valuers' Office has the information on all the properties and their values to hand. For the politicians it's a no-brainer.
Merryn: The problem, of course, is that you then get fiscal drag give it a decade and everyone will be paying it. Now, what about the rental market?
Ed: It is definitely beginning to come off outside London. Supply is increasing.
Merryn: Why and how?
Ed: I think a lot of them can't sell. There are more people becoming landlords who didn't really intend to be in the first place.
James W: Outside of London, rents over the last year have gone up because people can't sell and they can't afford to buy. But a colleague was saying that there is now almost a ceiling to rents outside London.
Jeremy: In London it certainly remains a strong market. Rental yields have jumped up to about 4% or 4.2% gross.
Henry: Which is woeful for property.
James W: It is. Again, it's down to artificially low interest rates. In thereal world we've got inflation at 5.2%. Historically speaking, the Bank of England base rate should be what 2% above that?
James F: I'd say 3.5%.
James W: OK, so we're talking about a base rate of 8% or 8.5%. Your mortgage rate then, in today's market, should be at 9% or 10%.
James F: More like 11% or 12%!
James W: How many people could afford to buy or buy-to-let at those levels? We are living in a false market.
James F: But that's the problem. At some point, when we get out of this environment, policymakers will have to go back to normal'. So in the medium to long run, property has to come down. For now, we're just looking at what it costs you day by day, or year by year, to live in the property. And so rental costs versus mortgage rates will be all important for new buyers.
James W: But there are a lot of other changes going on that you have to beaware of. Owner occupation peaked about five or six years ago it is projected to fall from 69% to 57% by 2020/2025. Then there's density. When I was an agent in the early 1990s, most of the houses I looked at in Chelsea and Kensington had a basement with a self-contained flat, which they used to rent out. So density of occupation is going to change as we go through these straightened times especially if a mansion tax comes in.
Merryn: All right. We are going to be back here in a year's time. So where do you think house prices will be then?
James F: Down 7% in real terms, probably 3% nominal.
Jeremy: Real terms, down 10%, nominal down 4%.
James W: In real terms, falls of about 10% to 12%. And I think inflation will continue to spike, so about 5% to 6% falls in nominal.
Ed: I'm just going to say nominal down 5% more grind.
Henry: Down 7% nominal.
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