Are we heading for a house price crash?

In this month's Roundtable, our experts tell us what they think about the property market

Merryn Somerset Webb: Most of you were here at our last meeting. The consensus was that if interest rates hit 6%, it was game over. Base rates have not hit 6% and may not, but mortgage rates are rising, so they may as well have so is it game over or not?

Ed Mead (Douglas & Gordon Estate Agents): At the moment you've got about 30% to 40% fewer buyers and about 50% more property that's happened in the last two or three weeks. Great, that's relatively normal conditions. Prices will stop going up great! Who the hell wants prices to carry on like they have for the past 18 months? What's the panic? Yes, there have been liquidity problems. But in the short term things look like they might approach something called normal market' conditions.

MSW: So a stable market where prices stay pretty flat for a couple of years?

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EM: Yes, I can't see any reason why we should see anything else.

John Wriglesworth (Wriglesworth Consultancy): I'm more pessimistic this time. The Governor of the Bank of England made this speech in Scotland about three years ago. We'd had a few interest-rate rises and the market was still steaming ahead and suddenly Mervyn King said house prices could fall. The Daily Express put it all over the front page "House price crash imminent, says the Bank of England Governor" and a malaise set in. Prices got sticky because people were reluctant to sell, but transactionally (you must remember it) there was a complete crash and it took about five or six months for it to rise up out of that quagmire.

I think what's happened now is similar but this time, it's a huge great credit crunch that has created runs on the banks. Confidence has been knocked for six. I think it's going to be spring before transactions pick up which will depend on banks lending to each other and money markets restoring. So, in short, it's not a normal market.

Henry Pryor (PrimeMove.com): Northern Rock was responsible for about 20% of all new mortgages in the first six months of this year. Who will fill that gap? People lending that sort of money are borrowing it from other institutions, it's not coming from depositors. Three-month LIBOR [the key rate at which banks lend money to each other] is 6.75% today. It was 5% this time last year. Anyone coming back to standard variable rate is going to be faced with considerably higher borrowing costs than they were six months ago.

JW: Do you think the mainstream lenders who are not so constrained by all this such as Abbey, Halifax, Bradford & Bingley will provide the finance to keep the market going?

HP: No, because they are going to be fussier than they were six months ago.

Stuart Law (Assetz): This is my theory. We have entered a period where underwriters have got control of businesses. We've had Investec decide it doesn't want to fund a ski-chalet operation that somebody we were close to was setting up it was "um, err, no actually, we won't lend on that any more". Across the board, all sorts of different assets are being reassessed. But how many underwriters run banks? Not many. So in about three months' time the directors are going to say, "Hang about, we're not making any money!" They are going to panic and we will see very competitive deals as the banks scrabble to protect shareholder value and their bonuses and profits guaranteed.

HP: You make a good point, but can I just go off at a tangent? I think scarcity of supply is keeping up prices. According to Land Registry, in SW11 in the first six months of this year there were 430 properties sold. For the 46 agents who allegedly fish in SW11, that would mean they were selling nine properties each. I think it's that lack of supply that's keeping up that market and insulated markets such as Cambridge, Oxford and Bristol. In the wider community, in Cheshire and Monmouthshire and Lincolnshire and Leicestershire, where prices have actually fallen in real terms, as soon as you start to get some supply in, people get choice.

SL: Choice is going out the window. There is less property on sale across the country.

MSW: You can't say there isn't an oversupply of city-centre two-bedroom flats all over Britain.

SL: Even the Royal Institution of Chartered Surveyors confirms the top rental growth is going to be in city-centre flats. I'm seeing it. I'm seeing rents for city-centre flats in Manchester going up 10% this year across the board!

James Ferguson (Pali International): These 10% rental rises what's the yield on a Manchester flat?

SL: It's probably about the 5% mark.

JF: Gross or net?

SL: Gross and 3.5% net.

JF: So you've got a 3.5% net yield and that goes up 10%?

SL: So it's getting towards 4% net.

JF: Ooh, getting towards' 4%. Let's say I give you 4% a nice, big rental increase because people are rightly going, "Oh my God, I would rather rent, thank you very much". What's your cost of debt?

SL: It depends on the product, but 5.5%.

So where will prices be in 12 months?

James Ferguson

Economist and stockbroker at Pali International.

Down 35%

Stuart Law

Managing director of property investment advisers Assetz.

Up 5-7%

Ed Mead

Director of Douglas & Gordon Estate Agents.

Up 1-9%

Henry Pryor

CEO of property website PrimeMove.com.

Down 15%

John Wriglesworth

Managing director of Wriglesworth Consultancy.

No movement

JF: Well, I'm here to tell you that 5.5% will not exist in your wildest dreams by the end of the year. Mortgage rates are not tied to base rates they are tied to base rates plus the spread [what banks have to pay to borrow money, over and above the base rate]. At the moment, I can give you a tracker loan that tracks the base rate plus 20 basis points, because if my cost of debt is ten basis points over the base rate, then I get the ten basis point spread. Once my cost of debt is 75 to 100 basis points plus, it's all looking a lot more wobbly. So what you are going to end up with is much less availability of credit, much more expensive credit, much higher qualifying restrictions and your 5.5% tracker, or whatever, is toast.

SL: But there is a fundamental point there. If the Bank of England thought 5.75% to 6% was the right zone for interest rates, then we've got this increase in spreads, it's going to have to move its base rate back. A 5% to 5.25% base rate would compensate for the increased margin and leave mortgage rates at current levels.

JF: So you now reckon we're going to get a 75 basis point cut in the Bank of England base rate

SL: By summer.

JF: Punchy stuff, punchy stuff.

SL: Point five by January.

JF: It's still likely to leave your cost of debt as a mortgage holder unchanged unless you're buy-to-let, in which case it will probably still go up.

SL: Buy-to-let is better risk, though.

JF: No, it's not.

SL: Yes it is. Lower default rate, better credit, better

JF: Do you know what causes every single crisis in credit spreads every cycle? It's the fact that people look back at the most recent default rate and go, "Oh, that's quite low", so we can afford to lower standards and lend more. Then, of course, the tipping point comes and default rates shoot up. Let's get to the nub of this. Your Manchester guy who, if we're being generous, is getting 4% for his flat has probably got a base-rate tracker, interest-only, at 5.75%. But that's about to go, if he's really lucky, to 6.75% and, frankly, more like 7.5%. Because this is the bit you guys may not be so familiar with, but this bank credit issue is a very real problem. Right now, buy-to-let and owner-occupier borrowers are able to borrow at very close to base rates, which is the level at which banks lend to each other. There is no profit in that. Northern Rock grew its business 55% in the first six or seven months of the year, and it's so unprofitable that well, look what happened.

SL: It was profitable, they just couldn't refinance the debt.

JF: My definition of not very profitable!

SL: No, they got caught in a credit crunch not quite the same thing.

JF: No. They were lending long and funded short. Let's not beat about the bush the people who lined up outside the shop were absolutely right. Northern Rock went bankrupt, just like that. Because their margins were wafer-thin, as soon as there was a spike in their funding costs they had to go to the Bank of England and say, "We're done for what are you going to do about it?"

MSW: So what impact is all this going to have on the market?

JF: We have never had a down-cycle with buy-to-let investors. We know they have a completely different financial profile to owner-occupiers because they are interest-only. When interest rates are very low, a funny mathematical thing happens, which means that your repayment mortgage costs something like 40% more to finance per month than your interest-only. This doesn't occur when you are at 15% base rates. So at low interest rates, your buy-to-let investor could out-price, by 40%, any owner-occupier and he did.

HP: And that's why he has the market share he has.

JF: Now the most important element about buy-to-let investors is that they are all governed by the same matrix. If I sell in an owner/occupier-dominated space, you say that's great, because I've just got a new job and I would like to buy, and so there is some cancelling out. But the buy-to-let investor creates additional volatility in the housing cycle by going well above the owner/occupier's affordability. And because they all move together in the same direction, be it up or down, when the turn comes they are all sellers. HP: And they are all in a queue outside the shop

JF: Exactly, like Northern Rock, and the next buyer is the owner/occupier who was left way behind. Do you want to know where the crash will go down to? It will go down to the price where it clears for first-time-buyer owner/occupiers. Do the maths and you come up with some pretty scary numbers. The historical downturn in house prices over the last three down-cycles has, in real terms, been exactly the same amount: 35%. But they were all owner/occupier downturns. This one has taken prices 40% higher again because the funding is 40% cheaper for buy-to-let than for owner/occupiers we will presumably have to add that to the 35%. Now you may think that this is scare tactics, but right now anyone who bought a buy-to-let flat is being criminally advised by their financial adviser, or has not done the maths because no buy-to-let flat you bought today makes any sense.

SL: In what way?

JF: Because it's yielding you 3.5% and your cost of debt is 6.5%.

EM: What's the average mortgage on a buy-to-let property?

SL: Not a lot. £112,000 or £120,000.

EM: Let's say they've suddenly got to fund a 2.5% gap what's that going to cost?

SL: Negligible £2,500 a year.

EM: So they are going to get rid of their entire investment and panic for an extra £2,500 per year?

MSW: That's £4,000 before tax that's a lot of money to most people.

EM: I simply don't believe people would go into those sort of investments and just get out of them.

MSW: For God's sake Ed, people buy to make money! If they're not making it on yield they've got to expect to make it on the capital gain, or they won't buy!

EM: I think people will squeal a lot harder than you think before they let go. I accept it's going to be difficult, but I can't see why they are just going to abandon

HP: How do you think the economy is going to do when the cost of debt goes up? This country is totally driven by debt. Do you know what the net savings are? We are down at almost record lows.

SL: Which is even better for first-time buyers not buying and having to rent.

MSW: One more thing, James what makes the first buy-to-letter sell?

JF: I think the first guys will have to sell to make up the shortfall between their cost of debt funding and their rental income, which means the first to sell will be the most recent ones in. That means the guys who are most at risk are the ones sitting there saying, "I started five years ago and I've made a fortune and I'm going to sit it out because I'm taking the long-term view". This is a massive Ponzi scheme (see page 44) because all buy-to-let investors are governed by the same equation and the first guy out wins anyone who waits is toast.

JW: What percentage do you think buy-to-let demand is in the housing market?

EM: It's about 20%, isn't it?

JW: So there is a lot of emphasis on this.

JF: Most of the market is people swapping properties and the swappers don't matter. What props up a market is the new people arriving at the bottom. The conditions for first-time buyers and now buy-to-let investors are what matters.

MSW: OK, let's move on. I rent and I want all of you to tell us whether you rent or own, how much you expect the property market to have moved up or down by in the next 12 months and if you're a bull where the place is to buy right now.

HP: I live in a rented property. I think the market in 12 months' time will be down 15%.

SL: I own. Prices over the 12 months from today are going to be between 5% and 7% higher.

MSW: And where would you buy now?

SL: In a town that hadn't properly gone through any regeneration as yet.In Preston, for example, where the centre has barely begun to be regenerated.

EM: I'm an owner, but I'm seriously considering becoming a tenant.

HP: More seriously after this conversation?

EM: I would say up to single-digit inflation for house prices over the next 12 months, nationally.

MSW: If you were advising our fictional first-time buyer to buy, where would you suggest he look?

EM: As central as you can get in London for as much as you can afford. It doesn't matter where it is, just be as central as you can and sacrifice size for position.

JF: I'm a renter. I say, for the next 12 months, probably down 3%-5%. The reason I say that is that the last time we had a property crash' it took seven years. These things happen very slowly and the first thing that happens is that sellers cannot admit that prices might be lower than they thought. The Rightmove index of property asking prices is an early indication of when this starts to happen.

HP: That is happening now.

JF: But it takes a long time. Usually, as John was saying, the first year of a crash is actually a crash in transaction volumes.

MSW: John, what do you think?

JW: I am a homeowner and I think prices will do nothing for the next year because of the factors I mentioned before. But I think, on the whole, buy-to-let investors are there for the longer term, so I reckon prices will be sticky, transactions will have a 12-month lull and the market will restore. And in terms of long-term fundamentals, we are an overcrowded island and all the supply initiatives are just snowflakes on icebergs. We've got a growing population; people are dying later in life and leaving home earlier; people are buying second homes; immigration is at record highs. If you take all this into account then, as I said, there is more chance of finding life on Mars or sighting Elvis on the moon than there is of experiencing a housing market crash in the long-term. So it's a case of stay in there and it's a great investment.

MSW: And where does our fictional first-time buyer buy today?

JW: Where I live, in Southfields or Earlsfield. Earlsfield is a good bet. For ten years it really was a complete dump and it was dead cheap. But now it's up and coming in fact, it's the next Clapham.

EM: Luckily, most people couldn't give a damn whether the value of their house is up or down, as long as they can afford to live in it.

MSW: But all markets are moved at the margin, they are not moved by the middle of the market, they are moved by the buyers and sellers around the edge.

EM: I accept that and for the reasons I outlined earlier I don't believe people are suddenly going to start dumping their buy-to-lets.

JF: But soon they will be forced to. I would advise a buy-to-let investor to sell his entire portfolio. And anyone who advises a buy-to-let investor to buy right now, should, I think, be legally sueable because to do so is irresponsible. The thing is, when the maths is no longer there to justify doing the trade yet everyone keeps doing it they are doing it for the momentum. They are doing it because it's worked in the past, and therefore they are assuming it will work again. And the usual trade-off statement is, "I'm not short-term, I'm doing it for the long-term". And that's the easiest way to lose your shirt that was ever invented.