Each month, we invite the best investors we know for tea and ask them for their opinion on the markets. This month, we focus on housing. Is the crash coming this year?
Merryn Somerset Webb: Henry, you recently said you thought we were seeing the top of the market. Why's that?
Henry Pryor: At PrimeMove, we gather together huge amounts of data from all the property portals. Looking at this and at what came through last year in September, October and November, I see similarities to the things I saw in the last two property recessions. Supply was down 30% in those three months, which clearly pushed up prices. But now you're getting to a stage in places like Cambridge (where prices rose 25% in 2006) where people are looking at what their neighbours have been getting and wondering if they should cash in too. Avarice is kicking in.
Usually the next thing to happen is that lots of property appears on the market and buyers, suddenly feeling they have a choice, hold off. They lose the sense of panic they had and you get a bit of stagnation. Then all those who have to sell divorcees and so on have no choice but to cut their prices to stir up interest and prices fall. I think when we look back, we'll find this year marks the beginning of that process this is the top.
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MSW: So now is the time to sell?
HP: If you want to sell in 2007 it is.
MSW: Ed, would that be your view too?
Ed Stansfield: I would not predict an outright fall in prices. I have some deep-rooted sympathies with the bearish view, but I don't think the rate rise in January is likely to be a trigger of any kind. It was designed to be noticed, to say "you'd better be careful", rather than to increase unaffordability or slow the market. I still think there's a strong probability that rates are going to go up again, and I'm concerned we might be facing a more problematic situation with inflation than most people think. Everybody assumes that when the sharp rise in oil prices from last year drops out of the consumer price index (CPI) it will fall from 3% and everything will be great. But history suggests that people who wait for oil-price rises to drop out of the CPI have a long wait. Inflation at 3% is not a huge problem, but it is above target and it is possible that it will remain at 2.7% or 2.8% for another six months and that base rates will hit 6%.
MSW: What keeps inflation high even if oil prices don't rise again?
ES: Partly expectations. Inflation has been above target for some time and the broader measures the RPI and RPIX indices are at ten or 11-year highs. That has an effect on people's expectations and hence their pay demands. There is some evidence it's a bit patchy, but it is there that the size of pay settlements began to creep up in January. Firms and households have also been under pressure from rising energy costs, utility bills, council tax and so on. That has made the Bank of England concerned about something else that as energy prices come down, people will start loosening their budgets and spending more than before on other things.
It's just a very gradual process, but may mean that companies find it a fraction easier to put through price rises. All the surveys are suggesting that companies have got stronger pricing intentions than we have seen for many years. And that may be the biggest risk to houses that we have a strong economy and that rates carry on rising further than people expect.
Our panel
Stuart Law - Managing director of property investment advisers Assetz
Ed Mead - Director of Douglas & Gordon Estate Agents
Henry Pryor - CEO of property website PrimeMove.com
Ed Stansfield - Commercial property and housing market research manager at Capital Economics
John Wriglesworth - Managing director of Wriglesworth Consultancy
MSW: And that will hit affordability?
ES: And sentiment certainly at the margins at the lower end of the market. But this isn't my core view. That's the consensus there will be a slowdown in 2007, and 2008 will be very boring.
Stuart Law: I don't believe there is any evidence to suggest inflation will stay high. The one risk is wage inflation, but that's what the January rate rise was all about. It was 110% designed to scare business into constraining wage increases. I can't see where another 0.25% on interest rates would come from. The vote on January's rise was only five to four I think there was a hell of an argument going on in the Bank of England's Monetary Policy Committee. The rise almost didn't happen. And as long as we can keep wage rises under 4%, I think we're OK. Remember that an American slowdown will if anything feed more deflationary effects into the UK because Chinese and Indian exporters won't be able to raise prices as global demand slows. I can't see any shocks coming.
MSW: And at what interest-rate level would you see trouble?
SL: I'd say 6%-7%. At 6% we would see a slowdown. At 7% we'd see the market retracing noticeably.
MSW: Repossessions have been rising very fast is that not an indication of trouble to come?
SL: I'm not convinced. Look at affordability in terms of interest costs versus income. It isn't the slightest bit stretched. Rates would have to go to 7% or 8% for affordability to be as bad as it has been at previous market peaks. Affordability isn't about house prices to income, it's about interest costs to income.
John Wriglesworth: I'm reasonably sympathetic with that argument. Back in 1990, rates were 15%, but lenders were giving people 3.5 times their income. It's taken them a bit of time to work out that now rates are 5% they can afford to lend more, especially now we have longer-term fixed-rate deals, which insulate people from rising rates. Three years ago, four times income was considered a bit shocking not now. Two years ago, five times income would have been headline news not now. I'm telling you: six times income will not be shocking next year. That's going to create more demand it doesn't take a genius to see that if you can borrow five or six times income instead of three times, you can pay more for a house.
I agree with Stuart that if interest rates go up to 6% or 7%, or unemployment doubles, or something like that, everything would change. But I don't see any pressure in the next couple of years at all. The fall in the cycle of house prices is always later than people predict always has been and always will be. I'm pretty convinced it's not going to happen yet because of that demand-push.
MSW: But it will happen?
JW: Eventually. I'm not saying house prices will never fall that would be stupid but not now. If interest rates go to 8%, yes. Otherwise, not now.
MSW: But are house prices really going up even now? Isn't it just London price rises dragging up the average?
Ed Mead: I think prices have been stagnating in the rest of the country for some time now. But don't forget London prices had been flat for a while before the recent boom and from 2003 to the beginning of last year, they probably even fell. So you have to look at last year's rises in that context average it out over five years and it doesn't look that huge. There are so many different factors driving the market now at the top end, the domestic economy and rates are irrelevant and elsewhere stamp duty is cutting liquidity. It costs so much to move now that a lot of people would rather just build an extension. A year ago in central London, £1,000 a square foot was considered to be expensive. It's now £4,000.
MSW: Stamp duty means it is almost impossible for a lot of Londoners to move house, doesn't it? If you bought a house eight years ago for, say, £250,000, when you were earning £50,000, you might think the fact that it is now worth £850,000 is pretty good news. Until you want to move. Then you find you will have to spend £950,000 to get another bedroom and come up with £40,000 for the stamp duty. Where's that money going to come from?
EM: It's going to cost you £80,000 to move once you've paid fees, solicitors and stamp duty.
MSW: And you don't have that amount of cash because you're still on an ordinary income. So you're stuck.
EM: Yes. What this means is that we're seeing a seismic shift in transactional volumes that is changing the market. The chancellor thought he was getting his hands on free money by raising stamp duty as he has. But not only has he created this structural difficulty for the market in the process, he also forgot that every time people move, they buy carpets, curtains and so on. When stamp duty is so high that they can't move, he misses out on the duty, but also the VAT on all that.
JW: I wonder how important transaction levels really are. There is first-time-buyer demand, of course, but in general, if you are not selling a house you aren't buying a house, so things are in balance to a degree. So how many transactions there are in the market isn't such an issue in determining prices as interest rates are. In 2004, transactions fell about 35%, but prices didn't fall. They held up.
SL: I think they'll keep doing so. In central London we see prices up 100% in real terms from last January, within five years or just over.
EM: At the top end, that's possible. By top end, I mean houses that cost £2m upwards the level where people are so rich they don't care about price. Below that a house is a more normal, domestically driven purchase, where London is subject to the same vagaries as the rest of the country. It's driven by sentiment and interest rates, not by
the global economy. I think prices for houses worth less than £2m are going to flatten this year. There isn't much demand and an awful lot of people are thinking about selling I'm doing a lot of valuations.
HP: At the moment, we see three buyers to every seller.
EM: There's an institutional bias to all those numbers, however. An awful lot of houses being sold never appear on databases they get sold too quickly for that, so there's a load of supply not in the numbers. And buyers register with loads of agents, so you've got double counting going on there.
MSW: Let's talk about buy-to-let. Interest rates are rising and yields are very low. How long will would-be landlords keep buying if they find they have a negative cash flow every month?
SL: I don't think you can look at it like that. I'd guesstimate' that during the first three years of a buy-to-let investment today you'd lose money, but on the long-term view, you'd make it. Most buy-to-letters take a ten-year view. And you lose a tiny amount of money versus the projected return in, say, ten or 15 years.
MSW: Projected being the key word here.
SL: It's also not that different to a pension. You put money in every month, and for the first few years it all goes in charges.
MSW: But pensions shouldn't be like that. And it is different. If you stop paying your mortgage, you will lose your buy-to-let investment, but with a pension you can say I can't afford it this month, so I'm not going to contribute. You don't leverage your pension either, and your pension can't bankrupt you. Buy-to-let comes with more risk. And if people are making a negative yield, it seems rational to think that there will at some point be an even faster rise in repossessions or, at the very least, a flood of sales of two-bedroom flats everywhere.
SL: It's all down to affordability. Generally speaking, I think the negative cash flow is affordable with most buy-to-leters. If they bought everything six months ago, then they might be in for a shock. But if they have bought over the last five, six, or seven years, a lot of their property is going to be seeing positive cash flow.
JW: About 50% of landlords are planning to buy another property, so they can't be doing that badly. I can see that you might have a negative cash flow with a 100% mortgage, but if you've got a wee bit of equity, you shouldn't have and you'll have capital appreciation to rely on. Most investor-landlords know that we're an overcrowded island with not enough houses for our growing population and too many planning regulations. It does not take a genius to see that housing is in short supply over the long term.
EM: Maybe. But for now I don't see prices outside the top end of London moving much. People aren't stupid when it comes to property they don't all believe what they read and sentiment is everything. A lot of people think the market is at its peak at the moment. And the fact that interest rates are rising is enough to make people have a good look at their costs and decide to step back.
SL: But the foreign money is still going to come in. There's no cap on that. And in London that is going to squeeze people out of prime areas into secondary areas.
ES: One thing I wonder if transaction levels are so low, why are the mortgage approval numbers running at record levels?
HP: Because people are getting mortgages approved but not spending them. There are also a lot of deals taking place off-market where an agent isn't involved at all. Also, if an offer gets made and falls through, it counts as an approval but not a transaction.
MSW: How much do you all expect house prices to have risen by the end of 2007?
HP: Down 2%.
SL: Plus 8%.
ES: Up 3% or 4%.
JW: I say 7% I really can't go higher than that.
EM: I think 4% and for central London, I'd go for 10%. More at the top end, less lower down.
MSW: Any final words?
JW: Yes. There is more chance of
Jade Goody becoming Commissioner for Racial Equality than there is of a housing crash this year.
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