Why house prices will keep falling

Markets around the world are in recovery mode.

Anything considered remotely risky is rocketing Russia for example, is among the top-performing markets. The price of oil has doubled from its December low of $30 or so.

And now it even seems that the UK property market is in rebound mode. On Friday, Nationwide reported that house prices rose 1.2% in May, compared to April.

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So is British housing a buy?

Are the good times back?

News that UK house prices rose (on a monthly basis) during May sent house builders' stocks higher on Friday. The 1.2% jump between April and May saw the annual rate of decline slip to 11.3% from 15%, said Nationwide. Meanwhile, top-end London estate agents have seen the return of gazumping, reported the Financial Times at the weekend.

So does this mean the good times are back? Sadly not.

In the story about gazumping, the FT also points out that the proportion of cash buyers at the top end of the market is unusually high. Knight Frank reports that 45% of sales over £5m in London were made in cash last month, compared to more usual levels of about a third. And Savills reports that the percentage of cash buyers has almost doubled compared to 2006 and 2007.

This points to one problem in the market a shortage of debt financing. You might be able to squabble over top-end properties if you're a wealthy foreign buyer with piles of cash, tempted to pick up a house while sterling is cheap. But if you're Joe Bloggs, with a 10% deposit and a shaky employment outlook, you can forget about it.

Another issue being raised by the bulls is the current lack of supply on the market. But as the FT adds, "stock levels may be falling not because demand is soaking up inventory quickly, but because so few homeowners want to put their property on the market."

The 'reluctant landlord' phenomenon

Whereas rocketing interest rates in the 1990s slump meant that people in trouble didn't have any choice but to default, slashed rates have made life a lot easier for those who would perhaps have struggled to stay in their homes otherwise. It's also led to the rise of the "reluctant landlord" phenomenon. This is where people who want to move elsewhere, simply can't bear to part with their current property at what they regard as a "knock-down" price, so they rent it out instead.

At least some of the people in this situation will be left with two home loans the one on their new property, and the one on their old property, which is being paid by their tenant. That's a pretty precarious existence. What happens if you get a bad tenant? What if you don't get any tenant at all? What if the government introduces tight new regulations on landlords that push up the costs and risks of renting out property?

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This sort of situation can't go on forever. Being a landlord isn't something you can do as a hobby, particularly not if you want to make a profit from it. As it is, I suspect a lot of these "reluctant landlords" are probably subsidising their tenants, with the hope that they'll make it back when the property market recovers.

Anyone in this situation should try to remember that homeowners who bought at the peak of the last boom, in 1989, were still waiting to make back their money more than 10 years later (adjusting for inflation). Take the hit and get out now, rather than putting up with the stress and pressure of trying to run a part-time property business on the side.

Further bad news came in a report last month from David Watts of CreditSights. According to Watts, British "non-conforming" loans those given to people on the basis of little or no documentation, or to those of questionable creditworthiness are going bad even more rapidly than US ones. Nearly 30% of non-conforming British loans made in 2005 are more than 90 days in arrears, compared to 27% of US subprime loans made the same year. "The numbers are ugly, uglier than I expected," Watts told Bloomberg.

Rising defaults are another reason why banks will continue to be reluctant to increase lending, regardless of how much money is pumped into them.

Yet another problem for property owners

Finally, even if this recovery is genuine, there's another problem looming for property owners. Governments and central banks around the world have been pumping money into the economy on a scale never seen before, and the Bank of England is among the worst offenders. In the normal scheme of things, this would be massively inflationary. So assuming that everything's well on the way back to normal now, all this stimulus will need to be pulled out of the economy.

But that's easier said than done. At some point, it will involve raising interest rates perhaps quite sharply to combat rising inflation. Higher interest rates would be very bad news for anyone who has bought property relying on current low borrowing rates to be around for the foreseeable future.

What's the conclusion? House prices will fall for a good while yet this crash isn't going to be any different to the rest. And if you already own a house, and are planning to switch lenders, it probably makes sense to get a fixed rate.

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