Why our experts are still pessimistic about property

Is a property crash now inevitable? Or could interest-rate and Government intervention engineer a soft-landing? MoneyWeek invited six experts to dinner and asked what they thought

Merryn Somerset Webb: At our last property Roundtable in January, everyone was pretty pessimistic. Has anything happened since then to cheer you up?

Nick Booker: I can't see there has been. I'm bearish at the moment. I think the market will get a shock in the autumn when all those buy-to-let investors who committed to buy new-build flats two years ago, when interest rates were at their lowest, have to complete on them. That's in the six months from this summer to early next year. With rates where they are now, 30% of them, at least of the ones I know, are finding it impossible to sort out funding. With rates higher than they were and rental returns lower, no one will lend them the money, so they can't pay for the flats.

Miles Shipside: You say this is the case in cities throughout the UK?

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NB: Particularly in a lot of the northern cities. When returns in London cooled off a few years ago, people went north and expected the high rental returns they saw there initially to be sustainable, but they haven't been. There's now an over-supply of very similar apartments. Developers have been building foinvestors and investment clubs, rather than for people who are buying property to actually live in. That puts us in uncharted territory.

Lorenzo Codogno: You're talking mainly about private investors?

NB: Mostly. The worst hit are going to be people who've bought uncompleted flats via property-promotion companies at seminars and now can't sell them. They're going to be providing lots of miserable case studies to the papers pretty soon. People seem to think that they don't have to worry because the fact that you will be able to buy a property via a self-invested personal pension (Sipp) will keep demand up. But the same dodgy people who have sold these buy-to-let flats to innocents in the last few years are getting on the Sipps bandwagon and over-hyping it. It won't take long for everyone to realise that buying direct property investments through Sipps isn't actually that exciting. If the change in regulations does anything, it will just give the market a small, temporary boost.

MS: I think you're all a bit overexcited about the buy-to-let problem. It's jusa small part of the market.

James Ferguson: The reason it is vitally important is because buy-to-let hasuperseded the first-time buyer, once the main driver of the housing market. In the early 1990s, the average age of the first-time buyer was 23. Last year, the average age was 35, and even then they bought with someone else. Now, if the buy-to-let buyers stop buying indeed, if they start selling what's going to hold the market up then?

MS: What about the shortage of supply in property and the growing population?

JF: I would definitely ignore a shortage of supply in property, that's a complete red herring. If there's a shortage of property, then explain one thing to me: why, until very recently, have rents been falling?

NB: Quite. If there's so much demand for property, people should be renting more and rents should be going up. Everyone needs somewhere to sleep at night, so where are all these people who need houses particularly first-time buyers and immigrants? Where are they? The first thing you do at the bottom of the ladder is rent.

Ed Mead: Everyone feels they should be able to own a house.

JF: Why? What the hell is wrong with renting and not being on the housing ladder? Particularly when it is cheaper to rent than buy as it is now. And all this nonsense about houses being a long-term investment: every time you hear that something is a dead-cert long-term investment, I wonder if you aren't at a cyclical peak, calculating backwards. If you remember, in 1999 equities were touted as being an absolutely guaranteed long-term investment that, on average, always rose. But we were at a short-term high! Look back now and the long-term investment theory doesn't look so good.

Don't touch anything that becomes known as a long-term buy. You only ever make money if you buy on the downs. Buy on the top of the ups, it will take you decades even to get back to flat. And that is most definitely the case if yoare stupid enough to buy a new-build apartment with a view to letting it out today. There was a survey out from Nationwide the other day showing that 46% of those questioned think it is "a good time" to invest in buy-to-let property. Dear oh dear.

EM: I don't deny that there is an oversupply of these new-built properties Nichas been talking about, but I still think we have to separate them from the "I want to buy a home" market. The encouraging thing for us is that we've found that demand is still there. People still want to move and they still want to buy. I'd also point to the fact that, historically, the rest of the market has tended to follow what has happened in London. And in London, we've had a couple of very static years. So that is what I would expect elsewhere, rather than the crash James is always anticipating. That said, I always advocate that you should buy a house as a home rather than as an investment. To buy a property purely for investment, or to use it as a mortgage equity-withdrawal piggy bank, is a mug's game.

MS: And James, whatever you might say about prices in the market, first-time buyers still want to get on the housing ladder and there is a successful market when properties are priced at the right level. It's a surprisingly active market at the right price. The problem is that so many sellers won't accept the levewhere prices should be. They want too much.

NB: Why don't the estate agents talk the market down and get people to asrealistic prices?

EM: It's still a very competitive market. Whatever you might think, there aren't that many sellers out there everyone believes what they read in the press and so they won't put their properties on the market. So if you're a seller, everyone wants your business, so they won't give you a low valuation. They'll give you a high one to get the job. It's a terrible way of doing business. The fact is that there are too many estate agents around and one of the very few good things about a downturn is that it gets rid of all the rubbish: you get load of people going out of business, which is fine by me.

MS: I think that's probably more in London where there's just a shortage oinstructions. In other parts of the country, there's plenty. There are also agents who appear to be seeing sense and encouraging people to put their houses on the market at the right price.

MSW: Why are there more sellers outside London?

MS: London's had a stagnant market for a longer period of time. If you bought two to three years ago and you're not making any money on your property, are you going to put it on the market? Probably not. You've got to fund the move yourself and you haven't built up any more equity.

EM: I think one thing we do have to bear in mind and this is something that really has changed in recent years is the cost of moving. If you buy a £300,000 house these days, you're looking at paying between 6% and 7% to move. You've got estate-agents' fees, stamp duty, moving costs, solicitors. Put that into the equation and it is no wonder that people are saying I'll just stay here'. I wonder if Gordon Brown realises how much money he makes out of people who move buying white goods and all that sort of stuff. If he did, perhaps he would at least cut stamp duty.

MSW: Ed, you're just buying a house I gather?

EM: I am. I'm buying a house on a 25-year lease and this tells you something about how easy it is to borrow money I've got a 90% interest-only mortgage from the Woolwich to do that. It's extraordinary. Still, I won't turn into a bad bet for them. The property is in the middle of London in a good location.

JF: But is anything in any location safe? Look at how much housing transactions have fallen. This always happens when a bubble comes to an end. The only people buying houses are buyers who feel they have no choice, men whose wives are pregnant, buyers who have just come back from abroad they buy, but discretionary buyers won't. They're waiting for better prices and they're going to keep waiting until sellers are forced to drop their prices substantially.

MS: It could be that we should put falling transactions down to a change ibuyers' habits. Buyers are more discerning and they can view the market more completely than before, thanks to the internet. It doesn't mean they aren't going to buy.

JF: Seems like a whole hand full of straw you've got there, Miles.

Fred Harrison: I think that a lot of these points are pretty irrelevant. People tend to analyse the property market in terms of its short-term trends instead of placing the analysis in a historical context. But if you look at that context, you will see that long-term patterns repeat themselves very clearly. So unless some enormous and new variable suddenly comes into play, we can, with some confidence, predict major turning points. As far as I can see, based on trends in the property market and in the land market, by the end of this decade we can predict a repeat of the early 1990s crash and the 1974 crash.

Right now, there's still a lot of steam left in the market. If history repeats itself, the market will recover for a few years then crash as it did in 1989, giving us a downtown with macro-economic consequences of 1992 proportions. The worry is that the next few years will deceive people into thinking that we are seeing a soft landing and that they can buy safely. They can't. I'm afraid this is going to end in tears. I can trace the historical evidence for this back over 300 years. And don't forget, by the way, that housing boom and busts nearly always precede major recessions.

MSW: But what can possibly keep the market going for a few more years?

FH: Public spending. The Government is committed to spending massively through 2007/2008 and that will keep things buoyant. People will start borrowing again, encouraged by this buoyancy. And the banks, of course, are just wanting to pour money into your pocket, even if you're a crook, so anyone can borrow. With so many people convinced of a soft landing, we're now into a period of illusion. The winner's curse. We'll be driven into competing for properties at prices that won't make sense and then it'll shut down as public spending starts to tail off.

JF: Your theory seems to rest on Government spending. But they've already spent so much. Can it keep making a difference? Do you know that private-sector employment actually fell last year? Fell. We should be talking about unemployment already. The only reason we're not is that Gordon Brown just keeps on hiring and hiring.

LC: He can't keep doing it there is a huge public-financing problem looming. We have no choice but to rein back on spending, or to increase taxes and I think that there will probably be a mixture of both but the problem has to be addressed.

FH: Gordon Brown will find a way to keep spending, he's a master at it.

JF: Brown's got this great illusion going about the economic stability he has created but it just isn't true. He's driven pensions to the wall, he's set up a system where we're spending all our money in the good times and we've got nothing left for the bad times. And we're probably going to have a housing-induced credit crunch and consumption downturn. He could turn out to be the worst Chancellor ever.

NB: In 1989, Gordon Brown came out and said to Lawson in the House of Commons, "You're building up a credit boom that's bound to bust." But now he's doing and is continuing to do exactly what he criticised Lawson for doing in the late 1980s. It's amazing.

MS: James, at our last meeting you said it was too late for interest rates to baltered to save us from the crash. Do you still think this is the case? Evethough the Government has plans to assist first-time buyers and the Bank oEngland seems finally to have linked consumer spending with the housing market, and hence is more likely to cut, rather than raise rates?

JF: It is absolutely shocking that anyone, let alone members of the Bank oEngland Monetary Policy Committee, ever argued that the well-established visible and rational relationship between spending and house prices had broken down. They've always moved together. Yes, they popped apart for six months, but that's hardly evidence of a breakdown. Now, as anyone could have predicted, they've popped back together again as pressure on house prices has led to a savage drop in mortgage-equity withdrawal, which in turn has hit consumption. Let's not forget that, at its peak, mortgage-equity withdrawal was responsible for more than 8% of total consumption. It's now fallen by 60% in 12 months. No wonder consumption is falling! Everyone's recognising the bad news now. Remember Marks & Spencer's coming out a few weeks ago and saying that it would be at least nine months until things picked up? That's code for, "We don't see any end to it at all."

LC: I agree with Fred that we need to learn from history, but we also need to note that there are major differences today from 15 years ago. One is that at the beginning of the 1990s the Bank of England had no choice or thought it had no choice but to increase rates to prevent inflation from rising, so we saw a significant tightening in monetary conditions. This time around if the housing market does look like it is in collapse the Bank of England could come to the rescue by cutting rates. Our official interest rate is 4.75%, significantly higher than that in any other major country, so there is significant leeway to cut. This means there is a good chance of a soft landing. And, by the way, the Bank of England has already engineered a slowdown of the market by increasing rates.

It's very difficult from an economic point of view to predict that a bubble will burst. You can certainly say the situation is overstretched, and that at sompoint there will be some correction, but I still think that all the conditions are in place for some kind of soft landing. If you look at the price data, you can see a pretty flat performance over the last six months, which suggests the situation is heading for some kind of stabilisation. I'd say the housing market will perhaps decline 5% a year over two or three years, and because of that the economy overall will probably grow at a pace somewhat below potential for two or three years.

JF: You know, I wouldn't be convinced that rates will fall. When you have a recession, what happens to sterling? It goes through the floor. And when sterling goes down, which is already happening, what happens to imported inflation? It goes up. So you get rising inflation from there and at this point in the economic cycle (when profits are at a peak) workers demand more money. The unions are already complaining about how some of their members haven't got average' pay rises. Well, we can't all have average pay rises. If your minimum pay rise heads for the average, then the average goes through the roof. Pay disputes are coming up; you've got lots of people talking about going on strike already. It's the kind of stuff we haven't heard for a decade. There's going to be more wage inflation too. And under those circumstances, it's going to be hard to cut rates.

FH: I don't see that central banks can stop crashes even if they are independent and can cut rates, or raise them whenever they like. Note that the central bank in the US has been independent for most of the 20th century and that independence hasn't stopped them from having classic property boom/busts. Why should it be different in the UK? The other thing we have to remember is that property boom/busts are now synchronised worldwide. There is a classic housing boom in America, Spain, Ireland, the Netherlands and Australia and the list can go on. And now they are all going to fall at the same time. In the rest of the world, interest rates are very low, so there's little scope for manoeuvre. To me, that says we are going to have the first global economic catastrophe by the end of this decade.

JF: The most important point here is that, historically speaking, housing bustpre-date recessions they hit consumption and they hit confidence. Falling consumption causes unemployment (note that retail employment in the UK has been falling for six months) and this scares people, so they save more and spend less. A classic vicious circle.

The saving rate in the UK is very low indeed our statistics say around 6%, but we measure it differently to other people. If we measured it in the same way, it would be about 0%. So there's scope for savings to rise. We all know we're indebted and our savings are pathetically low. The only question is what will trigger us to save more. In 1989 and 1990, it was when debt repayments hit 22% of disposable incomes. That number today, if you include unsecured debt, is 21%. So if you look at history, that suggests the time isn't far off. Also, I can't agree with you, Lorenzo, that cutting rates will make it OK. Rates fell every year from 1990 to 1996 and the property market fell along with them. Once the crash starts, cutting rates makes no difference.

LC: In that case, maybe. But that bust was caused in the first place by the Bank of England increasing rates which isn't happening now.

JF: But as soon as house prices were falling, they were cutting rates and and I need to reiterate this it didn't work. We don't need rates to rise this time to cause the bust. Not with people this heavily in debt. I spoke to someone at one of our largest retail banks the other day and he told me that the average household banking with them has only £750 in liquid assets. That's less than a month's salary for almost everyone, and means that when the bust comes and unemployment starts to rise, there is nothing to fall back on. That's how recessions happen