At MoneyWeek, we’re bearish on UK residential property.
Prices may have fallen across the UK in real terms (after inflation), but houses remain expensive in most areas relative to income, based on the long-term average. And we don’t like buying assets when they’re expensive.
However, it’s clear that the government will do all in its power to push prices even higher. You can see why: a house is generally a family’s costliest purchase, and its most visible asset.
So if prices are going up, people think that their situation is improving. Happy families make happy voters – and happy voters vote for the party in power. That’s why a massive mortgage subsidy scheme – Help to Buy – has been thrust upon us. And it seems to be working. Prices and sales are rising.
This reflating housing bubble will cost us all dear in the long run. But between now and the election, you can make some good money. Here’s how…
The housing bubble is back with a vengeance
All the major indicators suggest that prices are moving upwards. In June, prices were up 1.9% on the year before, says Nationwide. London did particularly well, up 5.2%. But prices were up in most areas – rising in ten out of the UK’s 13 regions.
Halifax’s housing index tells a similar story. Prices have been rising for five months in a row, and are now up 4% on last year.
Sales are rising too. The number of mortgages for house purchase is up by a third, to 37,300, according to the British Bankers’ Association. The more comprehensive data from the Bank of England has sales back up to the levels of early 2008.
Sellers are getting offers which are closer to their asking prices. The time taken to sell is falling too, says Hometrack. Surveyors and estate agents are optimistic, and new buyer enquiries are rising all the time.
Time to snap up a buy-to-let? We wouldn’t go that far. The rise in prices has not been matched by an increase in wages. As a result, the ratio of prices to income has risen, making houses even less affordable than they were last year.
Overall, house prices in the UK cost four and a half times the average person’s income. That compares with a historical average of 3.4 times. In London – as you’d expect – things are worse. Historically, the average London house has cost 4.8 times the income of the average first-time buyer. But according to Nationwide, the average London house now costs seven times a first-time buyer’s salary. That’s nearly 50% above the historic average.
Sure, if interest rates stay where they are now, that’s not necessarily a big problem. If you look at the ratio of mortgage payments to income, they account for half of net pay, which is just a little above the long-term average.
Trouble is, interest rates right now are at or near record lows. So mortgage servicing costs are only likely to rise. Ironically enough, it could be an economic recovery that does the damage: a recovery would result in higher rates, pushing mortgage payments up, and making many loans unaffordable.
The government might be happy to risk taxpayer funds to boost the housing market just now, while an election is just around the corner. But the subsidy scheme might not seem as smart an idea after the election is won or lost. And in the longer run, it’ll just mean that the inevitable correction in prices is even more painful.
A better way to play property before the election
Property takes time to buy and sell. And it’s a hassle – and an expense – to manage. A more flexible way to benefit from the current rebound in UK property is to focus on companies involved in construction.
There are two reasons for this. Firstly, government attempts to stimulate the housing sector are focused mainly on new-build properties. The Help to Buy scheme is the most obvious example. At the moment, a 5% deposit on a new property worth up to £600,000 can be topped up with a 20% low-interest loan from the government. The idea is that borrowers go to the bank with a much larger deposit, enabling them to get lower rates.
The flaws in the scheme are pretty clear. It leaves the taxpayer heavily exposed when the market collapses. And it’s a blatant subsidy for house builders. You give desperate and naive first-time buyers a big chunk of money for a deposit, and what do you think happens to new-build prices? They go up of course.
However, the government doesn’t care about that. As long as things look good come May 2015, it will happily ignore any potential collateral damage. And the scheme has had an almost-immediate impact. Formally launched in this year’s budget in April, it has already seen sales of new homes surge. The government now plans to expand it from next year.
Meanwhile – and this is the second reason to invest in builders – the government is loosening planning laws to make it easier to build new houses. Unlike the Help to Buy scheme, this idea enjoys broad political support.
Obviously there are plenty of house builders you can invest in. My colleague Phil Oakley looked at a few likely bets in a recent issue of MoneyWeek magazine. (If you’re not already a subscriber, subscribe to MoneyWeek magazine).
One that’s certainly worth a look is Barratt Developments (LSE: BDEV), a major British housebuilder. It currently trades on a trailing price/earnings ratio of 20 times. Thanks to surging profits, this is expected to fall to 12.3 times earnings by 2015. It trades at only a slight premium to its book value.
You could also look at home improvement stocks, which are likely to be boosted by any new rush to the property market. Builders’ merchants SIG (LSE:SHI) gets half its sales from the UK market. It will also profit from various schemes to encourage householders to improve their energy efficiency. While the weather has hit recent sales, they should bounce back in the next year. SHI is on a p/e ratio of 14 times 2014 earnings.• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
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