The big question for UK property investors
The latest overview of the UK property market appears to reveal some genuine green shoots of recovery. But is this a good or a bad thing for investors?
After all, a market in which prices are tumbling means bargains aplenty, surely? The last thing an investor wants is to miss the bottom of a market.
Of course, if our investment outlook is long term enough, maybe buying at the absolute market bottom is not so vital.
Actually, the situation is more complicated than this simple distinction and requires a rather more sophisticated approach from investors.
So, is there real evidence of green shoots? It's definitely there, and isn't just based on those with vested interests talking up the market; but we need to treat it with some caution.
We are seeing more sales - that's the first piece of evidence. This is undeniable. According to Hometrack sales over the last three months, if annualised, amount to 476,000 sales a year. That is up, but pretty much anything would mark an upward trend because the figure is coming from one of almost nothing. The 476,000 also needs to be put into perspective; a normal market would be represented by between 1 and 1.5 million sales a year! A staggering shortfall.
Okay, but we are moving upwards, even so.
Prices are still falling, but the pace of the falls is slowing. And there are some other key indicators - average time to sell is shortening and the percentage of asking price achieved at the transaction stage is rising. This equates to more realistic seller expectations and this is tempting more buyers with the means to buy.
The question is, is this a seasonal uplift - a blip - or the start of a full-blown recovery?
"With the average vendor accepting 88.8% of the asking price it is still very much a buyers' market and suggests to us that prices will remain under downward pressure for some time to come," believes Richard Donnell, Head of Research, at Hometrack.
We agree and we believe true recovery will not come about until the end of 2009 and into 2010, as we have said for sometime - and only when we see a significant rise in the willingness of banks to lend on better terms than currently - but there will be a limit to how much better those terms will be for a very long time.
"Not all households have been hit by the credit crunch. We have calculated that there are 8m households with either no mortgage or a mortgage worth less than 50% of the value of their home - and that's allowing for a 15% fall in house prices," said Mr Donnell.
"Yet these are households with a low propensity to move. Falling sales volumes means that these buyers now account for a larger overall proportion of sales. Yet a market can not be sustained on one subset of buyers. The true green shoots of recovery will only appear when first time buyers are fully priced back into the market. Even then they will still require access to a higher LTV mortgage at a competitive rate.
"An analysis of the dynamics between renting and buying suggests that house prices have further to fall before first time buyers are able to access the property market. On a pure £ per week comparison, it's still cheaper to rent than buy an average priced 2 bed flat. This said, at the bottom end of the market, renting is now more expensive than buying, but few first-time buyers will be willing to make their first home a small flat, in poor condition in a secondary location - faced with this choice, they'll simply continue to rent until the outlook becomes clearer, especially with rents under downward pressure," he added.
So, in order to achieve parity between the cost of buying and renting how much further does the average price of a two-bed flat need to fall, according to Hometrack? The answer: 12%.
No one can deny that first-time buyers must re-enter the market in larger numbers for a sustained recovery to get underway. Yet, this estimate of a further fall of 12% assumes lending conditions won't change when they already appear to be doing so.
The number of mortgages taken out by people buying a home jumped by 29% in March, says the Council of Mortgage Lenders.
31,000 mortgages were advanced during the month for people buying a property (rather than re-mortgaging) - up from 24,000 in February. This is still 33% lower than March 2008, however.
There was also a jump in first-time buyers, with 12,500 taking out a mortgage during March, or 40% of all loans, which is the highest proportion since April 2005.
The absolute number of first-time buyers is still very low though - 12,500, up from 9,200 in February, but well below the 17,800 recorded in March 2008.
First-time buyers on average borrowed three times their income and 75% of the value of their property in March. Both these average measures were unchanged from February. For those with deposits large enough to buy, the mix of low interest rates and lower house prices mean their monthly payments now equate to just 15.1% of their income, the lowest level since June 2004 (15.1%).
Borrowers, of course, still need large deposits to be able to enter the market - typically 25%, as the CML reports; but here too we are seeing signs of some easing.
Researchers at the Halifax also support the view that affordability is increasing for first-time buyers. Housing affordability for first-time buyers has more than trebled since mid-2007, they say. In the first quarter of 2009, the average price paid by a FTB was affordable for someone on average earnings in 21% of local authorities; compared to just 6% in 2007 Q3. In absolute terms, that's gone up from 19 LAs in 2007 Q3 to 61 in 2009 Q1 out of a total of 297 LAs surveyed.
The house price to earnings ratio - an imperfect but still relevant measure - is lower now than it has been for more than six years. It has fallen from a peak of 5.84 in July 2007 to an estimated 4.34 in March 2009; a fall of 26%. The proportion of disposable earnings devoted to mortgage payments has also tumbled due to the combination of the fall in house prices and the cut in interest rates to record lows - from a peak of 48% in 2007 to 31% in 2009 Q1.
Barratt Developments say they have seen an average of 243 houses reserved each week since the start of the year - equivalent to fewer than one sale per site, but, even so, up 4.4% on the same period last year and a jump of over 20% since the end of 2008.
Rival developer Redrow says it is planning to restart work on some mothballed housing developments after reducing its oversupply. And developers Persimmon also reported a rise in Q1 sales last month. This follows three consecutive monthly rises in the number of homes sold, as reported by the Royal Institution of Chartered Surveyors.
This is all well and good, but if banks don't lend at affordable levels, or demand high deposits, all the affordability indices become pretty meaningless and the recent pick up in market activity will soon fizzle out.
And there is unlikely to be any sudden switch to much freer credit flows -the change is far more likely to happen gradually. But happen it must; banks must lend to survive.
So, there is undeniably now a steady stream of reports saying that buyers are increasing (yes, from a very low level) others report that a lack of stock is a real problem. In other words, those who don't really have to, are not selling.
Clearly, however, if the trend of more sales and a steadying of prices continues, more stock will come onto the market - IF finance availability and affordability improves.
Credit conditions are easing, but the timescale of significant improvements is extremely hard to gauge.
Where does this leave the investor?
We are definitely still in a buyer's market. And yet, this is far more the case in some areas than others and we see this trend being exacerbated over time. In other words we are seeing pockets of quality emerging and these are proving far more resilient in the face of a market downturn than elsewhere.
In the past, when property came out of a downturn it recovered strongly and, without being too sweeping, it was possible to buy pretty much anything as all property would be carried along in the upturn. Not so this time round. This is why we say that the market looks very different.
Perhaps counter-intuitively, it is in the high-quality pockets where property actually costs more where the best investment buys are to be found and NOT in those areas that have experienced massive price falls.
Whether we have reached the bottom of the market is not entirely clear, but probably unlikely. In a sense, it doesn't matter because any investment horizon must now be long term. There will be no big short-term gains in the UK market, we are convinced of this. Instead, we will see a long bottom followed by plodding progress upwards simply because credit will not flow as freely as pre-crash for perhaps as long as a generation.
Having said that, slow and steady, elephant-step progress sounds pretty appealing to us after the near global meltdown of the second half of 2008.
Right now we are doing the equivalent of emerging from the cave of utter despair and blinking again at the light. What we are seeing is not so much a recovery, but something perhaps more reassuring - confirmation that a market exists again at all.
As Neil Lewis PS CEO explains: "We need to make a clear distinction between a falling market and one that evaporates. Last autumn markets evaporated.
"A functioning market requires that there are people in the same room. When there aren't then assets cannot be priced. That's what we had. There were pockets of property that were like this - they just could not be sold at any price. I saw this in Spain - am still seeing it. Many pockets will remain like this."
Any investor has three objectives: to get in to a market, to be able to stay in and to get out. They want to buy well but there has to be apparent potential for capital growth or yield.
In order to transact, there have to be other transactions, there has to be economic resilience and some certainty in order for rents to be paid and contracts to be honoured. Otherwise the whole system starts to break down. This is what we saw in the banking crisis and this ultimately leads to depression, a situation in which contracts are worthless and the only assets that are worthwhile are portable ones.
Lewis added: "But we are out of this phase. We are now in the recession phase and wondering what kind of recession it will be: what colour, and what shape. Now, at last, assets have a price.
"I think UK intrinsic property value has come down more than prices, judging by the restriction of credit. This can be rectified fairly quickly, but we are not going to go back to the free flow of credit we previously had and this will certainly hold back growth in capital value," added Lewis.
"Brutal falls in price actually devalue the intrinsic value of an asset. However good a bank's portfolio of mortgage lending is, if the underlying asset can only be sold for half the money lent on it, that portfolio looks pretty sickly."
A market in freefall then is never the best in which to buy. A calmer market in which prices may well fall further, but one in which at least there are some measurables is far, far preferable to the investor.
What then lies ahead - is it even possible to forecast?
Lewis again: "Well, if you asked me would I buy the Halifax property price index, for example, my answer would be 'definitely not!'
"We are going to live in a moderate lending market; but the crucial thing is that we are going to see - already are seeing - pockets of quality and pockets of awfulness."
It is in these quality pockets where prices have held up and will continue to do so relative to those around them. Quality pockets represent a store of value. Here we will see the plodding, elephant-step growth And that seems pretty attractive after the near death of the market experience of previous months.
The tasks for the investor now then are clear:
1. Identify the pockets of high quality
2. Find a motivated seller within them, i.e. a great deal
Neither of these tasks is simple. The first requires more research and economic modelling than ever. The second is probably even harder - these areas are, after all, by their very nature more resilient to price falls. At the end of the day, this comes down to the good old ability of digging out a deal.
Article provided by Property Secrets