Wednesday, 28 January 2015

UK House Prices To Drop 50%?

I nearly bought a house last week, but according to Paul Hodges, Chairman of IeC, and an expert in the economic impact of demographics, in an interview in Moneyweek, it would have been a big mistake.  Hodges believes that property in the UK is vastly over priced, and should fall by 50%. He believes the price falls have already begun, including in London.

I agree with him that property prices are vastly inflated, and should fall, and are falling.  According to Rightmove, even asking prices for houses fell by 3.3%, on the month, before Christmas, the biggest monthly fall on record.  In fact, as I've written previously, I think that prices are likely to fall more like 80% eventually, because the 50% figure is only what is required on average to restore prices to the long-term average relation between prices and average earnings, and prices never simply drop to the average level.  They overshoot to the downside as much as they have overshot to the upside.  A look at what is happening with oil prices demonstrates that.

Its one of the reasons, in the end I did not buy the house I was looking at.  It illustrates the dilemma posed by deflation.  Having kept a close watch on what property prices are doing locally I am acutely aware that whatever all the media hype might claim, the selling prices of houses here have fallen by around 30%, since 2010.  I know that from the fact of detailed studies of sold properties in the area, and of specific knowledge of some of the properties sold.  For example, my own house, that I sold for £150,000, at the start of 2010, can now be bought for £110,000; the house next door but one to where I live now was sold at the start of 2010 for £500,000, and the more or less identical semi-detached house connected to it, sold at the end of 2013 for £340,000.

The house I was considering buying was a 20 year old, large, detached four-bedroom property with en suite, and all the other modern facilities.  It had been up for sale for £195,000 a few months ago, and had now been reduced to £165,000.  The dilemma was to simply take into consideration the fact that the price had already dropped by 15%, and on the basis of current market prices seemed to offer reasonable value, or to take into consideration the fact that if prices do drop by even just 50%, to get back to fair value, that would mean losing £80,000, in short order.  This is the situation that arises where prices get into a continuous falling sequence, because buyers never want to buy, even at lower prices, on the basis that next week, prices will be even lower still.

In fact, as I've been having another round of looking at potential houses to buy, I've noticed that eventually there do seem to be a significant number of large new housing developments occurring around the area.  Again, rather like the situation where high oil prices eventually led to an increase in oil supplies that then caused a glut, which has caused oil prices to drop 60%, this noticeable increase in building could be a sign that property prices, like oil prices, are about to crash.  Already, I've noticed that builders are cutting their prices by around 20%, something which is usually a last resort, after they have tried other methods to shift stock, such as part-exchanges, and other offers.

But, the experience highlighted another fact.  The house I had been looking at to buy, even at that price, had previously been privately rented.  It shows the extent that the property market has been distorted by the government's "Help To Buy" scam, alongside the effect of low interest rates in promoting the development of "Buy To Let" landlords.

In more normal times, money is lent to businesses that intend to use it to actually produce things. They use the money-capital to buy factories, machines and employ workers to make things that people want.  The business makes a profit from the activity, and out of the profit pays interest to the money lender.  But, increasingly money is not lent for that purpose.  Increasingly, the money made as profits from production, or even just the money that swirls around in circulation, is used not to buy capital but simply for speculation.

I was watching an episode of the series "The Super Rich and Us", recently, which featured one of these "Buy To Let" merchants who had progressed on to organising seminars to encourage hundreds of other people to borrow money to become buy to let landlords.  It was an indication of just how much money is going into such speculation.  It creates not one bit of additional wealth, but what it does is to keep inflated already massively inflated property prices, but in so doing only creates a condition whereby the bursting of that bubble, when it does arise, will be even bigger than it would otherwise have been.

What is being seen is a similar thing to what has happened in the bond market.  Normally, Buy to Let landlords would have concentrated on buying cheaper properties, which they could more easily rent out to obtain a steady income, particularly if they obtained the rent or Housing Benefit directly from the local council rather than the tenant.  This is rather like bond investors, who would tend to buy the safer bonds issued by countries like the US, UK and Germany, which pay lower interest rates, but on which you can be pretty sure you will get your money back.

But, "Help To Buy" has meant that people who really could not afford to buy a house, have been subsidised to do so, as happened with the similar sub-prime mortgages in the US, that led to the 2008 financial crash.  That together with the demand for these cheaper houses from Buy To Let landlords, has both reduced the availability of such houses in the market, and to push up their prices relative to higher priced properties, causing a compression of prices in that sector of the market.  It means the potential rental return for Buy To Let landlords is thereby reduced, because although the rent is not increased, and may well be falling as a result of the effect of the reduction in Housing Benefit, the price they have to pay for the house has risen, so the yield on their investment drops.

That is the same as the fall in yields that bond investors have seen on safe haven bonds, which has then resulted in a search for yield, which causes investors to have to then invest in ever more risky bonds.  It is what has led to the increasing share of junk bonds to finance energy production in the US, which are now at risk of default, as oil prices drop, and energy firms are in danger of going bust. But, in the UK housing market, it means that Buy To Let landlords are encouraged to have to move out to more expensive properties, such as the one I was looking at, and for which they have to then obtain higher rents to justify their investment.  As with junk bonds, it is a highly illiquid market, which means that when the owners of the bonds or the property come to sell, there are no ready buyers, especially when, in the case of property, it is large numbers of houses they seek to sell in one go.

As Warren Buffett advises in relation to investment - "If you don't see anything that is a bargain that is worth buying, you don't have to buy."  On that basis, I'm happy to keep renting for a while longer, because there are an increasing number of houses coming up for sale, and each week they seem to keep getting cheaper!

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