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182: UK House Price Crash – Yes or No?

01-27-2008 Team


Back to the old subject – will there be a house price crash or not? Our view is that there will not be a fully fledged crash without a UK recession and/or dramatically increasing unemployment. Last month, employment rose to it’s highest level ever. UK GDP is forecast to drop from about 2.8% to 1.8% in 2008. Yes – a house price correction of some 5-10% is on the cards, possibly a little more over the next 2 years, but a fully fledge crash is difficult to envisage without many people loosing their jobs and distress in making payments on mortgages.


What particularly supports the UK house prices –as we have often re-iterated - is the supply-demand imbalance. The UK population has risen from 55 million in 1970 to 60 million today. The population is forecast to rise to 65 million by 2030. Meanwhile there are only ca. 200,000 homes being built a year, 30,000 are being demolished and the UK needs 300,000 homes because of smaller families, divorce, old age and net migration into the UK. Building land shortages, a slow planning process, the “Nimby effect” and regulation all hinder home building. Meanwhile, because of the house price slowdown, scare stories and banks tightening their lending criteria with the increased risks, builders will build less homes and hence further reduce supply. The current housing crisis will get even more severe in a quiet and little reported sort of way.


The likely effect will be a slowing down of the property market, less people moving, stagnation of property prices and first time buying continuing to be blocked out of the market – partly because of tightening of lending by the banks. Rental demand should increase. Buy-to-let investors will also slow their activity – but because of the supply-demand imbalance and rising employment – even despite the GDP slowdown from 2.8% to 1.8% - we envisage prices dropping by about 5% in 2008 overall in the UK. If conditions worsen, this could then extend drops further into 2009 – but this is difficult to forecast accurately at this stage.


One of the problems will continue to be UK inflation. In the period 2003-2008, wages were kept in check by immigration and low energy prices, plus low import prices of Chinese goods and Indian services. Now oil/gas prices have risen to dangerous levels and some eastern European immigrates may leave because of the declining pound, to work in mainland Europe – paid in Euros. Chinese import prices are rising albeit slowly. Indian outsourcing costs are rising.   CPI inflation will stay stubbornly high despite the slowing economy – and this will limit the interest rate drops the Bank of England will be able to give to simulate the slowing UK economy. Hence we expect inflation to rise close to 3%, interest rates to drop to about 4.75% by year end and GDP growth to decline to 1.5-1.8% by year end. We believe house prices overall in the UK will drop by about 5% - but considering they have doubled in the last 8 years, this is hardly a severe downturn – merely a minor market correction.


Despite all the talk of en-debted Britain, a little known fact is that the UK’s overall mortgage borrowing is £1.4 Trillion whilst the House Value is £4.0 Trillion – that gearing of (only) 35%. Hardly conditions conducive to negative equity! Granted, some people have no mortgage and many people may have 70% gearing, but because first time buyers have been largely absent from the market for the last 4 years, most people who have mortgages – including buy-to-let investors – probably have gearing of 40-80%. So property prices would need to crash at least 20% for any significant number of people to get into negative equity. This is why we believe the banks will continue to lend, albeit their criteria will tighten.


The other positive news is that the credit crunch in the UK is now largely over. The reason why we can say this is because the LIBOR rate has dropped to close to the Bank of England’s lending rate  and hence banks are now freely lending to one another again. It seems the national bank’s injection of lending helped fix the short term problem effectively.


The other interesting thing to note is that the stock market crash of 15% from late 2007 to Monday 20th January at 11 am in the morning (remember, the FT dropped to 5350, far lower than ten years ago!) has again spooked the average small investor. The severity of the correction – a drop of 6% in an hour – is further evidence that stocks are risky. We expect this wake-up call to again make wealthy people consider property as a safer investment than stocks. Many people may have cashed in their stocks to put into property – this happened in March 2000. Remember, if you had put your savings into the FT100 index in 1997, you would have not gained anything in asset price increases in ten years – the FT100 is the same today as it was when Tony Blair came to power. But property prices have more than doubled – they have tripled in London. And there is no way of leveraging with stocks and share with borrowed money against your assets – but with property, you can leverage up to 90+% borrowed money against the asset – so if the asset price rises, it can give the effect of a  ten fold increase in returns. Okay, prices can drop as well, so we need to be very careful, but at least you have a property as an asset – something tangible and if rented – earning money. If a stock crashes and the company goes bust, you end up with nothing but a piece of paper worth zero.


So for all those investors with large property portfolio’s do not get too disheartened. There is no evidence the rental market is going pear shaped, no evidence so far of a crash, and 2008 will not be a good year – but it won’t be Armageddon either.


For the large investor, the best time to buy is as interest rates peak and the market goes cold or has dropped significantly. The interest rates have just peaked and the market has gone cold – we are not sure how much price would drop (if any). But you need to be very careful. Don’t over-extend yourself in risky times.  We do not advise first time buyers to enter the market at this time, unless you have very good finances and can pick up a good bargain in a developing area (e.g, Hackney/Stratford East London, Ebbsfleet/Gravesend).


If you want to be more sure of house prices rising, read all our special reports on oil/gas prices and countries to invest in – the best countries we believe are Norway (all areas) and Canada (Fort McMurray, Edmonton, Calgary). Dubai is another option, albeit risks are higher.


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150: Peak Oil shortly due to be reach – unique insights for a property investor  

148: Take advantage of the oil/gas/coal boom – key insights


If you buy in the UK – do your homework, try and buy close to home, set yourself a target of purchasing at 15-20% below true market value – and thence you will protect yourself against a house price crash.


The outlook is uncertain, but if interest rates drop to something like 4.5% - do not be surprised if property prices start going up again! No-one is predicting this, but every time the Bank of England has dropped rates in the last 15 years, property prices have start moving higher again – will this be the first time they don’t? We’ll have to wait and see.


But be conscious that if oil prices rise to $125/bbl by end 2008 as we predict, then inflation will rise to over 3% which will limit the interest rates dropping. This could then lead to a move severe and longer lasting house price downturn. So oil prices over $100/bbl spell trouble – unless you invest in oil towns – Aberdeen and London being the best examples in the UK.


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