Tuesday, 8 January 2008

Happy days will soon return

For a long time, estate agent windows were incomprehensible to me. Prices simply did not make any sense. How could a grotty terraced house in North London be worth £500,000? Were city high flyers really spending their bonuses on houses that just one short generation ago were occupied by bus drivers and dinner ladies?

More recently, I believe I have developed a better understanding of the estate agent's window. With the virtual disappearance of first time buyers, the UK property market has become a closed community of speculators, trading with each other.

It works something like this: speculator A lists their overvalued slum at the estate agents. Speculator B buys it with a loan from the high street bank, and the estate agent takes his commission. The solicitor gets his cut arranging the transaction, and the Treasury gets the stamp duty.

A short time later, speculator B lists the same property at a higher price and passes it along to Speculator C. So long as the high street bank is prepared to lend out progressively larger mortgages, the cycle continues, with prices accelerating at every stage.

In Britain today, housing ownership is churning around in a stagnant pool of speculators. Each time a property changes hands, the new owner takes on a larger mortgage than the previous owner. At an aggregate level, the level of housing related debt has exploded. Nevertheless, everyone seems comfortable because property values have remained buoyant.

Occasionally, housing speculators turn to people like me and try to explain this debt accumulation cycle. Rather than talk about shoddy lending practices, they explain that there is a terrible housing shortage that pushing prices ever higher. In fact, there is so much pent up demand for housing that prices can only ever go one way.

There were occasions when these housing speculators gave me some advice - "go on girl, get out there and get on the property ladder". Here, I must admit to the occasional moments of weakness that led to some unpleasant trips into the estate agents office. I even looked at some potential properties. However, it was follow-up visits down to the high street bank that put me off home-ownership. As I looked at the 25 year repayment schedule, I just couldn't see the annual holiday, or the regular night out. All I could see was a lifetime of financial sacrifice.

These conversations with the home owning elite, the estate agents and the high street mortgage brokers gave the rise in house prices a dubious plausibility. After all, how can anyone argue against the iron laws of restricted supply and pent-up demand?

For a long time, I have to confess to being taken in by this line of thinking. However, one day I noticed that my rent had remained remarkably stable, despite the surge in house prices. If rents are not going up, then where is the housing shortage?

With the housing shortage justification blown away by my stagnant rent, I started to look to credit growth for the answer. Sure enough, the data told a very simple story; UK credit growth was smooching around the housing market like a teenage boy with his first girlfriend.

It soon became obvious that this bubble depended on excessive credit growth and debt accumulation. The housing shortage was merely a abili for irresponsible banking. Furthermore, it was also obvious that house prices would continue to rise so long as banks extend ever larger loans. It would stop as soon as the credit tap was turned off.

After ten years, it appears that the UK housing market has finally reached this point. UK banks have severely restricted mortgage growth. Credit growth has jilted the housing market. The separation will be painful.

Today, speculator A can no longer sell her overvalued property to speculator B. The estate agent will not receive their commission, and the solicitor will not arrange the sale. As for the Treasury, it will not be receiving its stamp duty.

Speculator A, however, will be carrying a very large debt that the high street bank will expect to be serviced. Initially, speculator A will avoid facing up to the harsh truth that their property can not sell at a price sufficient to pay off the mortgage. She will be left with just two choices; either keep paying the mortgage or default. Both will be painful, but the High Street bank would definitely prefer the former rather than latter option. Some speculators will pay, but way too many will end up defaulting.

As for the future, house prices will fall; the bus drivers and dinner ladies will eventually recover those shabby North London terraces. The city highfliers will again buy houses out in Amersham. As for me, I will be able to pass by one of the few remaining estate agents offices without feeling either confused or angry. Yes, better days will soon be upon us. Normal people will again be able to think about buying a home.


Anonymous said...

Good article. Very clearly explained. Thanks.

Anonymous said...

A beautifully written piece, Alice.

Anonymous said...

You missed one thing Alice. Todays city high fliers will be tomorrows dinner ladies/ lollipop men once the economy goes T1ts up and they get laid off.

Anonymous said...

So, you did not have the guts to leveradge your savings and make some money, and now you are whinging about how you have been done down by the nasty ¨speculators¨.

Point the finger at the real culprit, the government, they have printed the money, they have kept the interest rates artificially low, the government is the villian here.

¨Speculation¨ is the sensible way to make your money WORK for you in the economic climate the government has created.

Putting your savings in the bank is a foolhardy way to increase your capital. The government taxes your interest and and errodes you capital value with inflation. Net - net a bank interest bearing account is a sure way to lose money.

Budvar said...

Hey, people can put their money where they like, property has been over priced for over 5 years now. Hell I never thought we'd see the ridiculous prices we see today, with people earning £10k-20k a year, (they do here in a northern mill town) and a crappy ex-council house on a sink estate is priced at £120k???

Give me a f*cking break!!

Anonymous said...

"So, you did not have the guts to leveradge your savings and make some money"

Er......surely you mean you were smart enough not to buy into the bs and aren't sitting on a whopping debt?

Does it take guts to get in on a pyramid scheme or supidity?

traderboy said...

Yes, better days will soon be upon us. Normal people will again be able to think about buying a home.

i think it will be years before it is the right time to buy property. just look at the US for how long it can take (I estimate we are 2 years behind them, in that their market peaked in mid-2005 and ours in early 2007).

2005 - the peak is in
2006 - marginally falling prices and denial
2007 - large price falls in bubble areas, smaller price falls almost everywhere else, general acceptance that the market is going down
2008 - ugly crash coming?
2009 - having based out a little late '08/early '09, option-arms reset and the next wave of defaults hits the fan
2010 - broadly falling prices as more "prime" properties default
2011 - stagnating prices
2012 - the general consensus is that buying a property is guaranteed to lose you money, making 2012 or even 2013 the ideal time to buy property

that's just my guess, but lets say it's 7 years after the peak that you are supposed to buy (and given that housing in the UK peaked in 1990 i think, that would make sense given that 1997/1998 look like best time to have bought property in that cycle), that makes 2014 for the UK. Sad really, as I'd love to have my own place, but from an economic standpoint I think we are years from it.

Budvar said...

You could be right there traderboy, however, the world hasn't seen a run up like this one ever. Prior to the 90/91 crash, there was another in about 84ish and before that about 76/77.

We're in a siuation now where the only way people have been able to pay the mortgage on their houses is to keep drawing the equity out. Now that equity has dried up they can't pay, they cant pay the house is repossessed.

Once all these repossessions hit the market prices will drop like a stone.
Will all these buy to letters still keep paying a mortgage of over £700 a month with a rental income of less than £400 once prices drop with a vengence?

I may be wrong, but I pretty much doubt it.

Anonymous said...

Quite a good article. I am willing to concede that some people will have made money by buying, let's say, five years ago and selling last year but most have bought into a subtle ponzi scheme without realising it. I suggest that you do a bit of research into the role of money supply and structured finance (CDOs, SIVs) for a greater understanding of how this bubble kept growing.

Dirty Digger said...

But rents have gone up. On average in prime areas in C London a 1-bed is now around £400 p.w.--up at least 160% from 2000. And prices are still going up in prime areas--a friend just sold her two-bed in Notting Hill, bought 5 yrs ago for £700k for £1.4 mill!! It's not going to be the precipitous decline you'd like. Sorry!

Andy D said...

It's not so much London per se - at least in London there is a set of people with large amounts of cash. It's out in the provinces - places like Swansea, Stoke, Hull, Liverpool, where incomes are a lot lower (and so are rents), yet property prices are still extreme.

Dirty Digger - a rent of £1600 p/m would support a maximum realistic price of £250k. Yet the price of a basic 1 bed flat in central london is circa £400k; that means an interest cost of £2000 per month absolute minimum, plus costs of letting (voids, repairs, inspections, etc); anyone trying to invest will be out by a minimum of £500 per month.

So even at current interest rates, this is at least 30% overvalued.

Anonymous said...

Other Anon: "Er......surely you mean you were smart enough not to buy into the bs and aren't sitting on a whopping debt?"

Look, folk who got in on the rise in property prices at the begining are probably sitting on a whopping profit, good for them! They may well have bought delapidated and run down properties, given them a lick of paint and either sold them on or let them on the rental market. Either way a purchaser or renter got utility of the property, and the 'speculator' the reward. Good! And according to the data, they were charging reasonable rents for these properties too.

There is a risk involved, minimal at the begining of any bubble, and no, I do not feel particually sorry for those folk who are now sitting on losses. That is part of the deal, take the rewards but you are also exposed to the risk.

Other Anon: "Does it take guts to get in on a pyramid scheme or supidity?"

Well, if you got on the pyramid scheme at the begining, probably. Because at that point it is by no means aparent that the returns are guarenteed.

As a rule of thumb, if you see programs on television, "location, location, location" for example, then you are too late in the cycle and exposed to significant risk.

By the way, there is the other people you can legitimately blame for the hysteria. The TV media luvvies.

Those are the folk who took the idea and brought it into the mainstream conciousness. Made property 'speculation' look like a guarenteed moneyspinner.

So, your criticisms notwithstanding, the Government is still to blame, people will make rational choices when faced with the economic conditions created by the government. But yes, if you want to cast around to blame someone for the hysteria, blame, blame the mejia.

Markbaldy said...

Good article but you didn't mention how the housing market fits into Gordon Brown's "miracle" economy... well without house price inflation, there would be NO "miracle" economy - the vast majority of the UK's apparent economic strength lies in consumer spending where the money comes from borrowing against their houses.
This then creates more demand for housing (because houses are then seen as an ATM - cash on demand !) so the prices go up... and the cycle continues.
I think people selling houses now are still in denial that they can actually go down and price reductions we see now are mere token gestures rather than a crash... that will come later.
Sure the UK has financial services, but our balance of trade deficit, government debt, personal debt and dependence on other countries for food, energy, cars, consumer goods - will lead to complete economic meltdown that will last for more than a few months !(probably decades).
Ask yourself why Northern Rock was bailed out while companies like Rover and Cammel Laird were not - simple answer - to keep Gordon Browns "smoke and mirrors" economy going for just that little bit longer.

mogul said...

Your article nicely points out how the government has been silently collecting a truck load of cash from stamp duty over the boom years. This is undoubtly one of the reasons why the government wants the housing market to roll-on.

I just wonder how much this years budget relies on the projected income from this stamp duty...

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tahomaFromHPC said...

Top post Alice, thanks