Double Dip for UK Property?

By Joe McTaggart
August 2010

Economic Overview
The UK economy finally managed to find first gear posting a GDP increase of 0.3% for the first quarter of 2010 enabling it to drive slowly out of recession. This was later revised up to 0.4%, suggesting that there was a little bit more momentum than first thought. The latest Office of National Statistics (ONS) figures confirmed this as the economy grew by 1.1% in Q2, almost twice the figure the city was expecting.

While all sectors were in positive territory, it was construction that saw the largest gains at 6.6%, it’s biggest since 1963. More good news came in the shape of UK unemployment, which fell by 34,000 to 2.47m in the three months to May. This takes the jobless rate to 7.8%, the lowest for a year.

Stock Market
The FTSE 100 had an interesting six months which saw it threaten to break the 6,000 point barrier in April hitting 5,825. However worries about the euro zone PIGS (Portugal, Ireland, Greece and Spain) surfaced causing it to fall over 1,000 points by 17.5%. If you’d entered the market in January, as of the end of July you would be nursing a 2.8% loss.

Interest Rates
The Bank of England (BoE) continued to hold the base rate at 0.5% in a bid to encourage the fragile recovery. Although some commentators suggested the surprise jump in growth could lead to an increase in interest rates, the governor Mervyn King appearing before the Treasury Select Committee said, there was "some considerable distance to travel" before rates could return to normal.

He went on to recommend that the Monetary Policy Committee should keep it's "foot firmly on the monetary accelerator" while ensuring inflation levels are closely monitored and managed.

Finance
While low interest rates have been excellent news for existing borrowers, it is the availability of new finance that concerns us most. The most recent “Trends in Lending” report from the BoE showed the flow of net mortgage lending by all UKresident mortgage lenders had increased in May.

However gross mortgage approvals had in fact declined slightly in June with demand for secured credit for house purchases weakening in Q2. Major UK lenders expect demand for secured lending to remain subdued. The findings were supported by the Council of Mortgage Lenders (CML) most recent report showing an increase in gross mortgage lending in June.

CML economist Paul Samter commented that “gross lending estimate of £13.1 billion in June represents a seasonal pick-up and is higher than June last year, but is still indicative of low levels of activity” The back drop is the government’s paradoxical stance which on one hand is telling banks to shore up their balance sheets, while publicly admonishing them for not increasing lending to business and individuals.

I suppose it’s similar to a Chinese finger trap, the harder you pull, the tighter the trap grips. With the BoE soon to take control of the Financial Services Authority (FSA) and therefore the banking, perhaps Mervyn King can pull his finger out.

While on the subject of the FSA, it recently outlined proposals to ensure all mortgages are carefully assessed to make sure borrowers can afford them. If implemented the move towards what the FSA describes as “back to basic responsible lending” will mean an end to “fast tracking” the granting of loans without requiring proof of income and “self certification” mortgages. This will make it impossible for those without three years accounts/tax returns to support their claimed level of earnings i.e. the newly self-employed, to get a mortgage.

CML economist Paul Samter said “the consultation paper on responsible lending increases the regulatory burden on lenders and could make it harder for borrowers to access credit.”

Playing devil’s advocate, although price growth in some locations may slow in the short term, the move may contribute to a more stable and robust property market

Property Market Overview
Unlike the economy, the property market seemed to have gained better traction and some areas had accelerated through the gears and into fifth. Unlike the stock market had you bought a property at the beginning of the year, according to the latest figures from the Land Registry, you would be sitting on a handsome profit.

Year to date the market was up 5.97%, London up 11.5% with the best performer being the Royal Borough of Kensington & Chelsea where prices jumped by 19.7%. These are impressive figures, especially when you consider that prices in Kensington & Chelsea and Westminster are now higher than at the peak. But, is it too late to turn that paper profit into cold hard cash?

Looking at the month on month change we see the numbers starting to lose their shine as the market slows. A closer inspection of market drivers suggests the market may have changed down a gear or two or even slipped into reverse, but why now?

We have stated in prior editions that the recovery was driven by a lack of supply, lots of cash buyers, either from the city spending their bumper bonuses or overseas taking advantage of price falls and a weak pound. At its lowest point 12-18 months ago, many sellers choked on the sales valuations they were getting and opted to let their properties. With typical leases lasting 12 months we are now seeing landlords, forced or professional, looking to take advantage of the recovery which is resulting in an increase in supply.

We have witnessed this first hand during several property searches for private clients. In one particular search, 80% of the properties on the short list were being sold by landlords.

The second factor influencing the market is the lack of mortgage finance. According to moneysupermarket.com the total number dropped from 28,416 in June 2007 to a low of 2,177 in July 2009. However despite a 42% increase over the last 12 months to 3,100, the number of hoops borrowers have to jump through have increased and become so small, only a contortionist could possibly fit through them.

Again during a recent private client search approximately 50% of new properties coming through were not new instructions but had previously been under offer and had fallen through due to problems with finance. Combine these two factors with the fall in the number of cash buyers; we get a shift in the balance of power from the seller to the buyer. With too many sellers chasing too few buyers prices invariably fall.

So are we heading for a Double Dip?
The answer is yes and no, but as they say, the devil is in the detail. If you look closely, transaction levels started falling in January and although there’s a lag, you can see a direct correlation between transaction levels and prices

The reason for the lag is that it can take a few months for sellers to realise that the real reason their property isn’t selling is not because the 2nd bedroom is too small or that they have a north facing garden, after all no one likes to think they have an ugly baby. It’s simply too expensive.

This can be a bitter pill to swallow for sellers at the best of times and even more so if you’ve just put your property on the market to cash in.

In the short term the spread between asking and offer price will grow and some may perceive this as the market stalling. Like Mary Poppins, I would describe it as a spoon full of sugar helping the medicine go down. With prices now matching buyer’s expectations, transaction levels should pick up.

So can we put a number on it? The Office of Budget Responsibility (OBR) estimates that some 600,000 public sector jobs will be cut over the next six years which will undoubtedly have an effect on the housing market which could see short term falls of perhaps 8% from current levels.

While not immune from the axe, London and the South East have less exposure to public sector jobs. The private sector is slowly but surely growing having made the difficult decisions two years ago and with little prospect of the four horsemen of the apocalypse coming over the hills anytime soon we see the market taking a bit of a breather.

This should see prices fall 5% from current levels. They say fortune favours the brave and had you been so in late 2007 early 2008, you would have made a small one. Few will disagree that the economy is in a far better state and has brighter prospects than it did 18 months ago.

We feel comfortable with the medium term outlook for property and a carefully considered and well timed investment over the coming months is likely to yield another small fortune.