Subsidence Damage

12/02/2016 at 4:31 pm

Stock markets are enjoying a bit of a bounce today, and oil futures are up. Risk assets are showing weak signs of an effort to get back up onto their knees. Of course the Chinese stock market opens now after the New Year holiday and may fall 7% in twenty minutes again on Sunday night. And at the end of the week David Cameron will emerge from a European summit, proudly clutching some kind of permission slip and ushering in the Brexit referendum. But today we can enjoy some relief from the carnage. However . . .

Worries have surfaced over the London property market this week. Only this morning, Bloomberg reported that central London has “fallen into the grip of the bears”. One can quibble with some of the detail: falls in REIT shares are not the same as falls in the price of property, for instance (which is why the sector is currently on a price / book ratio of 0.85x). Still, their data shows a fall in buying interest from sovereign wealth funds of £2bn in the six months to November. As one analyst put it: “London is becoming a victim of its own success as the petro-dollar trade unwinds, with SWFs selling assets.” Falling stock prices may not have much of an impact, then, but the falling oil price may be something else.

On the other hand, one headline out a week earlier stated that the prime central London residential market will benefit from cheap oil, the reason being that anxious sheikhs will see it as a safe haven. Or if you don’t buy that argument, what about demand from China, with investors and business people from the Far East just as keen on London as the Americans, Arabs and Russians before them? Admittedly both of these lines come from estate agents – but then again, who would know more about the market?

Of course London is only part of the UK market as a whole, residential is not the same as commercial – and even there the Bloomberg point about a £2bn reduction still apparently left incremental SWF demand of £16bn to play with. So even if those making a bull case for property are talking their own books up, we are perhaps some distance from the end of the world.

This will come as a relief to all those in Britain (almost everyone) who sees their own home as an inviolably valuable asset. For homeowners it is not a question of markets: there is a Property Ladder. And it will continue climbing up to Heaven long, long after we have got there ourselves.

Not as many people who live here do own homes as they used to, of course. Rather than being carried up the Property Ladder, they are pouring their money down what is seen as the Rental Drain. According to survey data from National Statistics the proportion of UK residents who own their homes has fallen to its lowest level for at least a quarter of a century. The proportion of those in social housing has dropped over a much longer period, standing at about the same level it was in the 1950s. Private rentals make up the difference. For obvious reasons this change has a demographic distribution, with just under half of those aged between 25 and 34 now renting (without counting those still living in the family home).

There are all sorts of reasons for these changes but one of them is indisputable: affordability. Again, there are various underlying factors at work here, but using a model of the strain put on average earnings by a hypothetical average vanilla mortgage arrangement, affordability fell below its 40-year average last year at a time when interest rates have remained near zero. In the immediate aftermath of the Great Recession, UK housing looked cheap on this measure. Since then, rates have not moved, and average earnings have only increased by about 1.6% per year. The movement from cheap to just shy of fair has come about almost entirely as a result of the appreciation in prices.

Worries about the oil price aside, then, we might raise a bit of an eyebrow about the vulnerability of UK homeowners – or at least, UK mortgagors – to any increase in interest rates as and when it comes. In many cases such an increase will be affordable: measures like these speak only of the affordability to those maxing out the credit card today. On the other hand, mortgage approvals are running at the rate of over 70,000 per month at the moment – low by historic standards (affordability again) but still high enough to cause problems for large numbers of those caught out when the music stops.

This blog has argued lately that the current market pessimism is overdone. Many fears seem groundless, and too many people appear to be looking for lightning to strike in the same place twice.

But there are reasons to be fearful where the conditions exist for painful disruption to markets which have become complacent about risk. Whatever the timing, and whatever the scale of the eventual damage, there are cracks showing which suggest that the UK property market might be in just such a situation.

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