This went out on onefreesharetip.com a few weeks ago but perhaps meriots a wider audience I stand by my view expressed here:
It is part of the British DNA that we believe that house prices must always go up. That is not the case. Be warned. Falls of 30% or more are inevitable within the next few years.
Of course inflation (the erosion of the purchasing power of the pound) has made house prices a one way bet since the early 1970s. I will not bother serving up a chart just imagine climbing a ski slope. But this is an inflation given gain. It simply reflects, to misquote Harold Wilson that the pound in your pocket is worth far less than it was. You might note that in 1971 you could buy an ounce of gold for £14. Today that will cost you more than £1000. The destruction in the purchasing power of Sterling during the past 42 years has meant that all physical assets look, in headline terms, like smart bets, housing included. You cannot live in a bar of gold but it has actually been a better bet than UK house prices. So as it happens has been am 1870 Wisden cricket annual, but again you cannot live in it.
House prices have not, as anyone who bought in 1987 will remember, moved in a straight line. There are periods when they fall sharply. That happens because a) they get overheated and b) because there is one of two external shocks: either a sharp rise in unemployment or a sharp rise in interest rates and either of those two triggers mean that large numbers of people with mortgages cannot pay, default and become forced sellers.
For the feature of housing as an investment as opposed to, say shares or gold, is that the market is very illiquid. If Kylie Minogue moves into your street and there is a sudden demand from dirty old men to buy housing there too, prices will rise very sharply as there will be far more demand than supply and each transaction will set a new benchmark price for the whole street. But Kylie can live in only one place at a time.
If you suddenly face a few forced sellers in your street and there is no rush of buyers each will compete to shift their property as quickly as possible and each time one sale goes through that sets a new benchmark – a lower one. And that is what will happen at some stage soon. At this point I bring to your attention a chart which shows average UK house price to average income ratios over time.
You will see that the long run average is c4. Of course the ratio is very rarely exactly 4 it tends to get ahead of itself and then correct below mean and then bounce above mean. Right now we are at a level ( above mean) seen only twice before in living memory. The first time was in 1987 when Chancellor Lawson engineered a housing bubble with the announcement that in 1988 he would abolish double MIRAS. Folks rushed to buy in 1987 and the ratio headed just above 5. Look what happened next? Er..oh – the value of your house just halved.
The second time was in 2007 when Gordon Brown pumped money into the UK system with his vast ( unsustainable deficits) and when credit was easy and base rates low. Then came the 2008 global crisis and the ratio crashed again. But not back to 4. And over the past couple of years that ratio has pushed higher and we are once again at 5+ and the amber warning lights are flashing.
You might ask why has the ratio climbed once again? It is not that average incomes are falling but the reason – as ever – is political. The Coalition reckons that rising house prices wins votes. It is probably correct. And so taxpayers cash is being blown in a myriad of ways to push prices up – we are being bribed with our own dosh. Banks have been given cheap money to lend which is passed on via cheap mortgages. There are numerous schemes to help first time buyers onto the property ladder. That they need assistance at all is down to a benefits system which underwrites sometimes exorbitant rent bills for those who have never worked ( see today's latest installment of the increasingly vomit inducing tale of Heather Frost here). Landlords know that housing benefit picks up the tab and can thus afford to charge more so pushing up both rental and purchase prices for those who do actually work.
The whole system is not sustainable and is pretty ludicrous to boot and at some stage the realities of the UK Government deficit will force an overhaul which will inevitably lead to a total de-rating of house prices. That is probably a good way off (at least until well after the next Election). But interest rate rises are not so far off. The UK lost its AAA credit rating last week. That should mean that the Government has to pay more to issue bonds to fund its gaping deficit which will push up interest rates generally. Moreover there are clear inflationary pressures in the system. At some stage base rates will have to increase and – assuming that the banks do not take a margin hit, a safe enough bet – that means sharply higher mortgage costs.
If you currently have a mortgage paying 2.5% - one fifth of that (0.5%) is base rate the rest is bank margin. If base rates increase by even 0.5% your monthly payments on an interest only loan jump by 20% (2.5% to 3%). An increase of 1% sees you seeing a 40% hike. There are an awful lot of folks out there who have overborrowed and a 40% increase in monthly payments will be hard to bear. But base rates of 1.5% could be just the start. Young people may not remember this but even in my mortgage lifetime paying 10% on your mortgage over a sustained period was a reality of life. At some stage that will happen again.
And that is why house prices just have to correct. It will be interest rates that kill the market. Even if house prices simply return to “norm” that implies a fall of 27% in the average house price. But the reality will be far worse. House prices will over-react on the downside just as they did on the upside and so brace yourselves for falls of 40% or more.
It is when, not if. The Government ( whoever is in power) will Canute like try to resist market forces by pissing away taxpayers cash for as long as it can but, like Canute with the tide, in the end it will fail. So how do you profit from this?
1. If you are thinking of buying a first house or a bigger house ...there’s no rush.
2. If you are thinking of downsizing your house in the next few years do not hang around – start the ball rolling now.
3. If you simply have a mortgage you might take advantage of low base rates while you can and pay it off even if only by a little. And you should then keep your monthly repayments the same so that you are then in effect repaying a tiny extra bit of capital each month. If you are paying 3% on your montage you are effectively getting a 3% tax free return – that is better than you get in the bank.
4. Consider going short of housebuilding stocks. They have had a phenomenal run and several now trade on growth stock ratings. That might be credibly if we were at the bottom of a cyclical slowdown and earnings were set to race ahead over the next three years. But we are not. This is a cyclical industry and while we are not at the top of the cycle we are pretty close. I provided a detailed analysis of the bear case for three household names last week.
To see why shares in Barratt Developments are a slam dunk sell click here
To see why shares in Bovis homes are ludicrously mispriced click here
To see why shares in Redrow are a slam dunk sell click here
I am not calling the top of the housing market for tomorrow. I cannot predict X-Day. But UK house prices are now a clear bubble and it is a bubble that this Government is fuelling. Bubbles by their nature expand even when folks start to realise that they are bubbles. And then one day they go pop. This bubble will be no different.
Brace yourselves. Start to prepare now.
Tom