Hi Tony

Interesting piece. http: / /www .propertysecrets .net /article /5 _reasons _why _uk _investors _should _consider _buying _now /2617 .html

Couple of things - while I basically agree with the overall thrust, I think your reasons are not entirely spot on.

"History tells us from previous market crashes that the harder the fall in property prices, the harder and faster they bounce back."

Well, history might. But on this basis we are going to see one heck of a climb in prices! I don't see it, not at all. Recovery will, if anything, be stuttery, with a few false spikes and then plateaus. We could well be in one now as supply constraint seems to be the key driver of those tenatively rising asking prices. That will fade as 1) fixed rates continue to become less attractive and 2) More supply is attracted to the market by the reports of rising prices.

But the biggie, I'd say, for investing right now - regardless of whether we are at or near the bottom - is coming inflation. It may not be just around the corner, but it now seems inevitable that if deflation is to be beaten - and the determination is obvious - then inflation will follow.

Others might point to asset classes that can do this or that when inflation is the big concern, but one thing history DOES teach us is that generally house prices go up when inflation does. Oh, and of course, inflation makes what once seemed like a huge loan shrink very rapidly Alice in Wonderland style to something much more manageable.

cheers

I agree with your point about house prices going up as inflation goes up historically. This time around tho' the UK (or at least many home owning households) are up to their eyeballs in debt. They weren't the last time we had house price rises on the back of inflation.

I feel their is a strong liklihood that if inflation does kick in then unlike previous inflation booms we may get an inflation bust as interest rates climb and many more repossesions come to the market

Hi

I think the deleveraging that has taken place among banks, businesses and even individuals has been quite staggering over the last year or so, hence the sharpness of this recession. Government debt is getting all the headlines now, muddying the picture.
There is still huge amounts of equity available in property - only 40% is mortgaged at all.
A key, I think, will be negative equity and there is no really accurate way of measuring that - but a recent BoE report quotes data suggesting:

"Between the Autumn of 2007 and the Spring of 2009, nominal house prices fell by around 20% in
the United Kingdom. There are no data which accurately measure the scale of negative equity.
Three estimates presented in this article suggest that around 7%–11% of UK owner-occupier
mortgagors were in negative equity in the Spring of 2009, although for most of those households,
the total value of negative equity was relatively small."

That 11% is the same as in 1995!

The difference this time is that price falls have been far, far more rapid. This has given property owners far less time to make repayments to avoid negative equity - prices fell by 19% in just 18 months between 2007 Q3 and 2009 Q1. It took almost six years for house prices to fall by 15% between 1989 Q3 and 1995 Q2.

This is why people are able to talk of a bottoming out now, in such relatively short period of falls in historic terms - those falls have been so severe.

Another surprise - at least to me - 'despite the emergence of the adverse credit sector in the early 2000s, the proportion of mortgages issued at high LTV ratios was actually lower than in the late 1980s and early 1990s'.

So, my view is that, yes, there is , of course, a lot of personal debt sloshing around, but I think it has been recalled, repaid or written off on a pretty huge scale and will be gradually inflated away. Interest rates will certainly rise - what else can they do! - but that is not really the problem for debtors. The problem is - as we've all learned - the spread between base and lenders' rates. Everything was fine when the base rate was, what, 300, 400% higher than now, because the spreads were lower. Once banks start to function again - and there are some signs that they are - we will be able to recover in a higher base rate, higher inflation rate environment. It will all depend, ultimately, on how severe the inflation that's coming turns out to be.

Or is that just the super-sanguine view?

I have to say, we keep seeing tentative signs that can only be described as positives. None of them, in themselves, can be take to herald the end of all the problems, nor even all of them together. But, so many people - especially media commentators - have gone so deep into the 'we haven't seen the half of it yet' school of thought, that they seem incapable of making assessments that are not totally negative.

Cheers

History tells us from previous market crashes that the harder the fall in property prices, the harder and faster they bounce back.

Tony, could you please explain this as the last property crash in the early 90's took many years to see out.

Asset bubble pop and then dissipate slowly. A return to 'real' price growth takes years or decades (Germany/Japan/Hong Kong) to see out.

I don't see property with the potential to bounce like a stock market. Particularly in the UK where the fundamentals of Price to Earnings and dividend yield against the historical yield at market bottoms is still saying that UK property remains overvalued.

I don't believe we have seen a 'real price' market bottom. Nominal prices may not fall much further than say 10% but a real term market bottom adjusted for inflation is not here yet.

As for inflation, great for property and great for large mortgages. The problem this time is that we will more likely see stagflation than good inflation. Earnings are going nowhere. Commodity prices may continue to rise and create an inflationary environment but UK earnings will be hard to rise in tandem with such inflation. Employers will have the upper hand for sometime and therefore I see inflation as a threat in the short to medium term for UK property (i.e next 1-4 years).

How will UK property rise when earnings are weaker than the rate of inflation, interest rates rising as well as other costs (i.e. food and oil) are eating into disposable income?

At some point down the line (5-10years) we may see a market bottom in real terms and inflation acting in a good way on property but I feel it is not going to be soon.

And don't forget to factor in the inevitable tax rises and/or public sector works cuts in order to bring our debt to GDP back down from 80% to 40%.

Most respectable commentators say it will peak at 100% or so.

Factor in a decade at least for this sort of adjustment to take place.


This guy talks some sense on UK PLC -

http: / /www .marketoracle .co .uk /Article11088 .html

http: / /www .marketoracle .co .uk /Article11247 .html

Therefore the government is borrowing a net £175 billion for 2009 and £175 billion for 2010 to generate £15 billion of growth, and then a further £140 billion for 2011 for £42 billion of growth. Thus total net borrowing of £490 billion to grow the economy by just £67 billion, (£595 billion my forecast) which shows the magnitude of the scorched earth economic policy now implemented that literally aims to hand the next Conservative government a bankrupted economy that will be lumbered with the consequences of continuing huge budget deficits and therefore necessary deep cuts in public spending.

To weigh in...

If anyone tells me to BUY NOW in capital letters, I'll assume they are selling me something?

If anyone tells me to buy now - because everyone else is doing it (even if they are Aussie's), I'm inclinded to do the opposite...

There is a good case for saying 'LOOK now...' but there is no case at all for BUY NOW - because the average UK market will stagnate for a number of years yet.

It is true that good opportunities come and then they go - I expect this situation to remain like this for some time - the trick then is to act on good opportunities and let the rest go...

This is no time to buy options in the Halifax's property price index - because as we pull out of the recent nose dive, we'll discover that banks can not or will not be allowed to expand credit in the way they did before.

This is what George Soros was saying in the FT earlier this week - and he is right that regulators can't just manage the money supply, they have to manage the credit supply too. They can, they will and this will dampen property price growth for a number of years.

Still - here are some figures I worked out

For a property to double in value in 10 years you need any of the following

i) a cash positive investment plus 7.2% price growth per year - very unlikely
ii) a cash positive investment plus 5.7% price growth per year AND a genuine discount of 15% against today's market price - possible? - maybe!
iii) a cash positive investment plus 3.8% price growth per year over 15 years AND a genuine discount of 15% against today's market price - yes, pretty likely.

A word of warning - most BMV property does not fit into any category as there will be pockets of uk property that don't see any growth in price for many years....

So, you have to be highly selective and very realistic. Still, option iii) is probably a lot better than many of the alternatives such as stocks - as you retain a very low risk of losing your money....

leverage will allow you to increase the returns - but leverage will need to be modest to ensure that you always retain a cash positive situation both now and in 3 to 7 years when we can expect inflation and interest rates to slowly creep up.

Neil

just saw this article on negative equity predictions which are significantly greater than in the article you have referenced and which was out last week I beleive Robin.

http: / /www .guardian .co .uk /money /2009 /jun /23 /mortgages -negative -equity

time will tell which is more accurate but my general feeling is that whilst people are reigning in their horns and paying off debt where they can they aren't being able to keep up with the falls in asset values (personal balance sheet issue) or indeed their personal p&l in the form of loss of income from wage freezes, wage cuts, bonus reductions or job losses.

I suspect we have yet to reach bottom.

Hi

Yes, that estimate from Fitch does look alarming, on the face of it. Bear in mind there are no accurate figures for this and this is an estimate - not sure how they arrive at their conclusions. But, even assuming they are accurate, it really depends on how much negative equity we are talking about, and they don't say.

I think you're right, we're not near the bottom yet, but substantial falls are likely to have ended.

Of course, negative equity only really matters, ultimately, if income is reduced drastically and a mortgage can no longer be paid. What you describe as personal p@l is indeed crucial, you're absolutely right - it feels almost like a race to pay down debt before a job is lost, wages cut and so on.

Even so, the deleveraging IS measurable and fear (and few alternatives to invest) are driving it as the latest data show - overall spending on overdrafts, plastic and net mortgage lending are all negative - mortgages for three months in a row.

My feeling is that the speed of this recession and this property crash is actually causing such radical readjustments, rather than a prolongation of the initial simple denial and then panic, that we may well be well-poised for a very gradual, but very obvious recovery from next spring or thereabouts.

But, as you say - time will tell!

cheers

Tony's report refers to gross yields averaging 5.1% now.

I'm too young to remember the level that yields bottomed in the early 90's after the last recession but surely 5.1% does not reflect an asset that is dirt 'cheap' as found at market bottoms.

I have a theory on the market cycle, ignore the price level as price cannot be compared between different time periods due to inflation.

Likewise you cannot say that as prices have fallen much further this time than against previous downturns then property is fairly priced now. If (as was the case in 2008) property was far greatly overvalued than in the course of history, a large fall from peak may not show a relationship to property having fallen to a level that now represents good value.

If property became far more overvalued in this boom than all previous ones, then the fall needs to be much further in order to make the market cheap at the bottom.

All that counts in my opinion is yield. Its the only real measure of value that stands the test of time.

The yield level runs in a cycle, running above fair value and peaking at approximately 3-4% yield (height of boom) and then falling below fair value and prices bottoming at around 8-10% yield (depth of recession).

Fair value in my eyes is around 7%. The reason I use 7% can be explained in these links below. The first relates to valuing stocks but the concept can in my eyes apply too to property. A bit scientific but from my emperical analysis of housing markets not far off the mark.

On the basis of yield, UK property remains severly overvalued in my opinion. I don't see major nominal falls ahead but we certainly need to see some major inflation to raise earnings and rents in order to bring yields back into whack and make UK property 'dirt cheap' as occurs at any major market bottom.



http: / /www .marketoracle .co .uk /Article5519 .html

This fair-value concept is very important to understand. Why 14x earnings? Over centuries, across many stock markets in many great nations, 14x earnings has simply been the long-term average valuation for common stocks. Sometimes valuations are higher, sometimes lower, but they always oscillate around a secular mathematical average of 14x. While long-established historical validity is enough proof, this number is quite logical too.

Stock markets exist solely to facilitate capital transfers between those with surplus capital (savers, investors) and those who need capital (debtors in a loose sense, companies). In order to transfer this capital, both sides of the deal need a fair and mutually-beneficial exchange. If capital is too cheap, investors won't offer it up for investment. If it is too expensive, companies won't want to “borrow” it. 14x is just right for both parties.

Interestingly the inverse of 14x earnings is a 7.1% yield. If an investor buys stock at a 14x P/E, it will take the company 14 years to fully earn back the price he paid. Without compounding, this translates to 7% or so. 7% is both a fair rate of return for investors' hard-earned capital and a fair price to pay by companies who need this capital. All over the world for at least hundreds of years, capital has flowed freely at 14x and 7%.
Stock markets oscillate around this 14x fair-value level because this is where the markets clear, all investors with surplus capital have the opportunity to invest it and all companies that want surplus capital have the opportunity to procure it.

So this fair-value concept for stocks is not only historically verifiable, but it is eminently logical too. After 8 long years of mean reverting, it is exciting to see the Dow fairly valued again.

This 14x fair-value point is also the anchor from which undervaluation and overvaluation are objectively measured. At half fair value, 7x earnings, stocks are very cheap historically. As soon as you see 7x earnings in the major stock indexes, it is time to throw every dollar you've got at the deeply undervalued stock markets. Such levels are only seen at the end of 17-year secular bears, like 1982.


http: / /www .sbpost .ie /post /pages /p /story .aspx -qqqt=DAVID+McWilliams -qqqs=commentandanalysis -qqqid=36999 -qqqx=1 .asp

In the US, analysts claim that, in the long run, house prices should be equal to between 12 and 14 times earnings. This means that if a house is generating a rent of $10,000 a year, it must be worth between $120,000 and $140,000 a year.

Apply this test to Ireland. A quick search of Daft.ie will reveal, for example, that a three-bedroom house in Co Wicklow - advertised as an investment property - is on sale for €289,000.

The same website tells us that the average rent for a three-bed in Arklow is €850. So let us say that, in the best possible case, this place is rented for 11 profitable months a year - the final month’s rent goes on various costs. The implication from the American model is that the house is worth about €122,000.

The implication from this, compared to the advertised price of €289,000, is that the house is still wildly overvalued. The Irish calculation means that the house is trading at 31 times its annual yield. This clearly needs to fall dramatically by close to 60 per cent for it to make any financial sense to buy.

So one of the factors impinging on Ireland’s recovery is that we have to see house prices fall dramatically for any investor in their right mind to get back into the market. As long as estate agents, banks and builders are in denial about where prices need to go, we will not have a platform for any recovery.

Hi Tom

Very interesting post; but ultimately, in mho, it's flawed.
Why? Because property is not traded in the same way as stocks and shares.
Property buyers and wannabe property buyers do not apply ‘fair value’ when saving for a house, or upgrading. They don’t look at yield. They look at what else is selling in the market – traditional comparables.
This may well lead to bubbles as financing versus interest rates versus income become so stretched one eventually snaps; but it is nevertheless the way the property market functions.
I agree, as an investor, yield is key right now and a sensible investment measure; but it’s not all-exclusive.
You say: ‘As long as estate agents, banks and builders are in denial about where prices need to go, we will not have a platform for any recovery,’ and I have to disagree with that. We might add buyers there too – not investors (they are not fundamental long-term drivers of mature markets). So long as all these parties are ‘in denial’ as you say, or we could say, so long as they refuse to assess fair value based on analysts’ assessment of a yield to capital value ratio, then property markets will defy those who apply stock market analysis. Isn’t this just what the Economist did all those years back and concluded that everyone should sell and rent? Those that followed the advice missed out on more than four years of (perhaps irrational) capital growth - gains, that in most cases, still will not have been lost even after the current downturn. That’s been my experience anyway.

Cheers