Fleet Street Letter’s record in forecasting the fortunes of the UK housing market has been good. Time and time again the merchants of gloom, like Professor Andrew Oswald, Durlacher and Capital Economics have insisted that a housing crash was just around the corner. And each time we urged you to ignore their advice and in the process saved yourselves from a dismal existence rotting unloved in a bedsit without a handsome tax-free capital gain. As an example, Professor Oswald urged British homeowners to sell up in May 2003. According to figures from Nationwide building society the average British house price has since risen from £107,905 to 165,730, a capital gain of 54%. But where do we go from here? The last time we commented in depth about the UK property market was in January this year. We noted that long-term bears of the housing market were capitulating. For example Capital Economics, which for three years had stood by its forecast that house prices would fall by 20% from 2004 to 2006, finally gave up the ghost. This development together with news that Rightmove, the property website, claiming that average asking prices had jumped £2,000 in the first week of 2006 made us more nervous about the housing market than at any time since the early 1990s. We went on to argue that if house price inflation continues to gather momentum and picks up again to double figures by the summer, then the chances of an eventual house price fall become much greater. Indeed the best thing for the UK property market would be an extended period of house price stagnation to work off the stretched valuations in the market.
Why rates doubled in the 1980s
Six months on our stance remains broadly unchanged. All along we have maintained that the housing market would be the victim rather than the assassin of the UK economy. In other words, the underlying economy needs to fail to bring the housing market to its knees as was the case in the late1980s when interest rates were hiked from 7.5% to 15% to curb Lawson’s runaway boom. With interest rate policy in the more capable hands of the Bank of England, policy mistakes on this scale are much less likely. Indeed levels of employment are 272,000 higher than a year ago and interest rates remain historically low. This background will underpin the market though the upside is increasingly constrained by the high level of house prices relative to earnings and the low level of affordability for first time buyers. Fortunately in the last six months we have been spared a return to double digit house price inflation. Indeed after a worrying 1.4% rise in house prices in the month of January 2006, house prices have risen by just over 1.5% in the following five months. According to Nationwide figures, house price inflation in the UK stands at a modest 5% in the 12 months to June 2006.
What the Old Lady will do next
With house price inflation moderating, it follows that the chances of a major correction in house prices is now lower than we feared in January this year. The key factor in cooling the housing market has been the change in outlook for interest rates. The rally in house prices from September 2005 to January 2006 was partly the result of a moral hazard inadvertently created by the Bank of England. Prior to the August rate cut, people were coming round to the idea that the Old Lady was hiking interest rates partly to cool the runaway housing market. But once there were signs that the housing market was slowing, an interest rate cut duly arrived. This created a misguided impression that the Bank would act to stem further incidences of house price weakness. This encouraged house buyers to become more highly geared. In the four months to January 2006, house price inflation was running at an annualised rate of nearly 10%. But this now looks like a classic “sucker’s rally”. The cut in interest rates last summer did not lay the foundation for a succession of further rate cuts. Indeed the move was controversial in that it was the first interest rate change opposed by the Governor of the Bank of England. Moreover the markets now expect UK interest rates to be at 5% by March 2007, up 0.5% point on rates prevailing now. This change in market sentiment has already affected fixed rate mortgages. Back in February this year we alerted you to a 10-year fixed rate mortgage with the Woolwich at 4.67%, now 10-year fixed rate mortgages are typically around 5.2%. According to Rightmove over 70% of buyers are taking out fixed rate mortgages right now. So it follows that the rise in fixed rate mortgage rates has contributed to the cooling of the housing market seen in the last five months. The UK interest rate outlook is not as benign as it was a year ago and consequently we see house price growth remaining sluggish. The exception is London. Bucking the trend of a slower market in other regions of England and Wales, the capital’s house prices rose by 10.3% over the 12 months to May, according to the FT house price index. In the past two months there has been a pick up in lending for London properties after a lull at Easter and prices should remain firm as shortages for prime properties remain.
Foreign billionaires love London as a “tax haven”
In the past, the capital has normally led trends in house price inflation nationwide. Property prices took off first in London in the early 1980s while houses in the capital were the first to decline in price during the late 1980’s bust. Once again in the early 1990s London and the South East was the first region to recover and was the first to show signs of slowing in 2002. So is the London house price surge a precursor to a renewed rally in house prices throughout the UK? I doubt it. The rally in house prices in London and the South East is most marked in the large and expensive properties, which are proving to be the easiest properties to sell right now. These properties should be viewed in the context of a global market for prime residences rather than in the context of the UK housing market. The taxation policies of new Labour have made the South East an attractive place for Russian billionaires and the like to live. Instead of squeezing the small number of very rich individuals with very visible high marginal tax rates in the old Labour way, Mr Brown has raised his money from the huge swathe of middle income tax payers with largely invisible stealth taxes. So the very rich have got even richer under Mr Brown helped by his refusal to tax non-domiciled foreign billionaires living in Britain. The strength of the London property market also reflects its unique attributes as an international centre.
The “Watford Gap” getting wider
According to HBOS, Southern England – which comprises Greater London, the South East, East Anglia and the South West – accounted for two-fifths of the overall rise in UK house prices in the first half of the year. Compare this to 2005 when the South contributed less than a quarter to the increase in UK property prices. This is significant. Long-term readers of Fleet Street Letter will remember that four years ago we were more bullish of house prices outside the capital. In 2002 we ran the headline “For decent property returns in today’s market you must look outside London”. This call has proved to be correct. In the second quarter of 2002, the average house price in the south was 2.19 times the average house price in the north. This ratio has fallen to 1.58 in the second quarter of this year. But we have now come to the point where this ratio will pick up again. In other words the North-South divide is set to widen and the greatest scope for house price increases in the coming months is in prime residential property in London and the South East. This is the sector of the market where shortages of desirable properties are most evident.
Why your builder speaks Polish...
Property prices will also rise in areas where employment opportunities expand the fastest. People move to where the work is. And today the most common form of migration is not from the North to London but from Warsaw to London. This development has caught the Government and its planners by surprise. In the first 18 months since the expansion of the EU in May 2004, 329,000 immigrant workers from the new accession states have registered in Britain. The Home Office was expecting 13,000! This is not the only factor leading to increased household formation in the UK. The average size of a household is falling. The elderly are living longer, and couples are starting families later, so there are more households without children. High divorce and separation rates mean more individuals living on their own. At current assumed rates of household formation there is already excess demand for housing in England. Back in 2003 the Government projected that at prevailing rates of house building there could be over 100,000 frustrated potential households by this year. But in the light of higher than expected mmigration this deficit could be over 200,000. Our conclusions on the property market are straightforward. We expect to see continued sluggish house price inflation outside London and the South East but no crash – not yet. Meanwhile, the North-South house price divide will widen as immigration, higher household formation and supply shortages underpin the market in high employment growth areas. Indeed if you hold a prime residence in or near the capital, it’s a sellers’ market. According to Rightmove, sellers in London are seeking sums 13.8% higher than a year ago. Expect further capital gains ahead.
Brian Durrant is investment director of the Fleet Street Letter.
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