Property Crumble

Are Property Prices in for a Battering?

The UK election has past and now we can get on with the new age of austerity.

All data now points to UK mortgage rates rising later in 2010 and moving steadily upwards in 2011.

This is the picture following an almost perfect storm of bad – but predictable – data:

• UK Govt 10 bonds (gilts) jump from 3.662% per year interest rate to 3.99% on May 7th.
• Against German Govt 10 year bonds (Bund) this is a premium of 1.248% per year (the highest for 12 years).
• FTSE fell 2.6% on Friday to complete 8.8% fall on week (although it recovered 4% on Monday as Euroland agreed a deal for Sovereign debt).
• UK factory prices rose 5.7% in April 2010 (an 18 month high)
• UK retail price inflation was 3.4% in March 2010 (well above the 2% target) and the hope of inflation subsiding back to 2% by the end of 2010 is fading fast.

The Times reported on Saturday 8th May, that service companies margin’s are being squeezed as they absorb rising costs and that they will start to rise prices soon.

Halifax reported that UK property prices fell 0.1% in April due to an increase in supply (homes for sale) compared to buyers. This is despite extra UK Govt intervention in the form of a tax incentive for first time buyers (no stamp duty on first purchase up to £225k).

R3 – the association of business recovery specialists – reported that while only 35,000 people went bankrupt or sought voluntary credit arrangements in the first quarter (Jan to Mar) of 2010,. However, there are a further half a million people using debt management plans and another 961,000 people who are struggling with debt and have not yet sought help.

These people – many with bad debts and lower income – have survived the downturn thanks only to historically low interest rates.

The evidence is that this extra-low interest rate environment will not continue and there will be a steady rise in personal bankruptcy – which will peak in 2011 as rates rise over the next 12 months.

Once the spring is past, the net supply of property will increase until a tipping point is reached and property prices head downwards again.

This downward momentum will be maintained by rising interest rates which will force owners to sell empty properties – for lower prices – rather than hang on to them.

Equally, a substantial increase in bankruptcy will ensure that more properties are repossessed and returned to the market, which will only make the supply of property worse.

Of course, it could be worse and public sector employees could receive a 5% pay cut as in Spain. In the UK perhaps we’ll escape with just a pay freeze for the next two or three years.

Where can this end? Surely, only one thing – a steady and on-going decline in UK property prices beginning around the late summer of 2010.

This graph tells the full story anout UK property prices in 2009.

No, it is not a graph of property prices, but of the two measures of inflation used in the UK.

The modest inflation – or CPI – is used to set interest rates and dipped last year but remained positive.

The more volatile inflation – RPI – dropped rapidly last year and gave the UK economy 9 months of deflation.

Only, the deflation fact was kept firmly in the bag because no one uses (or talks about) RPI any more.

So, what is the difference? Essentially RPI includes the cost of housing including an average mortgage. Even though nearly everyone either has no mortgage or a much larger mortgage.

Hence as mortgage costs dropped due to the interest rate cuts, so this RPI measure fell sharply. Ordinary consumers - especially those with large mortgages –  must have felt a sudden surge in the cash available in their wallets and an increase in their willingness to spend it.

So, housing demand rose and prices stabilised and even lifted around 10% from the year’s low point in March 2009.

But what does the graph tell us now? It shows rapidly rising RPI and CPI inflation in December 2009. In other words the benefit of the sharp drop in interest rates is falling out of the figures and therefore the new inflation figures show what is happening in the world outside of housing. And the picture painted is one of rapidly rising inflation.

Now, the next step in the 2010 scenario is that the Bank of England may have to start tightening interest rates, which will make the RPI figure rise much higher and faster.

The interesting comparison is that fall in RPI last year mirrors the pick up in the property market.

And the rise in RPI this year mirrors the fact that houses sold before Christmas are falling through and ’sold’ stock is coming back onto the market just as demand is perishing.

Property prices are already falling for the simply reason that sales have stagnated and there is little prospect of an increase as the cost of living rises sharply couple with gradual tax rises through the year and into 2011.