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Getting the right balance

  • 18/11/2002
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Low interest rates and consumer confidence will not guarantee smaller risks. While the future of the housing market still remains unsettled, what are the possible outcomes?

It is difficult to know what is more frightening: the annual house price reviews that point out how wayward the predictions at the start of the year were, or the waves of market profiles for the coming year that we are loath to put faith in lest we be made fools of.

Tales of market experts being trumped by beginners or forecasting methods of chance are not uncommon, although the purpose is not to belittle their efforts, but to highlight the difficulty of the task that lies before them.

Although we are aware of the basic factors influencing house prices, it has continually proved difficult to know what weighting to give to each and how extenuating circumstances will affect them. Indeed, a common mistake that is often made, especially by consumers, is to accept the generic trends attributed to the housing market as representative of all regions ‘ without accepting each has its own sub-market relying on its own unique set of factors. Each affects the other, but rarely do they act as mirror images, or make it easy for us to predict their next turn.

For the homeowner, perhaps the biggest folly is a failure to realise in earnest, that properties ‘ like any other commodity ‘ are only worth what a buyer is willing to pay, and when sentiment and consumer confidence comes into the equation, it is difficult to make a constant of anything.

Laurence Sanders, economist for Bristol & West, believes there are three main drivers to house pricing. These are personal disposable income, long and short-term interest rates, and demand for alternative investment.

Disposable income determines what level of mortgage repayments con-sumers can cope with, and with low levels of unemployment and rises in average wages, life seems good for the man in the street.

Since 1993, unemployment has fallen from around 10% to nearer 3%, while average earnings have increased between 2% and 6% annually. With more consumers earning more money, they have taken the chance to scramble onto the property ladder, and the demand has helped fuel the price rises seen in recent years.

An all-time low

Looking at interest rates, Sanders predicts they will be contained by a 5% ceiling until at least the end of next year. Andrew Clare, economist for Legal & General, says interest rates are operating at generation lows. ‘Since 1995 average earnings have risen by 35% and headline mortgage rates have fallen by 41%,’ says Clare.

The switch from a high interest and unemployment environment to a low interest and unemployment environment has meant there has been a readjustment needed in property prices, and many believe the market boom has been a reflection of this, as the appropriate realignment has taken place.

Estate agent FPD Savills noted this price readjustment in its July UK Residential Research Bulletin. Richard Donnell, head of residential research for the estate agent, says: ‘Rising incomes and the shift to low interest rates over the last decade have given average UK house prices a huge one-off boost. This should not be confused with a runaway boom that will necessarily end in bust.’

However, while the low interest rate environment has helped drive prices upwards and made people feel confident about taking on increasing levels of debt, it is a double-edged sword upon which some may find themselves falling.

Donnell continues: ‘The biggest risk to the housing market at the moment comes from a rise in interest rates. The currently low level of interest rates means even a small increase will have a disproportionate impact on what households spend servicing debt.’

This will also be magnified by the consumers’ rush to take on increasing personal debt out with their mortgages in the low interest environment. This view is also purported by global consultancy PricewaterhouseCoopers.

In its UK Economic Outlook October 2002, the consultant states: ‘If the world economy does recover as planned, then the main risk looking further ahead might be that consumer spending does not moderate as expected pumping up domestic demand to inflationary levels in the medium term. The Monetary Policy Committee will be alert to any signs that this is happening and in this case UK interest rates might need to rise more rapidly next year than anticipated. This could be of concern to both households and companies where debt levels have risen significantly in recent years.’

One saving grace, and a direct result of the mortgage market’s evolution is the proliferation of capped and fixed rate products. These were not available in the 1980s and by limiting consumers’ exposure to a sudden rise in interest rates should it occur ‘ and will help ensure there is not a backlash of homeowners dumping their properties onto the market.

Moving on to the third of Sanders’ main drivers behind house prices, he believes the drop in the equity markets and the poor returns they have been offering investors, has helped push them towards the property market.

He says: ‘In the personal investment sector the Enron scandal, a host of fund managers making excuses for the underperformance of funds and the shortfalls in endowments have created a low perception of the market.’

Although Sanders believes the equity market may have turned, it will be the professional investors that reap the full rewards and the public will not return in numbers until it has reached a mature phase in its cycle. It can be argued that many people withdrawing capital from the equity market to put into property are only doing so in the buy-to-let sector. They are nonetheless important, accounting for 6% of all property transactions in England and Wales last year, according to FPD Savills’ July UK Residential Research Bulletin.

Should buy-to-let landlords take fright and decide they want out, a surplus of property on the market could well have a knock-on effect on residential property prices. However, Clare points out that to date investors have seemed happy to accept falling rental yields in return for long-term capital gain and show no signs of exiting the sector in droves.

Region to region

Clearly the availability of property is a massive determining factor of price and any sudden swing in the amount of property on the market will affect this. Regions differ dramatically in terms of the demand for property, but overall there is a shortage of housing in the UK, which has helped drive prices to current levels.

In his research paper The Outlook for Residential Prices ‘ October 2002, Neil Chegwidden, head of research for property consultancy, Cluttons, says housing completions have fallen from over 350,000 a year in the late 1960s and 200,000 a year in 1980, to just 128,000 in 2001. Without a surplus of housing in the UK, it becomes difficult for many to forecast prices imploding in the near future.

While it seems unlikely there will be a crash, it is impossible to rule it out when prices are not calculated by a cold constant calculation, and confidence and consumer sentiment come into play. Chegwidden says people tend to follow one another like sheep: ‘There has been a slowdown in the last few weeks and once people think prices have gone as far as they are going to go news gets around quickly.’

The consumer seems to consider that future gains are still to be made with property and Chegwidden continues in his October research paper: ‘The current period of uncertainty has pushed everyone onto the back foot so it is none too surprising that consumers as well as businesses are being cautious on spending and investment ‘ hence a stall in the rampant growth in house prices.’

This backing off is something that has been noted from the front line where the intermediaries operate. Allan Rosengren, chief executive for Falcon Group is not overly confident for the future, and believes consumers may feel the market to be peaking: ‘I think people buy when they believe prices will rise and as we have seen on previous occasions, will do little if they believe prices will stagnate and may seek to sell if they believe prices will fall. I also think speculators may withdraw from the buy-to-let market, which would depress prices, particularly if a lot of such properties were to go on to market.’ Although this is at odds with what Clare believes, it seems the consumer is beginning to think more about their involvement in the housing market and what sort of returns can be expected.

With interest rates remain-ing at 4% for the coming month it is unlikely consumer confidence will take a sudden hit. However, as Rosengren points out: ‘Predictions are not necessarily the same as outcome ‘ one could even say they are rarely the outcome.’

Edward Murray is news editor

sales points

What happens in one region is not necessarily a good indicator of what will happen in others.

There are three drivers in the market: disposable income, interest rates and demand for alternative investment.

The shortage of new housing has pushed up prices and makes it harder to predict a crash.


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