It is becoming increasingly clear that this is not an “if” event but a “when” event
Over the last few months we have considered whether we are about to experience a correction in the residential property market.
Since writing these pieces we have started to pick up warning signals and in this blog we want to explore this further.
A short term bubble
An article in “The Week” showed that there was a 22% increase in the number of home purchase loans issued to prospective landlords in January and the amount borrowed increased by 40%. The reason seems to be that investment buyers are rushing to buy properties before the beginning of April, therefore avoiding the new 3% stamp duty surcharge.
There is little doubt that this has inflated house prices in the short term because demand has been outstripping supply.
But this mini bubble is starting to slow. Visit estate agents and you can see that where once houses would come on the market one day and be sold the next this is simply not happening; houses in some areas are taking longer to sell. Crucially it appears that estate agents are recommending reductions in house prices to encourage sales.
This is important because the longer houses take to sell the more likely the vendor is forced to reduce the price, and therefore we start to see the shift of power move from the vendor to the buyer meaning (potentially) house prices start to fall.
Interest rates will go up
Interest rates will go up; we just don’t know when. Borrowing is currently relatively cheap but this is not going to last, and any increase in rates will naturally dampen demand. Homeowners with mortgages may find it difficult to re-mortgage with new more stringent lending rules and this could be compounded if house prices fall.
But where there is real concern is the buy to let market. We have indicated in previous blogs that after expenses rental income received by the landlord is perhaps as low as 1%. By 2020, landlords will no longer be able to deduct mortgage interest before calculating tax, pushing many into higher brackets, and the relief will be at a flat rate of 20%, effectively halving the break for higher-rate taxpayers. An automatic 10% maintenance deduction is also being removed and landlords will have to prove expenses for which they are claiming.
Adding this to potential rises in interest rates this could easily move rental income into negative territory for landlords. If houses have been purchased at the peak, and property values fall landlords may find themselves sitting with negative equity. With negative income and equity landlords may have no choice but to sell.
Effectively they become forced sellers; if it’s a trickle it might be okay but trickles have the potential to become streams and then rivers!
Interest only mortgages
According to the Guardian there are 1.9 million people with interest only mortgages. Most of these deals were taken out when borrowers didn’t need to prove they had the means to pay back the loan. Since 2012 most lenders have stopped lending on this basis and those that do have strict lending criteria which makes it available to only the few.
As rates rise those with interest only mortgages are likely to want to re-mortgage to keep costs down, or perhaps they will be coming to the end of the term of their mortgage. If they re-mortgage, then they will need to include capital repayments which will significantly increase costs and has the potential to force them to downsize (if that is an option). Equally if at the end of the term they have no means of repaying the capital they will have to sell the property.
Interest only mortgages have in the main been used as a means to get on the property market especially in hotspots like London. Similar to buy-to-let this has the potential to flood the market with forced sellers which in turn pushes down house prices.
London is a city on its own, creating its own property bubble which few can see ending.
There is however a question mark. If we vote to leave Europe, there is the potential for European companies to move their offices away from London to other European cities. This in turn creates an exodus from the London market which could burst the bubble.
If the bubble bursts the ripple has the potential to spread across the UK, but the important point is that London is not immune from a downturn in the property market.
A toxic mix
None of these factors should be seen in isolation, but together they could create a spiral of house price decline. This is bad news for those homeowners with high levels of debt, but could in the long term be good news for those who are unable to buy a house at current prices.
As for buy to let landlords, those with high levels of debt and who bought at the peak of the market could be facing a very difficult time and could end up investing in a negative producing return asset.
In summary, there are early signs that cracks are appearing in the residential property market. It is becoming increasingly clear that this is not an “if” event but a “when” event.
Like everything there will be winners and losers, and those most likely to suffer will be homeowners with high levels of debt and properties purchased at the peak of the market. Those likely to benefit are those unable to buy at current levels because as prices decline property once again becomes affordable to the masses. (A true property cycle of decline, recovery and growth).
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.