When I was a child, we went to Spain most summers. We flew to Malaga, then we drove along the coast to Velez Malaga, turned inland and headed into the mountains to a tiny village just beyond a slightly less tiny village called Periana. It took three hours and destroyed the average hire car. These days, the flight is more trying than it used to be. But the drive takes an hour and, on last week’s visit, we lost just one hubcap.
However, it wasn’t just the car rental bill that surprised us on our return this year. It was the remnants of the property bubble. The fact that much of the Costa del Sol is an overdeveloped hellhole is hardly news, but I wasn’t expecting the signs of mania to have moved so far inland. The road to Periana is almost entirely flanked by flats and mini villas. Most are half-finished: some have reinforcing rods sticking out of top storeys, suggesting there once was more to come; others are windowless; and more are completed but deserted.
It is hard to see how the market will clear. If Spain left the euro, the new peseta collapsed, and impoverished pensioners from the UK could pour in to survive in the cheap warmth, you might just match supply and demand. But failing an expectation of that, you would have to have a particularly high-risk tolerance to invest in today’s Torre del Mar.
In the UK, things aren’t quite so obvious. There are no half-built blocks, no empty resorts, no billboards outside ageing developments promising 100% financing.
At the same time, buy-to-let investors are thrilled by the fact that tight credit and high prices mean the number of people being forced to rent rather than buy is rising fast. According to the Halifax, 64% of renters aged 20-45 do not think they will ever be able to buy. They can’t come up with the right deposits or persuade mortgage lenders that they are a good bet (67% see little point in even applying). So rents are rising, and we are apparently soon to be a ‘nation of renters’ – a state of affairs that will make those cashed up and clever enough to buy the right portfolios of flats very rich indeed.
But this is, of course, nonsense.
The truth is that buying to let in the UK now is no less dangerous than doing so in Spain. The bulls are keen on pointing out that gross yields currently come in at about 7%.
But while that sounds nice, it is pretty pathetic. Take off maintenance, voids and bad tenants and odds are that the average net yield is well below 3%. Take inflation at around 4% into account and the real gross yield is, at best, 3% – making the real net yield almost definitely negative.
When prices are rising, that might not matter to an investor. When they are falling, it has to. And, while bare reinforcing rods aren’t exactly the norm in the Home Counties, UK house prices are falling and will continue to do so.
The key point – and the one that investors should keep firmly in mind – is that the UK base rate at 0.5% is not normal. It was never this low in the 18th century, in the 19th century or indeed in the 20th century. Up until our recent crisis, the floor for rates was always 2%. It has also always hovered a couple of percent above inflation and that is, eventually, where it will return to.
When it starts to do so, mortgages will become less affordable, the forced selling will finally begin, and prices will fall. A report just out from Morgan Stanley has house prices down another 10% by the end of next year (so, 15-18% if you include inflation).
This isn’t good news for landlords. Not only are they likely to make capital losses, but falling prices mean we won’t be a nation of renters for long. When prices fall to the right level (or overshoot on the way down) and credit returns, renters will turn into buyers and we’ll be back to our usual status – as a nation of frantic property-ladder climbers.
When will that be? Back in the mid-1990s, the average gross yield was around 9.5%. That may not sound much above the 7% being claimed today, but it is. Then, consumer price index inflation was 1.6%, so the real gross yield was not 3% but more than 8%. That’s the kind of number would-be investors should be waiting for if they really want to catch the bottom of the market.
● On another matter, I wrote here recently about the difficulty of getting exposure to a basket of Asian currencies. However, if you aren’t bothered about the basket bit and just want to hold renminbi, there is a simple way to do so. Go to the Bank of China (in London, Birmingham, Manchester or Glasgow) and open a sterling account and a renminbi account. Then, put money into the former and transfer it to the latter. Now you hold renminbi. I haven’t tried this myself, but am assured by the Bank of China that it is very straightforward.
• This article was first published in the Financial Times