Will interest rates rise – and if so, when? And what will that mean for our property values? John Stepek chairs our Roundtable discussion.
John Stepek: Where are we now in the British property cycle? Incredibly expensive, just expensive – or cheap?
Jeremy McGivern: Comparing where we are now with the last cycle, I would say – 1998. It’s classic cycle stuff. Everyone says prices are too high – I’ve got some newspaper quotes from 1998 to 2005 and it is astonishing how bearish they are, just completely wrong. As in 1998, you’ve got problems in Asia – which is why I’ve been advising clients not to buy high-density new-builds, which have been disproportionately popular with Asian investors, for about the last year and a half.
We’ve got problems in Russia too, which in the 1990s led to the collapse of the Long Term Capital Management hedge fund. Yet it had absolutely no effect on the property market. The City is convinced there’s a correlation between share and house prices – but there isn’t. Graph after graph proves that – except when a land-price-induced crash causes the banks to crash, as we saw in 2008.
John: So what’s next?
Jeremy: In every cycle, the top end of the market explodes higher first, because they’re the only people with any cash – the only ones the banks will lend to. That’s why there’s this huge disparity between London and the rest of the UK.
John: So you think the rest of the UK will catch up? Or will London fall?
Jeremy: I think London will go up slowly, and the rest of the UK will catch up. But avoid those pockets of off-plan new-build developments.
Dominic Frisby: Jeremy, if this is 1998, we’re on the cusp of another ten years of bull market. But you suggest we’re also on the cusp of a huge crash in new-builds – there’s a contradiction there, isn’t there?
Jeremy: No – the new-build market is 70%-80% international buyers. Their cycle is out of sync with ours.
Tristan Chapple: Look at Barratt. It’s the UK’s biggest housebuilder – so I’m not talking London, I’m talking nationally. About 10%-11% of its sales go to investors. Of those, approximately half are cash buyers, and only some don’t pay tax. So international buyers are a small proportion of housebuilders’ sales overall.
Jeremy: Savills has said that only 10% of investment properties in London are bought by foreigners. It just seems much higher because of new-builds such as Battersea Power Station, where there’s a high density of international buyers.
James Wyatt: I’m hearing stories every week of non-completions. On new-builds, people are trying to flip them at 20%-30% discounts off the price they bought at, and they can’t – there are just too many. And prices in some parts of prime central London are down 5%, 10%, even 15% over the course of the last year.
Tristan: But isn’t that because – when you get to central London valuations – prices defy any kind of rationality?
Ed Mead: Yes, the centre of London really has become disconnected from everything over the last six, seven or eight years. I’d ignore it. If you focus on areas slightly further out – like Clapham, say – where, dare I say, normal, wealthy, domestic English buyers are buying, you’ve seen prices shoot up then start to level off. And I think that will ripple out across the rest of the country. Overall, I agree with Jeremy – I think that people who say that prices are about to drop are just living in cloud-cuckoo-land.
Tristan: I’m from Bristol, which I’d suggest is closer to normality than anywhere within London. Talking to “normal” people there – those with household incomes of around £30,000-£50,000 a year – the things that drive the willingness to buy a house, such as wage growth and employment, have only started to approach normality within the last 18 months. That’s why I think we’re at an early stage in the cycle.
It would be easy to think that what we see in London just now is going to happen in the regions. I think we’ve got years and years of volume growth and gradual house-price rises ahead. The median house price – UK-wide – in terms of actual transactions is about £100,000. People assume it’s far, far higher than that, I think.
John: What’s your take on the “Northern powerhouse” – the government focus on development up there?
Tristan: I don’t think the government can mandate or do anything that can regenerate housing in the short term. Fundamentally, the housing market is driven by supply and demand.
John: Of money, or houses?
Tristan: Of houses.
Ed: Or supply of profit. A house builder builds in the south of England for profit – so what does it cost? Is there a difference between building a house just outside Scunthorpe, and one outside Guildford?
Tristan: That’s the problem. It doesn’t make economic sense to build a house in the areas you’re talking about – it’s cheaper to buy an existing property.
Ed: Exactly – the point is, the government has to mandate to build in those areas if housebuilders are going to do it. Why build if they’re not making a profit?
Jeremy: I used to own property up in Sunderland – a two-bedroom and a three-bedroom house. Total cost was £50,000 and the rebuild cost for each was for £80,000 and £60,000 – the land had negative value. So yes, a builder can’t build there without a mandate from the government. But if you spend big on infrastructure, then money will go there. That’s why Slough in 20 years’ time will be the Acton of today, just like the Acton of today is the Notting Hill of 30 years ago.
Reading, I think, has outperformed every other part of the property market in the last two years, because that is the start (or end) of Crossrail. This is how property prices go up and up – when the infrastructure improves. It’s that simple.
John: What about the recent buy-to-let changes? Will they have much impact?
Jeremy: It’s unlikely to have a huge effect on prices. But the risk is that rich buyers and investors will focus on lower-value properties as the stamp duty is less onerous, so this is not good news for first-time buyers. Developers in London who rely on international investors might also start offering to pay the 3%.
Ed: I think the Bank of England has a distorted view of who buy-to-letters are and the risks involved. More than 50% of these people are cash buyers and the majority are buying for their children, or have nothing else to invest in – so they’re not fly-by-night, “head for the exit at the first sign of a rate rise” types. Why did George Osborne do it anyway? To give first-time buyers a chance?
Jeremy: Well, no – to win votes. But for first-time buyers, it’s “look at those horrible rich, buy-to-let landlords”.
Dominic: I happen to think it’s a good thing – buy-to-let investors should compete on level terms with first-time buyers. But Osborne is just attacking the market, rather than the underlying causes of the housing crisis. It is a betrayal of the Tory heartland to an extent, but Osborne probably thinks, “I can get their vote anyway”. The main thing – for him, at least – is to occupy the centre.
Tristan: Ultimately, we’ve no way of knowing the impact of this measure because the housing market is far more complex than that. But it’s worth remembering that since the downturn the private rented sector has grown from roughly 10% of tenure type to 20% or so. So this is just one of a number of measures the government is taking to nudge the market away from renting and back towards ownership – this is a Tory government, after all.
Ed: I rented for 25 years and never had a problem with it. I could move when I wanted, put money into my business – there are lots of good reasons to rent. The problem is there are not enough good rental houses. I’m not saying you should have three- or five-year minimum contracts. But no one over here has managed to replicate a decent German model, where you have fantastic rental properties. That’s my biggest issue with this change – who’s going to supply the rental properties?
Jeremy: But the young are still being screwed. And they tend to be the ones who rent.
Ed: You mean the “me, me, me” generation, where everyone expects to be able to buy at 21?
Dominic: They should be able to buy! We’ve got the land, and you can buy a three-bed, timber-framed house on the internet for £20,000-£25,000. It’s not unreasonable for a young person to expect cheaper houses in the same way that they can afford cheaper clothing and cheaper food.
Jeremy: But cheaper food and clothing is because of cheaper land and labour in other countries.
Dominic: It’s also due to dramatically improved productivity. But that applies to houses too – we are now able to build houses for an extremely low price. The only issue is the distribution of land ownership.
Tristan: It’s not just that, it’s planning permission – although the planning system is slowly being tweaked to allow more development.
John: On that, I was looking at “change of use” figures today. The amount of commercial property being converted to residential is up about 65% on the year. Isn’t that a significant source of supply?
Ed: No, it’s not. What happened is that there was such a stampede to take advantage of the development rule changes that there is now suddenly a shortage of office supply. Rents have doubled in places such as Hammersmith, Fulham and even further out. But what would you rather do?
Rent your building to one commercial landlord and get the same yield across the board, or convert the thing and have four or five irritating short-term tenancies that you’ve got to manage? That’s why the trend you mention is going to plateau. But getting back to first-time buyers, I didn’t buy my first house until I was 35. Renting’s vastly underrated.
Dominic: As someone who rents, I agree, but property, particularly in London, is a huge status symbol. Those who own have done incredibly well, and not necessarily through their own endeavour. When people ask, “where do you live?” the subtext is almost “what are you worth?”
Ed: If more people rented and invested in businesses, rather than investing to support a house, we’d be better off.
Jeremy: Absolutely, but this country gives incentives to buy property. My brother just sold a business and he was looking online the other day and saw a flat in London that he owned ten, 12 years ago. He said: “That flat’s made pretty much as much as I made. I could have sat there twiddling my thumbs and watching Sky!”
Tristan: But for the vast majority, property is not a discretionary purchase or a piggy bank – it’s just something you buy at a certain age. In fact, I think it’s far more socially acceptable to rent in London than outside. Outside London, if you’re renting and in your late 20s, you’ve failed. People wonder why you haven’t bought yet. You reach a certain age, you meet somebody, you settle down and that’s what you do. It’s as boring as that.
Dominic: Has turnover risen at the lower end of the market? Obviously it has dried up at the top due to stamp duty.
Tristan: Post-2008, volumes fell from 1.3 million to about 800,000 a year. They’re slowly rebuilding now. The north’s been lagging in terms of volume and price appreciation, but it looks like it’s starting to catch a ripple effect from the south.
James: Yes, volumes are way down, but don’t forget, 20 years ago stamp duty was 1% across the market. That kept the cost of moving low and encouraged flexibility in the workforce. Stamp duty at 12% – admittedly at the higher end – is a real game-changer.
Ed: As an estate agent, I would gladly trade 30%, 40% on values for three or four times the volumes, any day of the week. You can trace that gentle fall in volumes right back to the introduction of stamp duty. People thought – why spend all this money on moving when we can just improve the place we’ve got? So they gave the money to a local Hungarian and Polish builder who sent it back to Hungary and Poland instead.
John: If you had to buy a house in this country right now, what areas would you favour?
James: I’d still go for Somerset.
Ed: The West Country or the north of the UK. Parts of the country have corrected and look pretty good value, in real terms.
Jeremy: Anything with infrastructure coming – Crossrail, the Northern powerhouse – Birmingham might be good.
Dominic: The main criteria if you’re buying a place to live is to buy somewhere nice. In London, the southeast is cheap. Birmingham, for all the jokes people make about it, has really nice bits. And Bristol’s a fantastic city. But I think there will be some big opportunities in prime central London in about a year or two’s time, if this new-build bubble pops. And the edges of central London, Clapham etc, they’re not healthy because the first-time buyers can’t get in there.
John: Is it still worth buying shares in housebuilders, Tristan?
Tristan: Barratt Developments is the biggest shareholding in our portfolio, which probably tells you what you need to know. When it comes to housebuilders, we’re not worried about what’s happening this year or next, due to a tweak in interest rates or a negative headline. We’re looking at fundamental supply and demand factors that will make this a great investment over ten years. It’s more than a decade since economist Kate Barker said we needed to build 240,000 houses a year. Instead, we’re building at a rate of 140,000 to 150,000 a year. So we feel quite good that we own the country’s biggest house builder in that environment.
John: But if we need all these houses and they’re not being built, where do all the “spare” people live?
Ed: With their mum and dad.
Jeremy: The figures are wrong. Those figures were based on a census that was out by about a million houses.
Tristan: But it’s not just Barker, there’s been a number of studies.
Jeremy: So why aren’t there more homeless people?
Ed: Aren’t there 700,000 unoccupied properties in the UK?
Tristan: There are always pictures of streets where you can buy a house for £1, or £10, or £1,000. In America, you can go to Detroit and “buy” a house for literally nothing because nobody wants to live there. There are parts of the UK like that. But that doesn’t mean nationally that there isn’t undersupply.
James: When I left university in the early 1990s, no one had a sitting room because everyone was using it as a bedroom. Now, if I look around at my neighbours in London, everyone’s dug down, dug out – literally built everywhere. So, I appreciate there’s meant to be a housing shortfall, but most houses, having been two up, two down, now have four, five, six bedrooms. They’ve just been expanding rather than trading up.
Tristan: Who knows if it’s 250,000 or 300,000 that we really need to build? The question is: do we need more than we’re building now? And nothing suggests we’re anywhere near the right level.
John: Does anyone think interest rates will move over the next year and half?
Ed: No.
James: I think the Bank of England should slowly raise rates by half a per cent every six months so that people realise there’s a cost and a risk to lending. But I don’t see that happening – the Bank’s too frightened. We could be looking at low rates for at least another five to ten years. The only potential problem is that right now we sell 30% of our government debt to foreign investors.
If they start to get worried about our national debt going up by £100bn a year, we could have a run on the pound. It’s unlikely, but it’s a greater possibility than most people realise. That’s the only thing I could actually see forcing a rise in interest rates.
Jeremy: Even if rates go up, there’s a consensus that they’ll go up slowly. Between 1990 and 1992, rates went from 10% to 16%. My first mortgage was 12.5% in 1996. You’re just not going to see that. And the mortgages that have been put out over the last five, six, seven years are rock-solid – the borrowers know that if rates went up to 5%, they could still pay their mortgages. In fact, I’m looking forward to when they do start raising rates and everybody stops talking about it as if it’s some dreadful thing.
Tristan: I think with wage growth at 3.5%, the population could withstand gently rising rates over a period of years.
James: That’s why they should do it now rather than be forced into a hurried reaction if something calamitous happens.
John: We’ve been doing this Roundtable since before the property crash, and I’d say this is the least bearish one we’ve had. That said, obviously James Ferguson isn’t here… but I don’t think anyone here fundamentally disagrees with Jeremy’s assessment that we’re only at 1998 as far as the cycle goes. Is that fair to say?
Dominic: London and the rest of the UK are two different markets. But I agree that we’re in 1998 for the rest of the UK.
James: The London market will continue drifting down. Osborne’s changes have taken the heat out and allowing the rest slowly to start to catch up. So nationally, prices will rise. But in London, the domestic market’s not there. A solicitor, a partner at a law firm, now has problems buying into Fulham or Battersea, or other secondary areas. The base of the pyramid is not there – it’s too weak.
Jeremy: But this has always happened. This is why London’s expanded. That’s why Earlsfield is now popular, why people now see Shepherd’s Bush as a bit desirable. In 1996, I bought a four-bedroom house in Shepherd’s Bush for £198,000. It’s now worth probably £1.6m. In 2002, house prices in Bromley were 10.4 times earnings, and people were saying the market would crash. The house price-to-earnings ratio (see chart) is not as important as everybody thinks.
Tristan: Yes – in America there are areas that have maintained very high house price-to-income ratios for generations – because it is not incomes driving values, it’s capital. There are parts of Texas, California, Manhattan and New England where incomes just don’t matter at all to house prices. It’s the same in London.
Dominic: Anyway, I don’t think interest rates are going anywhere. Like you say James, they are too scared. Low rates are the new normal and they are here to stay.
Jeremy: It will go horribly, horribly wrong, ofcourse. The next crash will make 2008 look like a tea party.
John: So, given where you think we are now, Jeremy, that next crash is in – 2025?
Jeremy: I’d agree with that.
James: Yes, I think you’re probably looking at eight to ten years. We’re so indebted that the tipping point will come. That’s when you’ll really need your gold or your bitcoins – your shotgun.