Not long now, a fund manager said to me the other day on the way out of a round table debate on the future direction of stock markets (the consensus was that markets will be down). Not long until what? Until you can finally buy a house, he said.
Seems that my refusal to handcuff myself to the property ladder alongside the rest of the country has become something of a standing joke in the financial community. Good news then that it looks – to me and to most of them – more and more like I’m about to have the last laugh.
The big news last week was the crisis at buy-to-let mortgage lender Paragon (PAG). It has become the latest victim of the credit crunch. Much like poor Northern Rock (NRK), its business model is based on borrowing in the money markets to finance loans, but now – again much like Northern Rock – it is finding borrowing hard to do. So it is lining up an emergency rights issue.
This might seem no more than a technical issue in a sub sector of a much bigger market. But it’s more important than that. Paragon is Britain’s third-largest buy-to-let lender and the result of its misery – the shares fell 38% on Tuesday – is that it is in effect backing out of the market.
Its chief executive, Nigel Terrington, expects lending for October to March to be half that of the same period in 2006-7. This means there will be much less competition in the market. And falling competition always means one thing – rising prices.
Worse, this comes at a time when mortgage lenders, desperate to recoup some of the money given away in the loose credit environment of the past few years, are already pushing up the cost of lending.
Standard Life shocked us all last week by bumping up its standard variable rate (SVR) to 7.46%. Why shocked? Because this just isn’t done. Usually lenders wait for a rise in Bank rate.
At the same time, lenders are hiking fees: take out a two-year fixed-rate mortgage from almost any provider these days and you will end up paying an arrangement fee of at least £1,000.
This is all horrible news for buy-to-let investors. Back in 1999, 73,200 buy-to-let mortgages were approved. Last year 850,000 were. Even more amazingly, a quarter of net new mortgages in the first half of this year went to buy-to-let investors.
Clearly, a lot of people were convinced they were going to make a lot of money. Unfortunately, they are probably wrong. Why? Because the numbers don’t add up. The rental yield on property is 3.5%-4%. The base rate is 5.75% and many buy-to-let mortgage rates are much higher than that.
Buy a flat now and you are going to have to subsidise it, and the lucky tenant living in it, from your cash flow every month. That means your after-tax income in most cases.
This isn’t in any doubt. Even Stuart Law, the relentlessly optimistic chief executive of property company Assetz, said that “an investor buying an average property may expect to lose around 1% of the property price due to rental shortfall in their first year”. So why would anyone get into property investing at all?
For some years there has been a simple and rational answer: investors are willing to subsidise the lifestyles of their tenants as long as they are making capital gains. What’s a couple of grand when the value of your property is rising at 10% a year?
The problem now is that the value of your property is not rising at 10% a year. Far from it. Look at the indexes. Every single one – including those issued by Hometrack, Rightmove, Nation-wide and Halifax – showed prices falling in October.
Estate agents tell me the market changed with lightning speed in the past two months. In some city centres prices of new-build flats are said to be down 30%-40% – and things aren’t much better in the countryside.
One agent in the southeast said hits on his properties listed on the internet are down 80%. He has very few buyers and those he has are demanding cuts of at least 20% on asking prices.
Anyone who doubts the veracity of this anecdotal stuff need only visit propertysnake.co.uk, which details price cuts in Britain. It is getting very full indeed.
You’d still be hard pushed to find an estate agent or mortgage broker forecasting a crash. But there is no doubt at all that the UK’s housing bubble is deflating – and quite fast.
I’ve written before about the idea that buy-to-let could be our version of America’s sub-prime loans – which kicked off the property meltdown – and I still think it will be. We are constantly told the sector is safe because default rates are at record lows. But this is rear-view mirror stuff. When your asset is rising in value it’s worth sacrificing other spending to keep it. If you can’t find the cash you can always sell it. So defaults are low.
Things change when prices are falling. There’s no incentive to suffer a depreciating asset, particularly when you don’t even live in it. People will fight for the homes their children live in but not for an identikit two-bed flat bought off-plan in Leeds.
I don’t think anyone will be talking about record low default rates this time next year. I don’t think many people will be queueing for buy-to-let mortgages either. As my fund manager friend says, not long now.
First published in The Sunday Times 25/11/07