The property market is made up of the twins, Supply and Demand, of which the first born, by a short time, is Demand. Where Demand goes Supply follows.

Demand is driven by a desire to improve itself, to make money or live well. Or both. Its ambitions are limited by experience and knowledge and tempered by (lack of) money. Given ready access to money, Demand tends to let its ambition flourish.

In the last 15 years there has been a surge in the availability of money. This has not been a minor change but a major one. It has become much easier to borrow more, from several different sources, and the loans have become more affordable with low interest rates.

 House Prices-Mortgages Granted + Buy to Let Mortgages 1990-2010

Risks Rediscovered

The August 2007 rumpus in the financial markets, a long overdue cold shower after a long financial run, means that lenders are more aware of the risk of default. Some reduction in the availability of loans for the least able to repay is already evident.

But this has not yet touched the majority of those already on the housing spiral ladder or who want to borrow for buy-to-let. Increases in borrowing rates, over base, are relatively small, so far, and off-set by reductions of the base rate. The majority of existing owners feel no worse off.

Buy to the Limit of Borrowing

People tend to buy up to what they can borrow. This pushes prices upwards when borrowing is easier.

We have now reached a point where the amount of net disposable income paid out to own a house has reached similarly high proportions to the peak of the last housing market bubble in the late 1980s/early 1990s.

There is growing evidence that first time buyers are no longer even trying to get on the housing spiral ladder, intimidated by the scale of the debt they need to take on.

This is one of two very important factors that may actually signal which way the market is going to go.

For the majority of people who already own a house, and want to buy something more expensive, they first need to sell their existing home. All of these moves are under- pinned by someone buying the lowest value house, enabling everyone else to move up a rung.

There are two broad types of purchaser for the lowest rung – the first time buyer and the buy-to-let investor.

The second market signal is that, in the absence of first time buyers, the market has become dependent on buy-to-let purchasers at the first rung of the ladder.

This category of buyer is driven by two factors. The first is rental income to cover costs and the second is the belief that house prices will continually rise, or at least not fall. This can loosely be described as the dominant ‘market sentiment’ in that sector.

If a buy to let purchaser has high borrowings it is quite likely that their rental income does not cover their borrowing and other costs. The headline monthly rent may well do so but after letting fees, empty periods (‘voids’) and repairs it is not always the case.

If an investor feels that capital values will decline he will not buy into that market when he needs to borrow a lot, because total returns could quickly turn negative.

Following a small downward step in the market, a pause for thought, in mid 2005 demand has continued unabated until very recently. Looking back at house prices over the last two years there has been a slowing of the pace of the rises but prices have not fallen in the south east (they have in some limited other parts of the country).

Depending on which statistic you go by, prices have risen in the first half of 2007 by about an annualised 9.5%. Whilst this is a slower rise than 2006, it is still a rise.

More tellingly, the number of mortgages agreed to be given has fallen from a high of 128,000 in November 2006 to 109,000 in August 2007 and 102,000 in September. Take out the seasonal variations and there is still a trend of less market activity.

Look at the graph below for house prices versus mortgages agreed, 2004 to 2007.

 house_prices_-_mortgages_granted_2004-7_qtrly

Changing Demand

House prices continued upwards when the number of buyers (approved applicants for mortgages) has been declining strongly. This reflects two broad trends.

Firstly, a change in who is in the market to buy - demand. There is a declining number of first time buyers and an increasing number of buy-to-let purchasers, as well as a growing feeling amongst buyers generally that they should hold back from commitments to new, larger borrowings. The anticipation amongst buyers of a price correction is a large part of this hesitancy.

The restriction in availability of mortgages for those least able to afford large borrowings, brought on by the credit crunch of August 2007, has magnified this trend but is not the sole cause of it.

The second trend is a heavily restricted supply.

It is certainly true that the production rate of new houses is low. The gummed up planning system is, frankly, appalling. The new, ‘more flexible’ planning system that the government is trying to bring in is worse than the old one and is further slowing supply. This is not going to change any time soon.

But new houses are less than 10% of all houses sold in a year. The greater part of the market is made up of existing homes and this is the sector we should watch.

With impeccable bad timing the government has introduced Housing Information Packs, the cost of which puts off people offering their houses for sale. The number of selling instructions received by agents has fallen again in September 2007, following the introduction of HIPs for three bed houses.

The government has also announced a change in Capital Gains Tax, reducing the tax on gains from April 2008. Many buy-to-let owners who may have been thinking of selling are now quite likely to wait until April 08 to sell. There is then likely to be a glut of properties for sale which, if the market has turned down by then will accelerate any downward price momentum.

This restricted supply should put prices up, shouldn’t it? Yes, but it hasn’t.

In September and October 2007 house agents actually reported that prices moved into negative territory in the south east, not growing at all. This has not yet shown up in the government’s house sale prices which lag about two or three months behind house agents reports of deals done.

London’s prices are skewed, up and down, by City bonuses and foreign buyers but that focused sentiment rarely affects the suburbs. Outside the hot spots of London market prices are stable with pockets of slowly slipping prices.

So what! Isn’t this just another pause for thought before a further surge? After all, they are not building houses quickly enough for the demand.

One string of logic says that there should be no more than a levelling off of prices, recognising that employment remains full, the economy generally is mildly positive and immigrants are buoying up demand.

An alternative view is that this restriction in supply could be masking an otherwise sharper slowdown in prices. When the shock of HIP costs has worn off, and supply increases again, medium term trends may become more visible.

Sentiment, confidence, momentum. These are what drive markets. They are not always logical.

In the early 1990s so many of us said that there was no reason for house prices to fall.

Market fundamentals were sound, we said. They are not building enough houses for predicted demand, we said.

But first time buyers were priced out of the market and buy-to-let had hardly been heard of. When first time buyers stopped buying, the market unwound like a spiral staircase collapsing on itself.

In the long term investing in property is a good thing to do. Not least because, in the case of your own home, you can live in your investment and enjoy it.

If the economy does slow then interest rates are likely to fall, relieving, to some extent, the cost of servicing your loans.

However, if the burden of paying for your home is becoming unbearable, history tells us it is better to sell early rather than hang on and get caught by a falling market. Moving to a smaller house may not be a bad thing to reduce your risk.

Investors will need to take a wider view. If you are young(ish) and a buy-to-let investment is your way of saving for a pension, then taking the long view and riding through the dip may be the best way forward.

If, on the other hand, you have made many investments and, collectively, they are not covering their costs with true net income, then think about reducing your exposure by perhaps selling some of your property investments. If the market does fall you can come back into the market when the signs are better, reaping a further reward.

Waiting until the April 2008 changes in Capital Gains Tax may save you 21% of any gain (perhaps 5-10% of the sale price if you bought recently) but if prices drop that much then there is no net benefit.

The worst thing you can do, if you are having difficulties meeting your borrowing commitments, is to ignore the issue and hope it will go away.

Banks have been able to be tolerant of minor transgressions in payments over the last few years but that is changing. Banks will be looking more closely at defaults and may decide to get tough. The number of repossessions has been increasing although still represent a tiny number compared with the early 1990’s.

If in doubt, talk to your bank and agree a plan with them. They will help if you are addressing the issue. Not talking to them can induce an unpleasant reaction.

If your property investments are adequately covering their costs, and giving you a positive income, then you may be able to ride out any dip in the market. You have the luxury of being able to wait to see which way the market goes.

This long view should cover at least a ten year period.

If you need to realise your investments within that ten years, then you may decide to take some of your capital profits now and sit quietly on the rest.

If you would like advice about your property investments, please phone Denise Ford or Dan Parkes on 01634 294994.

[Keep reading this Overview – the next article will be about commercial property investments.]