PropertyInvesting.net: Property Investment Special Reports

208: UK Market Update – is it all gloom?

07-20-2008

 

PropertyInvesting.net team

 

Gloom: Yes – it looks pretty bleak at present. Our prediction of -8% property price decrease in 2008 in the north and -4% in the south is now looking on the optimistic side – it’s heading for more like -10%. What we warned early 2007 was that -  oil prices rising significantly above $80/bbl would be the key risk – we predicted oil prices at $125/bbl by end 2008 and they have already surpassed this level unfortunately. So it’s hardly surprising there is a major retraction in the UK housing market because high oil prices feed through into consumer and energy price inflation, which acts like a tax and reduces disposable income. If people earn £25,000 a year and have to spend an additional £300 a year on energy bills and £300 on petrol bills, that’s about 3.7% of their after tax income. Any wander people cannot afford higher property prices.

 

More Negatives: A few other negative things that have happened since mid 2007:

 

• Credit crunch – mortgage approvals are down 37% on mid 2007 levels
• Interest rates have risen to 5%
• Heavily discounted mortgage rates have disappeared – hardly any of the interest rate drop after the recent 0.25% base rate decrease was passed on to customers
• Northern Rock when bust and had to be saved by the government
• Unemployment has started rising, albeit very slowly
• Inflation has risen from 1.8% to 3.2%
• GDP growth has slowed from about 3% to ca. 1.7%
• Manufacturing and retail growth have stalled – the services sector has been hit hard
• It now looks likely the “Golden Rule” will finally be broken and the UK will be borrowing more than 40% of it’s GDP
• Tax receipts from personal and business have dropped
• Oil prices have risen from $70/bbl to $130/bbl – energy oil/gas/coal prices have all risen
• Food prices have risen sharply
• Employment levels remain high, but this could deteriorate
• Building levels are predicted to crash to ca. 130,000 net properties a year from over 200,000 in 2007
• First time buyers have all but disappeared from the property market
• Public sector spending is likely now to slow since the government has run out of spare cash

 

Positives: Is there are good news out there for the property investor? Indeed yes:

 

• It could be a lot worse! And property prices have after all risen ca. 250% in the last 10 years
• Inflation at 3.2% with $130/bbl oil prices under these circumstances is a major achievement
• Income levels are still rising, albeit at ca. 3.2% rather than the 4.0% to 4.4% in 2007
• The UK is almost self sufficient in oil – hence government tax receipts are massive – both on oil companies and the private individual at the petrol station – they extract 90% of the oil wealth in taxes and this improves the government’s finances (and can be spent keeping public sector employees in work, who then purchase property – this in turn supports property prices)
• The rental sector remains strong, with some rents rising, others dropping slightly but plenty of demand out their in most areas
• The affects in the US  of the credit crunch are beginning to wane and this is likely to be followed by a waning in the UK (6 months delay compared to USA)
• Affordability levels for first time buyers have started to improve, albeit they probably have quite some way to go
• There is talk of a stamp duty holiday to entice first time buyers back into the market – this could help support property prices
• The level of building has crashed – latent demand is probably moderately strong when there is an upturn and a future housing crisis could develop quickly. This would again raise house prices because the level of building compared to population growth and demographics (particularly in southern England) is dangerously low
• A bit of inflation is not such a bad thing for property investors since over time, debit levels reduce in real terms – deflation is the economic issue to be most concerned about

 

Deflation Risk: As Japanese property investors will tell you, if property prices decline, inflation is negative and wage growth is negative, the debit levels never drop and a long slow decline takes hold. People stop spending, recession takes hold and property investors are saddled for years with bad debit. Not a pretty outcome – we hope this does not happen in the UK from 2008 onwards. It’s more likely we’ll get something like inflation at 4%, GDP at 1.5 to 2%, wage growth at 3.5% and property prices declining by say 5-10% a year for a few years. The property prices likely stabilizing then starting to pick up to inflation at 4% a year. The good news is, every year, the relative size of borrowing in real terms reduces by 4%. Okay, wealth is not created, but its not a doomsday scenario.  

 

Outlook: So overall, be believe there are worse times coming up, but a lot has to do with the oil price. If the oil price drops below $100 (we consider this unlikely) then the UK growth rate will rise and inflation will drop – and property prices would likely recover quickly.

 

But of oil prices stay at $130/bbl or go higher, we would expect continued weakness in the UK property market – higher inflation, possible strikes, disputes, demonstrations, petrol shortages, lack of confidence and house prices dropping further – possibly much further.

 

Stagflation Risk: Now the government has spent all the money from the good times, and is saddled with huge debit just before facing a slowdown (or even recession) then UK PLC has it’s hands tied. The Bank for England are better a rock and a hard place when it comes to balancing inflation and growth – it could develop into “stagflation” – that is, high inflation and zero growth. Expect some public sector jobs losses – slowing public sector spending and more stealth taxes – you probably won’t even notice.

 

Good news: The positive news is, the UK and London remains the most dynamic global financial market in the world (New York is also up there of course) and a base for wealthy investors, private equity, oil and mining companies from all over the world. It will take a global recession to knock London off it’s feet. So as we have advised for the last four years, any property within a 50 mile radius of London will have benefits from this massive economy. Even despite the credit crunch, we have not been hearing of mass city lay-offs. City bonuses were higher in January 2008 than at any time in history. Yes, there has been retrenchment, but with the East London regeneration, Eurostar to Kings Cross/Stratford/Ebbsfleet, Olympics and population growth with international business connections, we see developing areas of central London as good investment areas during the downturn.

 

Avoid: We would avoid far flung country areas and holiday homes (west and north-west Wales, Cumberland). And manufacturing dominated centres in the Midland and North (Birmingham, Nottingham, Liverpool, Newcastle, Middlesboro).

 

Invest: We have not changed our view that areas in London - Bow, Battersea, Stratford, Hackney Wick, New Cross, Peckham, Elephant & Castle and Southwark are all favorable for longer term regeneration and price increases. Further out – because of the Eurostar - Gravesend, Southfleet, Dartford, Northfleet, Rochester/Stroud and possibly Ramsgate are interesting. In the west, Newbury, Chiswick West London are also interesting. West London – Chelsea, Kensington, Knightsbridge, Fulham should be okay – there is too much global wealth from the Middle East, Africa and Far East for these areas to suffer too much. In the north, second hand property in Manchester and Leeds are probably some of the safest bets. Regenerating parts of Manchester are probably a highlight. Bradford is also low priced and improving.    

 

Cash is King: But best not over-extend oneself since worse times could be just around the corner – serious investors need to make sure they are “bullet proof”. Cash is king. Cashflow is all important. And you need to protect yourself from running out of cash as the prime part of your business plan. Nine out of ten businesses fail because they run out of cash – so if you don’t run out of cash you’ll likely succeed in business – sounds almost too simple to be true. But of course we all know it isn’t – generating a monthly positive cashflow in property investing can be challenging and needs focus, hard work, commitment and discipline. And we’re always at the mercy of interest rates rising and tenant demand dropping, plus house prices crashing. But the rewards if you get it right can be fantastic. Financial freedom. Setting your own agenda. Choosing what you want to do in life.

 

A Stock Market Comparison to UK Property: For those property investors that may be starting to doubt whether it was a good plan to invest in property, you might take heart from the fact the FT100 index dropped to 5150 last week from about 6600 earlier this year – that’s a massive 22% drop in six months. And the FT100 is lower now than when Tony Blair came to power in 1997 – despite inflation at ca. 2% per annum – that’s equivalent to an inflation adjusted drop of 24% in 11 years. Meanwhile property prices have risen 250% - or about 225% when adjusted for inflation. We cannot find the people that have managed to make serious money from the stock market - you need to be in the top 1% performance to make 20% return a year – this is Warren Buffet type performance (he’s made 22% a year for 35 years) and we cannot claim to be anything like as good as this master at investing! So for those that got in 9 to 11 years ago, you’re probably up there with Warren Buffet!   

 

Contagion Risk: And as our 2.4 million website visitors a year will attest, it’s never easy, it’s never certain and no-one really knows what’s just around the corner as contagion and panic can set it and alter markets dramatically, in a short space of time. Anyone that reads the newspapers would think the meltdown has started!

 

Positives about UK: That said, the fundamental for the UK still appear reasonably positive:

 

• Highly educated workforce, innovative, hard working
• Low wage immigration keeping wage pressures under check
• GDP growth at 1.8% despite the gloom
• Olympics in London 2012
• Self sufficient in oil and almost in gas
• 20% of electric power by nuclear
• Growing population – many young Europeans moving to UK
• London is business friendly – great place to live for wealthy investors
• Government will either have to markedly improve or will be voted out – this should help business and investors in a 2-4 year timeframe
• Tax outlook in 2-4 years time is likely to improve
• University and market towns are great – so is the countryside (85% of the country)
• London and major cities have good public transport (when compared with USA and Africa etc) – they are relatively energy efficient compared with many developed countries 
• UK is relatively robust to high oil price rises
• Population capable of adapting to changing circumstance – learnings from the 1980s
• English spoken – the global business language
• Massive foreign investment with dividends paid within UK  

 

So it’s not all doom and gloom!

 

Happy investing.

 

 

 

 

 

 

              

 

 

 

 

 

 

 

 

 

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