House Price Commentary In Today's Ft

[uncle_monty]

Interesting piece in today's FT. Its a Q&A of readers questions. John Messenger covers the contsruction and building materials sector for RBS.

http://www.ft.com/cms/s/0/30080272-5349-11...?nclick_check=1

The most pertinent points for me are below. I consider these to be the public, and therefore conservative predictions of one of the country's most established banks. His comments will have been cleared by the senior board, so I expect them to represent the minimum HPC case.

His comments on yields suggest carnage. 70%+ nominal reductions will be required to achieve this IMO.

Monty

How much longer till a turn around in Spain/Ireland/European residential property markets and if that’s not possible to forecast could you at least describe the events/areas of the economy that would have to change for the said recovery to occur (particularly Ireland & Spain).

Arthur, unknown

JM: Arthur if I knew the answer to this one with certainty I guess I wouldn’t be sitting here – I’d be prospecting for the ideal properties for buying as and when we hit the trough! That said there are several ingredients which will be common and differ in degree in terms of their relative importance in terms of reaching a bottom in each respective market. I would highlight these conditions as follows:-

A stable mortgage market (something which the credit crunch has unravelled at present) and is a prerequisite to recovery

A level of house prices and mortgage criteria where, as a general rule, the local population’s earnings would allow such to buy into that local market at prevailing prices. I say as a general rule as there will be some markets where incomers who may buy for whatever reason may be the driver of incremental demand with higher earnings at their disposal – the Devon / Cornwall second home phenomenon being a good example!

A level of house prices where on a pure financial risk: return basis the buy to let return looks fundamentally attractive and will in theory pull in capital to buy surplus stock. In the last recession rental gross residential yields rose to 13% in the UK. I believe gross yields need to rise to approximately 10-11% from 6.4% to look attractive with an assumption that running costs and voids absorb 2% of the yield, the mortgage absorbs approximately 7.0% of the yield and the remainder is there to actually over time repay the debt (which would still require me to assume rental growth going forward to accelerate the pay down of debt.

An improving confidence as regards house prices and the fact that they really start to look ‘affordable’ or ‘good value for money’ particularly in relation to the renting option. It is difficult to persuade people to buy if the product is still showing deflation but any signs that the deflation is slowing and may revert to growth will be a key point to watch for.

A robust economic backdrop is clearly a vital ingredient which looks a challenging requirement short term here in the UK and in European markets if a slowdown creates employment insecurity. The economic backdrop being vital in order to persuade buyers that their situation is sufficiently stable to allow them to press on with such a long term financial commitment.

In Spain and Ireland it should also be borne in mind that both countries have built dramatically more housing than any other countries in Europe of North America. This has created in my view more serious oversupply issues and excess stock which will take longer to unwind than might otherwise be expected.

In Spain and Ireland the housing and construction markets, through their dramatic growth in recent years, have also become more significant components of the overall economy (in terms of their share of GDP). As a result the adjustment in demand and the need to unwind excess stock is I would argue, likely to feed back into the general economy more dramatically than in, for example, the UK as so many of the working population have been employed in the real estate and construction sectors in Ireland and Spain.

Finally looking at Spain I would also have to highlight that much of the amazing growth in housing starts has been driven by demand from UK, German and other Europeans looking to retire to the warmer climate offered by Spain. I don’t have data to support this view but I would have to be concerned that equity release from UK or European first homes will have, for many, been a key ingredient in financing an overseas purchase in Spain and elsewhere. With equity release looking increasingly under pressure as house prices fall many who have hoped to buy an additional property overseas will now struggle to do so. Also those who have tapped their existing property for equity release in recent years may now, if they need to re-mortgage, be in the difficult situation of needing equity back here in the UK in order to secure an attractive (at best) or affordable (at worst) mortgage rate on their main residence.

The other events which could clearly change the back drop relate to Government intervention – tax breaks, excess stock buy up and changes to the transaction costs associated with property purchase and sale.

If house price downturns in the last two decades are any indicator, it seems the bounce back is typically in a two year time frame. Would you agree? What you think would be a realistic view in terms of percentage falland the duration of this downturn from the peak in Aug 2007? Also, some experts say those areas with good school or suburbs will have less impact. Do you have any historical data from earlier house price falls which suggest this?

Somnath Ghosh, Manchester

JM: The last major downturn, taking the Halifax house price index as a measure, saw a peak in May 1989 and took 45 months to go to a trough in February 1993. House prices then got back to the 1989 peak in January 1998.

I would therefore argue that any bounce back will take time to re-assert itself and that we are still in the very early days of the correction. It is worth noting that unemployment actually only began to rise from May 1990 with housing acting as a lead indicator. This current cycle may prove more rapid as the decline has been so rapid thus far with house prices already 8 per cent down from the August peak on the Halifax index.

Again looking back to 1989-1994 prices only fell a cumulative 12.5 per cent nationally in nominal terms and 30 per cent real terms so the adjustment so far has been far more exaggerated in both nominal and potentially real terms reflecting the credit crunch impact on mortgage lending.

The decline in house prices I believe will be significant given the degree to which house prices have moved ahead of earnings and my belief that the real cost of lending for house purchase may have been temporarily depressed in this last credit boom but will be re-asserted as mortgage lenders re-price mortgage lending risks. Given a 30 per cent real decline in the last two major housing downturns I see no reason why we will not experience as similar and possibly larger adjustment in the current cycle downturn.

Your point on geography and local amenities and facilities is absolutely correct with house prices varying in terms of the downward pressure they are likely to experience depending ultimately on supply and demand and the trade off house buyers will make for example in terms of great state education in one locality when compared with private school fees if they opt for the house which doesn’t sit in the catchment area for their ideal state school.

I’m afraid I don’t have any data to hand but certainly looking back in the last downturn it was developments at the periphery of ‘desirable areas’ where prices saw the most dramatic adjustment. In London the development of docklands is a good example where prices fell dramatically as buyers realised that follow on development and amenities weren’t coming and the social and physical infrastructure of the area failed to match expectations.

[VeryMeanReversion]

His comments on yields suggest carnage. 70%+ nominal reductions will be required to achieve this IMO.

Funny how all rational examination of house prices points to 50-70% reductions but anyone who actually says it will have their credibility shredded.

VMR.

[abharrisson]

Interesting piece in today's FT. Its a Q&A of readers questions. John Messenger covers the contsruction and building materials sector for RBS.

http://www.ft.com/cms/s/0/30080272-5349-11...?nclick_check=1

The most pertinent points for me are below. I consider these to be the public, and therefore conservative predictions of one of the country's most established banks. His comments will have been cleared by the senior board, so I expect them to represent the minimum HPC case.

His comments on yields suggest carnage. 70%+ nominal reductions will be required to achieve this IMO.

Monty

How much longer till a turn around in Spain/Ireland/European residential property markets and if that’s not possible to forecast could you at least describe the events/areas of the economy that would have to change for the said recovery to occur (particularly Ireland & Spain).

Arthur, unknown

JM: Arthur if I knew the answer to this one with certainty I guess I wouldn’t be sitting here – I’d be prospecting for the ideal properties for buying as and when we hit the trough! That said there are several ingredients which will be common and differ in degree in terms of their relative importance in terms of reaching a bottom in each respective market. I would highlight these conditions as follows:-

A stable mortgage market (something which the credit crunch has unravelled at present) and is a prerequisite to recovery

A level of house prices and mortgage criteria where, as a general rule, the local population’s earnings would allow such to buy into that local market at prevailing prices. I say as a general rule as there will be some markets where incomers who may buy for whatever reason may be the driver of incremental demand with higher earnings at their disposal – the Devon / Cornwall second home phenomenon being a good example!

A level of house prices where on a pure financial risk: return basis the buy to let return looks fundamentally attractive and will in theory pull in capital to buy surplus stock. In the last recession rental gross residential yields rose to 13% in the UK. I believe gross yields need to rise to approximately 10-11% from 6.4% to look attractive with an assumption that running costs and voids absorb 2% of the yield, the mortgage absorbs approximately 7.0% of the yield and the remainder is there to actually over time repay the debt (which would still require me to assume rental growth going forward to accelerate the pay down of debt.

An improving confidence as regards house prices and the fact that they really start to look ‘affordable’ or ‘good value for money’ particularly in relation to the renting option. It is difficult to persuade people to buy if the product is still showing deflation but any signs that the deflation is slowing and may revert to growth will be a key point to watch for.

A robust economic backdrop is clearly a vital ingredient which looks a challenging requirement short term here in the UK and in European markets if a slowdown creates employment insecurity. The economic backdrop being vital in order to persuade buyers that their situation is sufficiently stable to allow them to press on with such a long term financial commitment.

In Spain and Ireland it should also be borne in mind that both countries have built dramatically more housing than any other countries in Europe of North America. This has created in my view more serious oversupply issues and excess stock which will take longer to unwind than might otherwise be expected.

In Spain and Ireland the housing and construction markets, through their dramatic growth in recent years, have also become more significant components of the overall economy (in terms of their share of GDP). As a result the adjustment in demand and the need to unwind excess stock is I would argue, likely to feed back into the general economy more dramatically than in, for example, the UK as so many of the working population have been employed in the real estate and construction sectors in Ireland and Spain.

Finally looking at Spain I would also have to highlight that much of the amazing growth in housing starts has been driven by demand from UK, German and other Europeans looking to retire to the warmer climate offered by Spain. I don’t have data to support this view but I would have to be concerned that equity release from UK or European first homes will have, for many, been a key ingredient in financing an overseas purchase in Spain and elsewhere. With equity release looking increasingly under pressure as house prices fall many who have hoped to buy an additional property overseas will now struggle to do so. Also those who have tapped their existing property for equity release in recent years may now, if they need to re-mortgage, be in the difficult situation of needing equity back here in the UK in order to secure an attractive (at best) or affordable (at worst) mortgage rate on their main residence.

The other events which could clearly change the back drop relate to Government intervention – tax breaks, excess stock buy up and changes to the transaction costs associated with property purchase and sale.

If house price downturns in the last two decades are any indicator, it seems the bounce back is typically in a two year time frame. Would you agree? What you think would be a realistic view in terms of percentage falland the duration of this downturn from the peak in Aug 2007? Also, some experts say those areas with good school or suburbs will have less impact. Do you have any historical data from earlier house price falls which suggest this?

Somnath Ghosh, Manchester

JM: The last major downturn, taking the Halifax house price index as a measure, saw a peak in May 1989 and took 45 months to go to a trough in February 1993. House prices then got back to the 1989 peak in January 1998.

I would therefore argue that any bounce back will take time to re-assert itself and that we are still in the very early days of the correction. It is worth noting that unemployment actually only began to rise from May 1990 with housing acting as a lead indicator. This current cycle may prove more rapid as the decline has been so rapid thus far with house prices already 8 per cent down from the August peak on the Halifax index.

Again looking back to 1989-1994 prices only fell a cumulative 12.5 per cent nationally in nominal terms and 30 per cent real terms so the adjustment so far has been far more exaggerated in both nominal and potentially real terms reflecting the credit crunch impact on mortgage lending.

The decline in house prices I believe will be significant given the degree to which house prices have moved ahead of earnings and my belief that the real cost of lending for house purchase may have been temporarily depressed in this last credit boom but will be re-asserted as mortgage lenders re-price mortgage lending risks. Given a 30 per cent real decline in the last two major housing downturns I see no reason why we will not experience as similar and possibly larger adjustment in the current cycle downturn.

Your point on geography and local amenities and facilities is absolutely correct with house prices varying in terms of the downward pressure they are likely to experience depending ultimately on supply and demand and the trade off house buyers will make for example in terms of great state education in one locality when compared with private school fees if they opt for the house which doesn’t sit in the catchment area for their ideal state school.

I’m afraid I don’t have any data to hand but certainly looking back in the last downturn it was developments at the periphery of ‘desirable areas’ where prices saw the most dramatic adjustment. In London the development of docklands is a good example where prices fell dramatically as buyers realised that follow on development and amenities weren’t coming and the social and physical infrastructure of the area failed to match expectations.

I wouldn't disagree with his views at all although I don't agree that it would take 70% falls to accomodate this.... the key point for me is his view that rental yields need to be around 10% although one has to understand that this figure and the figure he quotes of 13% from the previous crash is not very clear... by its very nature these rental figures tend to be gleaned from rental properties rather than as an average of ALL properties .... by their very nature some houses/properties yield more than others while lets say your average semi in surbiton may not yield as much. In some parts of the coutry based on recent auction prices are already showing a 10% yield but sister properties within agents may yet need to fall 30% to get there. I am not sure what you are basing the 70% on but its difficult to arrive at an exact figure using the rental point becasue of the above.

[Moo]

His comments on yields suggest carnage. 70%+ nominal reductions will be required to achieve this IMO.

<snip>

Good lord, it's he's right about this, then you're spot on when you say "carnage". Did the numbers for the place I'm renting at the moment and to get an 11% yield it would need nigh on the 70% you suggest. Either that or the kind of rent rises that would make me think "sod this for a game of soldiers" and take up residence at my parent's for a bit.

[stuckmojo]

Funny how all rational examination of house prices points to 50-70% reductions but anyone who actually says it will have their credibility shredded.

VMR.

Funny how, at 50% less, it will be still too expensive, if one calculates the price/earnings ratio

[Leonard Hatred]

If house price downturns in the last two decades are any indicator, it seems the bounce back is typically in a two year time frame. Would you agree?

How is it possible to start a question with such a completely false statement and for it not to get picked up on?

[uncle_monty]

I wouldn't disagree with his views at all although I don't agree that it would take 70% falls to accomodate this.... the key point for me is his view that rental yields need to be around 10% although one has to understand that this figure and the figure he quotes of 13% from the previous crash is not very clear... by its very nature these rental figures tend to be gleaned from rental properties rather than as an average of ALL properties .... by their very nature some houses/properties yield more than others while lets say your average semi in surbiton may not yield as much. In some parts of the coutry based on recent auction prices are already showing a 10% yield but sister properties within agents may yet need to fall 30% to get there. I am not sure what you are basing the 70% on but its difficult to arrive at an exact figure using the rental point becasue of the above.

Yields round my way are 4.8%.

In order to achieve even your target of 10%, rents would need to spike substantially. Or prices fall by 70% plus.

In the likely, debt-driven, credit-constrained recession we face, which is more likely?

The party's over.

[bobthe~]

I am not sure how you would expect that kind of yield today.

Is he comparing apples with oranges?

Without wanting to appear like the "It's different this time" brigade, is it more valid to compare the rate of return in 1992 with the risk free rate then and add something to that risk free rate to get an adequate yield?

e.g. IR in a bank account in 1992 might have been 10%.

Having said that, you can already get 7% 1 year fix from quite a few places.

Also this 45 months to recover business:

This crash is different as it is affecting all regions, whereas the peak to trough last time was so long because some regions were recovering while others fell.

London took about 3 years to bottom out.

Good bear-ish article though.