London Estate agents’ profits fall by up to 98% in a post-Brexit referendum world

Article is here.

Countrywide’s profits are down 98% (!) and Foxton’s is down 64%. Wow. Why? Put simply, almost nobody is buying and nobody is selling, at least not through these estate agents.

What is the cause?

  1. Brexit?
  2. Changes regarding estate agent fees?
  3. the rise of online estate agents?

I don’t know what the exact cause is but clearly, there is a big problem in estate agency right now.

 

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House prices can only go up if there is more money available – so what determines how much money is available?

How much money is available is determined by a number of factors: the two key factors are interest rates and wages.

Interest rates:

Interest rates need to be low. Why do you need this? The lower the interest rate, the more people can afford to borrow from the bank in terms of a mortgage. Put simply. If the house you want to buy is £500,000 and the most you can afford in repayments each month is £2,371 then (for a 25 yr mortgage) the highest interest rates can be is 3%.

If interest rates dropped to 2% then you could get a mortgage for £560,000 all other things being equal. Note how you now have £560,000 at your disposal. If everyone had that, guess what the selling price would be for a house? You got it. £560,000. This is all thanks to a drop in interest rates.

Wage growth

Wages need to be going up.For that to happen, you need a growing economy. How are the two linked?

Take this example:

If you have 10 people in a village and all 10 work for the only business in the village for an annual salary of £20,000 per year then how much can they borrow assuming banks will lend 4 x salary? £80,000 right? Right. Now, new scenario. There is a big demand for the product the business is making, so much so that another business from out of town sets up shop just outside the village. This new business needs workers so it approaches 2 of the workers at the existing business and asks them to come and work at the new business. The workers say that they are happy at the old business and don’t want to move. To incentivise the workers to move to the new business, it offers them £25,000 per year. The 2 workers accept this offer. Now how much can each borrow from the bank? At 4 x salary, it would be £100,000. This, in turn, affects how much a property will sell for if there is competition among buyers who have higher incomes (and consequently can access larger mortgages).

So you can see how an increase in competition for labour that comes about in a growing economy can cause house prices to go up. Put simply – a growing economy is good for house prices.

An additional observation. For prices to go up, you also need a positive outlook by the public

While this does not affect how much money is available, it does affect prices.

This is how:

When people are positive about the future of house prices (i.e. they think interest rates will drop in the future and they think that the economy will improve), they are sometimes willing to buy now before those factors are priced in. If enough people think this way then demand goes up (even though interest rates are still high and the economy is not doing well). There is of course, a limit to this. If, after a few years, interest rates don’t drop and or the economy does not improve then people’s outlook will eventually change from positive, to stable and eventually to negative. If that happens they are less likely to want to buy property and consequently, demand drops. This drop in demand adjusts prices down.

 

Could London property prices crash by 40%?

Yes, according to Paul Cheshire, Professor of Economic Geography at the London School of Economics. Article is here.

The trigger seems to be when wage increases don’t keep up with inflation. Currently, inflation is 2.9% and wage increases are 2.1%. At the moment then, that is where we are heading.

Historically, inflation happens because too much money is chasing too few goods. This often happens when an economy is booming, people are getting paid more and are driving up the prices of goods (demand and supply). This is different though. Inflation has gone up because of the weak pound. Put simply, if you have to import parts or goods and you have a weak pound, you have to pay more to get them. You then need to raise the selling price of the goods to still make a profit. This is where the inflation is coming from. It is not coming from a rampant and booming economy.

So we have a weird situation – high inflation but a slowing economy (and hence lower wage growth).

The usual solution to inflation is to raise interest rates. This cools the economy and brings down inflation because people have less money. You can’t do this now because the economy is already cool. This means you can’t bring inflation down and you can’t stimulate the economy either. To stimulate the economy you would need to… cut interest rates. But this would… increase inflation. It is a no win situation for the Bank of England.

The only real solution would be to reverse Brexit which would strengthen the pound overnight. This would bring inflation down on its own. The economy would begin to recover and then we are back to business as usual. Without this happening, a 40% drop in property prices may well happen.

On a related point: Don’t rush to get on the property ladder. See the FT article here.