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.

 

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.

 

 

 

 

Buy-to-let purchases fall by 50% year on year

Article is here

Scary numbers but why are they happening?

Numbers are always interesting but what is more interesting are the reasons behind them. Put bluntly: purchases are down because people think they can’t make money in buy-to-let anymore. A combination of the higher stamp duty, disallowance of wear and tear tax deductions, and Brexit… all play a role.

The reason that the government imposed the stamp duty and disallowed tax deductions was purportedly to cool the growth of house prices and to allow more first-time buyers onto the ladder. However, at the same time, the government has the help-to-buy scheme that helps first timers get their first house by effectively giving them more money which has the effect of pushing prices up even further so there are some counter-acting policies in play at the moment.

Is this really helping first-time buyers?

A stat I would like to see is how much first-time buying is up year on year. That would be a good indicator of whether the measures taken by the government have been effective.

So, does that mean buy-to-let is dead in the UK for the time being?

In my view, yes.Right now, you know all those books “Rich Dad, Poor Dad” and “Real estate riches” that tell you how to get rich by buying and renting out houses with little or no money down? Well, you can forget about that for the time being. Not one of them is relevant in the context of current government measures. They are dependent on easy credit (can’t get that now), not having punitive stamp duty (which we have now) and the ability to deduct expenses for tax purposes (can’t do that anymore).

Right now, you know all those books “Rich Dad, Poor Dad” and “Real estate riches” that tell you how to get rich by buying and renting out houses with little or no money down? Well, you can forget about that for the time being. Not one of them is relevant at the moment. They are dependent on easy credit (can’t get that now), not having punitive stamp duty (which we have now) and the ability to deduct expenses for tax purposes (can’t do that anymore).

If Brexit goes through and is not done well, there will be huge changes in law and tax to get the economy moving again. Don’t be surprised if buy-to-let comes roaring back if Brexit goes sour.

Property prices in London fell 2.4% in June

According to this article here.

The real question is why? Despite inflation going up to 2.9%, interest rates remain unchanged. See article on this: here

The scary thing is, one of the key ways to deal with inflation is interest rates. Put simply, one of the reasons for inflation is too much money chasing a limited amount of goods. Why is there too much money? With low interest rates, people are encouraged to borrow more. So, if you normally don’t borrow and earn say £2,000/month, then you only have to £2,000 to buy goods. If you borrow another £1,000 then you have £3,000 to buy goods. The more money people have to buy goods, the more prices go up.

Put another way: Imagine an auction. If something is being sold that people really want and everyone only has £2,000. What does the item sell for? You guessed it: £2,000. If, however, people have £3,000 as per the above example, then what is the max price the item can sell for? You guessed right again: £3,000. More money = higher prices. Inflation 101.

The Bank of England is in a tough spot though. One of the key ways to grow an economy is also through interest rates. You lower interest rates to stimulate the economy. For businesses to expand, they usually need to borrow money. If interest rates are high they tend not to borrow and not to expand and may even reduce in size and lay off workers. When this happens the Bank of England usually lowers interest rates which means businesses can borrow cheaply and can expand their businesses and hire more workers.

At the moment, because of Brexit, there is so much uncertainty about the future, businesses are not in the mood to expand and everyone is tightening up. If the Bank of England raises interest rates it could push the economy off a cliff. If it does not, it can’t curb inflation which is being mainly driven by a weak pound (which has nothing to do with extra money through borrowing which is usually the culprit).

Quite frankly, I don’t think the Bank of England knows what to do which is why there are so much conflicting theories floating around.

So basically, interest rates should be going up but they can’t for political reasons.

Fun times…

 

 

The end for London property investment?

Some grim reading from Bloomberg, here

Short version: Government grabbing extra tax from buy-to-let landlords, extra stamp duty, property prices stagnating, rents dropping across greater London by over 4%.

What does this mean?

Depending on your tax bracket (the higher the worse it gets), you simply cannot make a profit by buying and renting out a property.

Where is the real problem? The average cost of a house is over 14 times the average salary in London. Look up the definition of a bubble and that is about it. Brexit is the needle that threatens to burst the bubble in a spectacular way. Time will tell as Brexit has not occurred yet.

The only thing that can save house prices is: powerful and growing economy (more money in people’s hands), more people coming to London (greater demand), continued restrictions on supply (lower supply). At the moment we have the opposite: Economy under great threat (less money), Brexit stopping the migration of people into London (lower demand), hundreds of residential towers coming onstream, more supply due to buy-to-let landlords unloading properties that are no longer profitable (excess supply). Add that the government seems intent on destroying the buy-to-let market with punitive tax measures and you cannot see a way forward for property investment, at least not for the time being. Not to mention interest rates are about as low as they can go with only one direction possible and that is up. Brexit will cause an increase in inflation, particularly with a weaker pound and if inflation gets out of control the Bank of England will have to raise interest rates to control it. That is very bad for the housing market as higher rates make owning property less affordable, with higher mortgages you need higher rents to cover the extra interest payments but as we know, rents are going the other way…

These are facts that we can’t get away from. If someone says that property prices are going to be ok then just ask them to explain which of the above factors are going to change. If they can’t then they are wishful thinkers.

London home prices down, rents down across the country

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Why is this happening? Article here and here

The londonpropertyguy’s view: A couple of reasons: uncertainty being one of them due to Brexit so people just don’t want to move house and incur the cost of doing so. But more worrying is that this may be linked to a slowdown in wage growth.

Why do wages slow down?

Usually because of a rise in unemployment. This comes from a faltering economy. When there is high unemployment, to get a job, people are prepared to accept lower pay. Equally, if you have a job, you are grateful for it and unlikely to push for a raise when the company could easily replace you with someone willing to accept lower pay.

With less money washing around, there is less money chasing the existing housing stock so prices have to adjust downwards to match purchasers’ ability to pay.

Another thing is supply. Take a look around North Greenwich and also Vauxhall. A huge amount of property is about to come on stream. Sadly, it looks like many developers started projects some years ago, anticipating business as usual (i.e. no Brexit) and now the rug has been pulled from under them. My sense is that many of them are less concerned about making a profit and more concerned about not going under. I expect large drops in asking prices just to get them sold so they can lick their wounds and head for greener pastures.

Another point is rent levels. Many of these new developments (particularly in North Greenwich) are bought as investment properties. For an investment property to make commercial sense, you have to be able to cover your bond with the rental payments from your tenant. The lower the rent you can achieve, the more of the bond you have to pay out of your own pocket. In a high growth environment, this is ok because the capital growth you get each year dwarfs the top up amounts you have to pay and you can refinance in due course releasing that equity for yourself. In the current environment, it is not ok because prices are going down, not up. To make matters worse, rents are also coming down and coupled with the second home stamp duty increase (something that was implemented assuming no Brexit) and suddenly it does not make much sense to be a landlord.

As a result, a lot of would-be investors will be dumping their investment properties which again means additional supply and this will cause prices to drop even more.

Now that France has voted firmly to remain in the EU, Britain stands alone in its negotiations with the EU. With negotiations already not looking good, look for further falls in Stirling, higher inflation, higher unemployment, lower wages… With interest rates already as low as they can realistically go, the Bank of England’s hands are tied.

Difficult times ahead.

Grosvenor property fund reports huge drop in return for London property

See the article here.

What sort of drop? 10.7% to 0.3% (yes, you read that right, 0.3%). How is the Grosvenor property fund still in business? It divested itself of the UK mostly and now invests elsewhere in the world.

Interesting Grosvenor is now focusing on building homes to rent out:

Mr Preston said: “…we’re looking at the mid market residential sector,” adding that the group is planning to build 4,500 homes across the UK. “We are doing our bit to help solve London’s housing problem.”

Well, actually, when people talk about London housing problem, they mean there are not enough houses to buy. They don’t mean there are not enough to rent. If you look closely, there are more than enough houses in the UK to house people (i.e. landlords take care of that). The issue is people want to get onto the property ladder and can’t. Becoming a tenant does not ‘solve London’s housing problem’ as Preston puts it. If anything, it makes it worse.

On a related point: I was speaking to an acquaintance who has just returned from abroad and now rents in Kings Cross. He told me that it is a bloodbath out there for landlords and revealed he negotiated £1,000 off the asking rent. I am assuming he meant the annual amount. If it’s the monthly amount then buckle up, Brexit is still to come.

 

Landlords in UK set to become corporate funds rather than individuals (Updated)

corp 3

This is according to Sky. Article here.

What does this mean for renters? One thing is that you are about to lose your power in negotiations. A private landlord with only one property really needs the monthly rent. They can’t afford to have the flat vacant for a month, let alone two or three months. That gives you some power as a tenant (particularly if you are trouble free and pay on time). Corporations are different, they could not care less. In fact, when corporates own real estate they often leave them vacant, sometimes for years.

Corporate landlords are looking for a certain percentage increase each year and if they don’t get it, they can afford to leave it vacant until they do. The reasoning is that it is better to have it vacant than let out at a low rent which they are then stuck with. When a corporate owns 10,000 flats, they don’t care if a few are vacant, it is not going to move the needle. For you, it is a matter of being booted out which is deadly serious so when they say jump, you say ‘how high?’

When it comes to negotiating, you don’t want to be negotiating with an intern running a spreadsheet who in any event, won’t be there 6 months. Which is a bit of a coincidence because if you don’t play your cards right, neither will you.

UPDATE:

It seems private landlords are a bit more savy than the government planned for. The changes that the government put through which penalised private landlords can simply be circumvented if the private landlord operates through a limited company. As a company, you should still be able to deduct interest payments from your taxable income (the ability to do this is much reduced for the private landlord) and you can deduct wear and tear.

Therefore, if you are a private landlord and don’t like the current tax set up, have a chat with your solicitor and accountant and consider setting up a limited company.

See an FT article on this here

 

Is Brexit bringing the biggest house price adjustment since the Financial crisis?

Big Ben stormBloomberg seems to think this might be the case. Article is here.

I am not so sure. From what I have read this appears to be in relation to the premium bracket, the fall of which is well documented.

In the normal housing market I think people will wait and see as if you are renting and about to buy, all signs are there for a correction. While it does not make sense to buy right now there still is structural demand rather than commercial demand (by this I mean, people want homes but not at any price). Prices are not going up and there is an outside chance of them coming crashing down, particularly if the Brexit negotiations look anything like the Gibraltar debacle.

Buying now is risky and I can’t see the upside. I would keep renting and watching. Possibly take out a pound hedge (move money into dollars) as if Brexit goes south, the pound is going with it which means you will become poorer from a global perspective.

Is there a storm coming? I think so but how big it is and whether the new look London (without its immigration lifeline) will weather it? Time will tell…