House prices – quo vadis?

September 7, 2009

I haven’t updated this blog for quite a while and in the meantime we had a recovery in the house prices in the UK. Or had we really? All the indices (Natwest, Halifax, Righmove, surveyors’) have reported house prices going up in England during the months of June, July and August. Of course when the market bounces like that, you think there’s a recovery round the corner. Especially when the stock market is going up too.
But the fundamental problems are still there … mortgages are not really available if you don’t have a sizeable deposits, which keeps a lot of the first buyers out of the market. Without first buyers, you cannot start a chain, which reduces the liquidity in the system. And that’s an important issue at the moment that might keep the prices down.
The other factor is the high unemployement levels which ultimately affects the buyers but also the banks which are more reluctant to lend out money in a climate with high unemployment.

Another factor is the market entering the quiet autumn/winter period when not many people go buying houses. This might lead to prices falling further.
I certainly put my money where my mouth is and for now I’m holding my deposit until 2010 hoping for bigger discounts.


I was looking today at some property prices around my area. You can find a one bedroom flat for 110-150K pounds. Rents for a one bedroom flats are in the 600-750 range. So let’s do some maths then.

Let’s assume the value of the flat is 150K and the buy to let mortgage rate is 7%.
That implies a minimum deposit of 15K and a LTV (loan-to-value) of 90%. Banks wouldn’t give you a mortgage with a higher LTV anyway these days.
Let’s look at some figures. In the table below, the columns are mortgage length in years, while the rows are different value for the deposit. The cells represent the cost per month, the first number is interest payment only, the second is repayment (interest + principal). This is the number that you will be paying each month for the mortgage.

10 yrs 15 yrs 20 yrs 25 yrs
15K 788 / 1548 788 / 1214 788 / 1047 788 / 955
25K 730 / 1452 730 / 1124 730 / 970 730 / 884
35K 671 / 1336 671 / 1034 671 / 892 671 / 813
50K 584 / 1162 584 / 899 584 / 776 584 / 707

Looking at the numbers, it’s easy to realize that a buy-to-let doesn’t make much sense. For a buy-to-let to make sense the rent needs to cover the mortgage payments. Moreover, it needs to cover unforeseen risks like not being able to rent your property for several weeks/months, repairs, risk associated with tennants, different costs (leasehold, ground rent), estate agency costs and other costs associated with finding a tennant. A rule of thumb is that the rent should cover 125-130% of the cost of mortgage.

With rents in the area between 650-750, it’s impossible to cover the mortgage payments. Unless you have a big deposit, more than 50K. Not many people however have 50K to invest. Some do and a lot of bankers actually used their bonuses this way.
The second and much more riskier way to cover the cost is if you opt for an interest-only mortgage. That means you only pay the interest. That’s easy to cover, however, you’re still left with paying for the property. The property is not yours as you’re not paying the capital.
At the end of the period you can either:
– roll over the debt, get another mortgage and continue paying interest only (you could make money this way in the short term, but you’re exposing yourself to a lot of risks)
– sell the property and hope to realize some capital gains (in other words hope to sell the property for more than the value of the capital you owe to the bank, so you can keep the difference as profit).

And the latter is the option that many buy-to-let investors were counting on. But with a falling market, this second option looks almost impossible now. It’s very likely that these buy-to-let landlords will realize big losses on their properties. Holding and hoping for the best doesn’t work very well, as the more prices fall, the more they lose. And at the end of the period, they end up with negative equity (the reverse of the capital gains they were hoping for). A nightmare scenario. That’s why many of them are trying to sell now, putting a downward pressure on prices.

So is Brown a hero now?

October 14, 2008

Brown seems to have got it right. Re-capitalisation of the banks was the real issue and as such he went straight to the point, injecting tax payers money into the banks directly. He used preference shares, pretty much as Warren Buffet does all the time and he recently did that with his investment in Goldman Sachs.
Very flattering perhaps for Brown is the fact that the european leaders and now the americans seem to be following the british capital injection.
Is it nationalisation? Pretty much.
Is it going to be effective? It’s really hard to say.
Will the UK government lose tax payers money on the transaction? It’s very possible, although it’s quite possible they will make money.
It’s really hard to say if Gordon is a hero at this point. Everybody thought Bernake was a hero when he dramatically cut interest rates earlier in the year and injected billions in the money markets. As that proved ineffective, everyone started calling him incompetent.
Time will tell. For now, I’m sure Brown is quite happy with his stunt.

Banking crisis

October 10, 2008

I haven’t written for a while as I was really busy at work. In the meantime, we’re in the middle of Armaggedon. A global bailout of banks fails to impress the markets and stocks are plunging, credit spreads going up, banks not lending to each other. We should expect heavy redundancies and corporate failures in the months to come and unemployment going steeply up.

The main problem is the way banks relied on the money markets in recent times. In the good old times, banks got deposits from investors and they lent these deposits out. If a loan was for 25 years (say a mortgage), then the bank used to keep the loan on its books for 25 years, collecting the profit slowly and the capital at the end. At the same time, it was bearing the risk of that loan for 25 years.
Banks used to lend only as much as they had from depositors.

But nowadays, banks borrowed from the money markets and lent to borrowers. However, a loan for 25 years is quite expensive on the money markets as it has to price in the risk. A 25 years loan is riskier than a 2 years loan. In 25 years the risk of a borrower losing her job and not being able to repay is greater than the risk of losing her job in 2 years time.

As such, banks borrowed short term from the money markets (say 2 years) and lent long (say 25 years) to borrowers. The idea was that after 2 years, they will borrow more from the money markets (perhaps still for 2 years. So in total, they’ll have to borrow 13 times to cover the total 25 years loan. These banks didn’t think very long term, as in the long term a lot of things can happen: borrowers can refinance somewhere else, they can pay off, or the banks can sell the loans to someone else.

The problem is that this roll over of credit is looking almost impossible these days as banks are not lending to each other anymore and the money markets are prohibitively expensive. That’s why Northern Rock had to close shop, that’s why HBOS is in trouble. And that’s why all the governments are making such a big deal out of this liquidity crisis.

So the next on the list are corporate borrowers. Some corporations won’t be able to roll over their debts and they will go bust. That’s the major risk of this banking crisis spreading to the whole economy. The longer it persists, the more chances it will spread all over the economy.

In a spectacular move, both FSA and SEC have banned short selling to prevent further meltdown in the financial markets. Equities that is, as there’s not much they can do about the credit markets, although they pumped a joint $180 bn into the money markets few days ago.
The markets rose mainly because hedge funds rushed to close their shorts. It’s no wonder, if shorting is banned, the trend will be temporarily reversed, so hedge funds rushed to be the first to take advantage of that and not be caught out by the rising wave. So the soar in shares is nothing more than a knee jerk reaction. There are still serious doubts over both UK and US economy, so it’s very unlikely the trend will be reversed and a new boom in shares will emerge.

However, the tactic of banning the short selling will probably put an end to rumours and fear mongering. In volatile times, it’s easy to spread rumours and fear to drive prices lower. The main problem is that no one yet knows the extent of the damage to the financial system, so the fear that many shareholders feel is the fear of that unknown. In addition, short sellers were rewarded in many cases: Northern Rock, Bear Stern, HBOS, Lehman … so no wonder that more people got into short selling.

Short selling however was simply punishing the banks for their opaque ways of dealing with their shareholders. Many banks kept the toxic off balance sheet, trying to hide it, trying to claim that everything was well. No wonder they lost the trust of shareholders and customers, a situation rife for short sellers. So in a sense, banks got what they deserved. Banning short selling is another form of bailing the banks out.

However, the problem is that once trust is lost because of several incidents, the whole industry can lose that trust, irrespective of how sane some banks are compared to others. HBOS, although solvent, was already on that slippery slope where they lost the trust of their shareholders, depositors and financiers. That’s not to claim they were sane though.
If trust is lost, the risk is perceived to be much higher which in turn pushes the cost of money much higher for that bank, which in turn, slowly pushes it out of business. It happened to Bear Stern, it happened to Lehman, it happened to Northern Rock, it could have happened to Merrill Lynch and it might happen to Morgan Stanley and Goldman Sachs.
However, with the short sell ban “bailout”, Morgan Stanley and Goldman Sachs might just survive. It comes too late for Lehman and HBOS though.

Apocalypse now

September 18, 2008

The world financial melt down just got worse when everyone was thinking that the worst was over. Lehman’s failure scared everyone as they finally realized that the US won’t save everyone, although they’ve saved Bear Sterns, Fannie and Freddie and AIG.
Merrill escaped by merging with Bank of America. Morgan Stanley is merging with Wachovia or going bust. Goldman Sachs? Well, there are rumours about HSBC circling it. Barclays got a sweet deal by snatching some dying Lehman bits.
In the UK, HBOS is swallowed by Lloyds TSB.
Many of these banks were solvent, however, the definition of solvency is re-written as credit is no longer cheap and eveyone has to deleverage. After de-leveraging, some of them are no longer solvent. Surprise surprise.
Let’s see what this all means for unemployment in the UK and US and if any of this will spread to retail banking, insurance, and the wide economy. Apocalypse is upon us!

Inflation is at 4.7%

September 16, 2008

The Bank of England governor, Mervyn King, has to write to the Chancellor every time the inflation increases above the government’s target of 2%. I think they will get to know each other really well, as inflation is more than double that and going up. Further more, it’s forecast to stay up well into 2009.
That means there will be no interest rate cuts soon, as the only means the Bank of England has to control inflation (its main target) is by controlling interest rates. When inflation is low, interests rates can be low, when it’s high, interest rates have to go up.
High inflation is the last thing Gordon Brown needs at the moment as the economy is on the brink of recession, house prices plummeting and his confidence at the lowest levels ever. High interest rates are no good for the economy, as they discourage borrowing by companies and ultimately investment as it makes the money more costly for companies.
High inflation also means that companies have also higher costs, so there feel pressures to increase their prices, which in turn makes the inflation worse. It’s a vicious circle. The alternative is to try to cut costs, which is turn means layoffs. And at the moment, the unemployment figures are up and forecast to continue upwards.
Either way, it’s bad for the economy and for the government.
So what’s the solution that the Bank of England recommends? A period of low growth or recession. That should calm down the inflationary pressures. But that also means a sick economy and high unemployment. There’s no easy way out unfortunately. But you know what they say … whatever goes up, must come down.

So who stands to win from lower house prices. The most obvious is the first time buyers. They need to borrow less money and pay less. By reducing the amount they need to borrow they can afford houses they couldn’t before, because of the salary multiples.

It also benefits people who move up the property ladder buying a bigger house. As the prices fall, the difference between a bigger house and your house decreases. 10% off a 250K house is 25K, while 10% a 400K house is 40K, so in the end you could be 15K better off, which in turn can mean you can pay off your house a year or two earlier.

Who stands to lose? Well, buy-to-let landlords and landlords in general. People that have bought houses as investments. Families won’t suffer as you don’t realise a gain or a loss on your house unless you sell. Why would you sell? To move up? Then you gain (see above). To leave Britain? Then you would lose out probably (unless you move to Spain where the property prices are falling even faster than here). But if all you do is live in your home and intend to do so for the foreseeable future, house prices won’t affect you directly. You might be affected if you want to re-mortgage your house or take equity out of your house to purchase other things (which is a bad idea at the moment).

However, there is a catch. The main problem is not lower prices, but falling prices. The fact that the house prices are unstable and they keep falling creates a climate that discourages trading in the house market. The house market is almost at a stand still as sellers cling to last year’s prices while buyers look at the next year’s prices.
The sudden illiquidity of the house market in turn affects a lot of participants in the house market. The most obviously affected parties are the property developers, either big companies building houses in bulk, or small developers like your mum and dad. It also affect services companies related to the property market and it also affects sales of house goods. When moving to a new house people usually buy new furniture, white goods (washing machines, fridges, etc.). It also affects sales of construction materials and everything relating to construction.

Ultimately the affected companies will react and many of them will try to cut costs to survive until the next boom. They’ll lay off people, avoid investment, etc. This affects sales of other products in rippling effect through out the economy. Once the ripple starts, it’s difficult to stop or reverse. That’s the government’s worst nightmare.

One of today’s headlines: Property sales plunge to one house a week. According to the newspapers this adds to the pressure on Gordon Brown and Alistair Darling to act and save the house market. But does the market need saving?

One of the fundamental principals of a “market” is that there isn’t one central force that controls it dictating supply, demand and ultimately prices. No one thought about moderating the house market when it was going up at 10% a year, so why are people now trying to prevent it from falling? Is it possible to prevent it from falling?

Well, the problem is that moderation cuts both ways. If you don’t want crashes, then you should prevent over-exuberance as well. You can’t just close your eyes and tacitly take credit for a booming economy that goes up pushing up house prices and asset prices in general. That’s exactly what the government has done. Gordon Brown was more than happy to let the market work its way up and taking credit for the booming economy at the same time. Credit was cheap, the borrowers on a binge.

And now it’s an abrupt reversal, as abrupt as the climb in asset prices in the first place. The borrowers that got caught out in their own binge are turning now to the government, expecting it to just “fix it”. And the tacit agreement is … if you don’t do it, the Labour gets it. That’s why the government is keen to be seen (and I stress “to be seen”) as doing something to “fix” the economy and the house market. One thing it cannot afford to do is to be seen as doing nothing. That would be worse. On the other hand, the economists and the business people in and around the government know that there’s not much they can do.

When the BoE started to accept mortgages as collateral, the Banks were happy to get funds in exchange, but the benefits weren’t passed to the customer and we’re even deeper in the credit crunch. As for stamp duty holidays, they have been tried before in the ’90s and they didn’t work.

The main problem at the moment is that the government is doing things just for the sake of not being seen as totally inactive. It’s acting to save its skin rather than actually helping people. Who can they help anyway? If they save the house market, they’re not saving the first time buyers. The first time buyers enjoy a falling market as that makes homes more affordable. They’re ultimately saving the irresponsible borrowers who got into debt that they’ll have to pay until they retire (if not longer).

However, there’s a more realistic reason for acting, besides the political masquerade. If the house market continues to fall, that will hurt the property developers, which in turn will shed more jobs, adding to the unemployment.

But the big question is … will the slow down in the property market reflect in a slow down in the retail sector? So far, the answer is yes. But the relationship seems to be one of correlation rather than causality.

The credit crunch is making people more realistic about their spending and about the sustainability of their lifestyles. In turn, they start to spend less. And also in turn, that tends to put the economy into the reverse. It’s a good enough reason to act. But if acting means for the government to add more debt to their already stretched balance sheets, maybe the best policy is cost cutting and becoming leaner. That in turn is something entirely new for the Labour government.

Tube and bus fares soar, but it’s Ken’s fault says Mayor

Tube and bus fares will rise by up to 10 per cent in the new year, Boris Johnson announced today.

I’ve never understood how TfL can be so bad at managing the network and everyone is paying for it. Fare prices are always going up, never down, the zones are shrinking, never expanding. How can the TfL management get it so wrong when other cities can do it much better and cheaper. Why does London have to be one of the most expensive cities in the world?

As for Boris and Ken, presumably Boris scrapped the cheap petrol deals with Hugo Chavez, Ken’s buddy. No wonder fare prices are going up.