Sunday 6 June 2010

UK Property Market – May 2010 Update

David Cameron, George Osborne and others are I guess as I write this post working hard trying to pull together the emergency budget that will take place on the 22 June 2010. We have already seen in the press plenty of commentary about the possible increases to Capital Gains Tax (CGT) and the effect it may have on property prices, particularly the Buy to Let (BTL) brigade out there. Personally I’m not seeing them doing anything to engineer a crash (or even significant reductions in values). This is for a couple of reasons:

- In an article in MoneyWeek this week it was highlighted David Cameron has a £2.7 million London house and a £1.0 million constituency house. Maybe I’m being cynical but I don’t think he wants that to fall in value significantly.

- Similarly George Osborne has a £2.0 million London house and a £0.6 million constituency house so I also don’t think he wants these to fall in value. Don’t get me wrong I don’t begrudge either of them these properties I just don’t think they want them to collapse in value via something they have personally engineered.

- If we saw big reductions in property values all the banks would be insolvent again (if they’re not already) if they valued to market value.

- The UK is now built around increasing property values. These days an increase in prices is seen as good where a fall is seen as bad. If a few weeks in to a LibCon (or ConDem depending on which style of newspaper you read) coalition house prices collapsed the general public would be up in arms. Of course if they engineer it now they may have time to recover the situation before the next election. If they keep the balls in the air the risk is that it all comes crashing down just before an election which would likely mean no re-election.

I’m probably wrong, after all I’m just an Average Joe, but I feel they will take a different route. Instead I think that what we saw this month with the Nationwide house price index is almost where they (and the Bank of England for that matter) would like to have the situation. That is, a slow erosion in real (after inflation) property values via inflation but with them stagnant or increasing slightly in non-inflation adjusted terms. The only desirable now is to get the average earnings index above the increases in house prices. This means that over the long term the ‘sheeple’ don’t notice that their houses are actually falling in value in real terms keeping them happy. Meanwhile house affordability starts to return to the long run average. We’re not there yet but are getting close. Let’s look at the charts.

Chart 1 shows the Nationwide Historical House Prices in Real (ie inflation adjusted) terms. This month the real inflation adjusted change is from £169,368 to £169,162 (a monthly fall of £206 or 0.1%). So while the press are reporting house price increases of £1,360 in the real inflation adjusted world prices are actually falling.

As always this chart also demonstrates that compared to average earnings property is still very expensive when a ratio is created of the Nationwide Historical House Prices to the Average Earnings Index (LNMM). In 1996 this ratio was as low as 607 and today the ratio stands at 1,044. If we were to return to that number the average house using the Nationwide Index would be £95,687.

Chart 2 shows the annual change in Nationwide property prices and compares this with the annual change in the average earnings index (LNMM) released to March 2010 (so a couple of months behind the house price data). It shows that the annual change in earnings has risen sharply and is climbing towards house prices quickly. If the government and Bank of England can get those two measures to cross they will achieve what is in my opinion their goal. This looks a possibility with the Unions already getting militant. Of course we already have BA on strike and now BT will potentially soon follow. If they get what they want then wage inflation may become imbedded. This would be perceived to be a win win for almost everyone. The only losers in this scenario are the prudent who saved money rather than heavily leveraging themselves with massive debt to salary multiples. They will see their savings inflated away. Of course these days I feel they are the minority and no longer matter.

In reality though the opposite is true. The whole country would be the loser as our purchasing power is eroded on the world stage. Of course the majority won’t even notice.

For now I’m still out of the housing market but watching intently from the sidelines.

As always do your own research.

- Charts using LNMM data are to March 2010.
- Nationwide data is to May 2010.
- RPI data is extrapolated for May 2010.

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