Safe as Houses?

On the 1986 tour to the West Indies, the England cricket captain Mike Gatting suffered a broken nose when he was hit by a very quick ball bowled by the legendary fast bowler Malcolm Marshall. Poor old Gatt was left black and blue around his already large proboscis - it looked like he had been punched in the nose by Mike Tyson. In a post hospital press conference an English reporter asked the fantastically obvious question: "So Mike, where exactly did it hit you?"

I'm not sure what has become of this inane hack, but I would imagine that the depth of his inquiry did not stand him in good stead for a long career as a sports journalist. Perhaps he has taken his endless search for the facts into the world of property in 2009 - I was reminded of the bleeding obvious nature of this exchange when reading an article in the Times this week titled: "Housing recovery stunted by 'lack of mortgages'". To the property developers of the UK this journalist had asked the same "Where did it hit you?" tester.

In the last week Barratt Developments and Redrow, two of Britain's biggest housebuilders warned that signs of stability in the UK housing market were being undermined by banks' reluctance to provide mortgage finance to borrowers. Quelle surprise.

Barratt said that it had witnessed a return to the traditional spring selling season this year for the first time since 2007. Visitor levels to new home developments were up 11.9% in the 6 months to June 30 with the previous six months. Similarly, Redrow also saw a "relatively stable" market over the past six months, with private home sales up by 22%. However, both developers said that a lack of mortgage finance was impairing recovery. Mark Clare, group CEO of Barratt, said: "The market is shut for an awful lot of people. It has removed the opportunity for many people to buy their first home." Redrow also noted that: "Without doubt this is a major obstacle to the recovery of the housing market and we are of the view that resolving this issue can play a significant role in a recovery of the economy as a whole."

OK, so we've established that extensive mortgage availability is important for homebuyers. It was also one of the prevailing factors during the boom times that allowed many to purchase homes that under any reasonable expectations they could not afford. Concurrently it is also why so many of the worlds banks are sitting on loan portfolios that don't look so attractive as they did when house prices were at their peak. The likelihood of mortgage lending returning to its highs looks very unlikely any time soon.

To characterize the situation for the banks, let's say that in 2000 the mortgage book of a hypothetical UK bank amounts to £100mm worth of loans, backed by underlying property valued at £150mm (a Loan-To-Value of 66%). Over the next 5 years the value of the underlying property goes up by 20% per annum, which compounded values the property at £373mm. As a consequence the bank is able to lend almost £150mm more in order to retain it's maximum Loan-to-Value of 66%. All fine as long as house prices remain high. If on the other hand they start to fall, the bank needs to reduce available credit in order to get it's numbers back in order. Estimates suggest that house prices have fallen between 20-30% from their peak already - so let's say for this bank the value of the underlying property is back to £250mm. To get their LTV back to appropriate levels they need to reduce their lending by around £85mm. The credit "multiplier" effect seen on the way up, also happens in reverse - we are currently in a period of the reverse multiplier effect taking effect.

For the last couple of years the housing bulls, panicky estate agents and other crash deniers have insisted that property prices won't crash because a) the supply of property can't cope with demand and b) the economic fundamentals are still strong. I would tend to disagree. The prop that held up the markets has been removed - that is cheap and widespread access to credit.

The fact is that it would be good for the UK (and many other countries) to break the notion that house price appreciation is a key part of economic growth. In the UK and elsewhere house price appreciation became the crux upon which consumer spending was based - increased personal borrowing sustained by ever rising house prices - which in turn was a key part of overall GDP growth. All of which was advocated by government action, either through credit agencies (e.g. Fannie/ Freddie in the US) or beneficial tax treatment for homeowners - the fact that UK homeowners pay no capital gains tax on the sale of their primary residence is quite a compelling reason to bet on housing.

The focus should shift away from a dependence on housing as an income generating asset, towards more long term productive interests - whether it be encouraging banks to create credit for "green" technologies or digital media - the two stated target employment growth areas for the current UK government. A zero % capital gains tax on investments in these areas would almost certainly have greater impact on job creation than the zero rate on primary home sales.

That is all very unlikely - it would be very dangerous to meddle aggressively with an already precariously positioned housing market. The likelihood is that Britain's lenders will come under further pressure to provide more finance to consumers and businesses as the Bank of England is widely expected to inject a further £25bn into the economy as part of its £150 billion money printing ("quantitative easing") programme.

The fact is that these lenders will be supporting a property sector that is still over-leveraged and inconsistent with long term affordability. Last October the IMF suggested that homes in the UK were overpriced by up to 40%. The average price of a detached house in the UK is now £315,000, with the average price of all property at £205,000. Average income growth has been anaemic at best in the UK over the past 15 year period, when house prices have appreciated so dramatically, so relative affordability is considerably less that it used to be. If the IMF prediction holds true, then the combined effects of the reverse multiplier effect for bank lending and the expected increases in unemployment should mean that the current cheerfulness in the housing market, will prove to be a false dawn.

As "Mike, Berlin" commented in relation to the article in the Times: "You people simply don’t get it, do you. House prices are too expensive, that’s why banks won’t lend. Maybe in another year it will start to sink in." In Germany, home ownership has never been seen in the same way as it is in the UK, Spain, Ireland and the US. Owning or renting remains a purely economic choice, just like making an investment in the stock market or any other asset. I'm not sure what the German is for "safe as houses", but I suspect it may find it's way out of the vernacular in the UK over the coming few years.