“Gambling promises the poor what property performs for the rich –
something for nothing.”
– George Bernard Shaw.
Where have
shareholders in UK lenders and homebuilders been living for the past year –
under a rock ? When the Nationwide reported last week that British house prices had
fallen at their greatest extent since the early 1990s – and homebuilder stocks
subsequently incurred intra-day share price falls of between 5% and 8% – it
should hardly have struck anyone, other perhaps than the Nationwide’s now
wobbly permabull, Fionnuala Early, as a complete surprise. But as with stock
markets, the housing market is only ever viewed by traditional investors as
something that inexorably rises over time, like knife crime and inflation under
New Labour.
As Pali
International’s James Ferguson recently pointed out, last month’s RICS survey
found that for every 20 surveyors asked, 19 responded that UK house prices were
falling. Until now, the lowest score over the last 30 years was -64.8% in 1988
as the UK property market slipped into a 6-year downturn. “That followed a 6-7
year real price uptrend but this latest uptrend in real terms has lasted an
unprecedented 12 years, so the downturn is highly unlikely to be short. The
RICS survey suggests it is also unlikely to be shallow.” What, asks James, is
the realistic downside ?
This is
difficult to say, as James points out, because the various estate agents and
mortgage providers who provide the numbers constantly fiddle the figures in a
naturally self-interested way. This is, of course, wholly different from Wall
Street banks who happen to be major commodity traders issuing self-interested
price “targets” to the markets and media at large.
The real figures
are almost as distortedly unrealistic as the official inflation numbers. While
house prices are variously quoted at the record level of over 6 times incomes,
the average UK house price (excluding luxury properties) according to Land
Registry data is over £230,000. As a multiple of ONS average wages, reckons
James, houses are trading at well over 9 times salaries.
The metric of
house prices to incomes is a moveable feast. Mortgage lenders use a measure of
household income instead of the average salary (£24,800) because more and more
home buyers are forced to combine two incomes to afford a property. Mortgage
lenders then began to use the average of their customers’ incomes rather than
the national average. As James points out, HBoS, the biggest mortgage lender in
the UK, claims that an average first time buyer’s house bought through
themselves costs £146,882. They also claim that this is less than 3.5 times the
first time buyer’s salary. The upshot is that to be a first-time buyer in the
UK, you now need to earn £42,000, or 70% more than the national average wage.
The average age of a first time buyer was mid-20s until around 10 years ago;
now it is mid-30s. “To price first time buyers back into the housing market is
not going to be a 5%-10% move whatever anyone says. It will take a substantial
drop.”
How much of a
drop ? James Ferguson suggests that mean reversion would see house price to
salary income multiples return to 5 times, which implies an average house price
of £150,000 (or a 35% fall) based on household incomes and trend multiples. But
that price could end up being
“£125,000 (-46%)
based on trend multiples and individual incomes; £105,00 (-54%) based on trough
multiples but household incomes; or £87,500 (-62%) based on individual salaries
and previous trough multiples. Since first time buyers are the lynchpin of a
falling market, stepping in where others fear to tread, another way of looking
at it is first time buyer house prices, which should fall to between £62,500
(-57%) and £50,000 (-66%) from today’s levels.”
His conclusion,
which by now should be obvious:
“Real UK house
prices will probably approximately halve and take several years to do it. This
is the Big One.”
But as with
negative financial market commentary, this message will likely get tuned out or
otherwise ignored by investors determined only to hear positive news and
hanging grimly on in a state of wretched denial until they receive it.
And this state
of denial is doubly unrealistic, because it ignores the fact that for consumers
of financial assets (all investors of means other than those in full retirement
with no alternative income), lower prices are actually in their interest. Or as
Warren Buffett puts it:
“If you plan to
eat hamburgers throughout your life and are not a cattle producer, should you
wish for higher or lower prices for beef ? Likewise, if you are going to buy a
car from time to time but are not an auto manufacturer, should you prefer
higher or lower car prices ? These questions, of course, answer themselves.
“But.. if you
expect to be a net saver during the next five years, should you hope for a
higher or lower stock market during that period ? Many investors get this one
wrong. Even though they are going to be net buyers of stocks for many years to
come, they are elated when stock prices rise and depressed when they fall. In
effect, they rejoice because prices have risen for the “hamburgers” they will
soon be buying. This reaction makes no sense. Only those who will be sellers of
equities in the near future should be happy at seeing stocks rise. Prospective
purchasers should much prefer sinking prices.”
But there is no
use shrieking into the wind about our psychological deficiencies. Since our
lizard brains are poorly adapted to taking the long view about investments, it
is little surprise that we are lured by the siren song of apparently wondrous
short term bull action and depressed by bear markets, even if those markets end
up consolidating rather than dissipating our longer term savings.
The financial
media are complicit in this trend toward collective impoverishment, in part
because their “long term” consists of a succession of our daily or weekly
purchases of their product, and, as discussed, we are easily lulled into
backing that inappropriate short-term horse.
While lower
house prices in the short term have little impact on settled homeowners and
improve the lot of those trading up or of first time buyers, their impact is
reported as akin to the effect of some dreadful type of plague. Lower stock
prices, similarly, have little impact on investors comfortable with their
overall asset allocation and again improve the lot of those entering the market
for the first time. The equation of “lower” with “worse” is understandable, but
lazy and in many cases wrong. (Though James Ferguson is surely correct, as he
suggested last Friday, with the view that falling UK house prices will cause a
collapse in mortgage equity withdrawal, which will in turn soften retail sales,
and probably trigger recession. But the supposed good times never continue in
perpetuity. On which note it was pleasing to read Jason Streets’ letter to the
FT last week: “The chief lesson.. from the Crewe and Nantwich by-election is
that if you take credit for economic benefits beyond your control, the
electorate will give you short shrift when you try to blame misfortune on
extraneous circumstances.”)
And not all
markets are necessarily even lower. It may come as a surprise to many, but the
long-despised Japanese markets are now showing signs of rude health. The broad
TOPIX Index is now up by over 20% from its March lows. And as Asian hedge fund
specialists Stratton Street point out,
“After ten years
of stagflation, an economic recovery has begun to take hold, driven by regional
growth, a consistently weak yen and significant structural reforms.. Japanese
reflation is no longer a hope but a seeming certainty which should finally lift
domestic demand and long term economic growth.”
It would also appear that
almost all of the long-only foreign managers have now abandoned the Japanese market
in disgust. If anyone were looking for a secular ‘Buy’ signal, that would be
it.
Download Unsafe_as_houses.pdf
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