Monday, November 08, 2004

Double whammy - UK market

Barrons, November 08, 2004

If this columnist received one pence for each unfulfilled prediction that the sizzling U.K. real-estate market would crack, there'd be money enough to buy a posh London pad. Still, tentative signs are again popping up that the British property mart could cool sharply.

U.K. home prices fell 1.1% in October, according to the Halifax house price index, released by HBOS Thursday. Of course, it was still up 18.5% from the level a year earlier, but the 0.4% drop in the three months ended October marked the first decline for a running three-month period since 2000. Other recent surveys show that mortgage approvals have dropped precipitously and that first-time buyers, the bottom of the food chain, so to speak, are dropping out.

The average U.K. house costs about £150,000 to £160,000 ($275,000 to $295,000), up from £67,000 ($123,000) in 1999.

Home prices are notoriously inelastic. If a seller doesn't get his price and has no urgent need for cash, he can simply wait for a better price. In a rising market, it doesn't pay for the buyer to wait, lest he be outbid. In a falling market, however, buyers begin to think they can get a better price tomorrow, so they'll wait, too.

If there is one useful long-term indicator of home prices, it's affordability, measured by the relationship between property prices and average personal income. And there the U.K. is in unchartered waters. Mortgages, on average, equal six times annual salary, a record high, notes Ed Stansfield, an economist at consultancy Capital Economics. The historic average, however, has been 3-3.5 times, he says, and the ratio was as high as 5 in mid-1989.

Now, it's true that mortgage rates are low, at 5%-5.25%, and that employment and incomes are growing, all factors that would allow that ratio to be higher than the average. Britons are wealthier than they were 10 years ago and can spend more on housing, as well.

"It's a bit old-fashioned," he says, for some to pay attention to this ratio, but it typically falls back to the average.

And the reason the ratio has gotten so high isn't because the banks are giving money away. Instead, the "buy-to-let" market, that is, the buyer investing in property not as a home but for rental income, is crowding out the first-time buyer. Typically, the "buy-to-let" owner uses equity in another home -- which has probably skyrocketed -- to help secure a loan that might otherwise not past muster with the lender. Once prices start dropping in earnest, there could be a double whammy, as first-time buyers hold back and falling home equity restrains "buy-to-let" buyers also. Is a vicious cycle about to be born?

Stansfield figures that the market would have to drop 20% over the next two years for the affordability ratio to fall back to 4. Granted, the stock prices of home builders like George Wimpy, Barrett Developments, and Persimmon, among others, have already started to soften, with some down over 10% and more since early September. Their price-to-earnings ratios are in the inexpensive single-digit range, too. But it's also true that the past few years have been very good to shareholders of British housebuilders, many of whose stock prices, are up triple digits in percentage terms since 2000.

At the risk of crying wolf, there might yet be more downside in these stocks.


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