This issue is close to the heart of many of our clients and, as ever, there is divided opinion about what the immediate future holds. Earlier this week, the Zoopla Housing Market Sentiment Survey showed that around 59 per cent of participants expect prices to rise over the next six months. Another article forecasts that house prices could plummet to Easter 2009 lows as a consequence of a further tightening of the availability of credit and the ongoing impact of the governments austerity measures.

Personally, I think the outlook for property is generally positive. It is very difficult to give a view on “the market” when there are so many sub-markets within the UK (eg: Prime London, London, South East, student accomodation etc.) but, with inflation dropping unexpectedly to 4% last month (and anticipated to moderate further over the coming year), that will reduce the pressure on the Bank of England to increase interest rates over the near future which, in turn, will maintain one of the key props under UK house prices for the time being.

So, what do you think?

Although somewhat simplistic, with the help of Savills Research below, one can get an idea of what the future might hold in store for the UK property market.

Savills property outlook 0810

On the 22 June, George Osborne announced the highly anticipated emergency budget. A combination of expenditure cuts and tax hikes to reduce the enormous £135 billion budget deficit, the largest in Britain’s post war history, within 4 years. On the whole, the budget has been well received by critics despite severe cuts in public spending, with many specialists regarding the budget as the best possible strategy given the current economic environment. (1)

The emergency budget unveiled several amendments to the current taxation scheme. These included a 1% annual reduction in the corporation tax rate and a 20% tax rebate for companies recording a profit of up to £300,000. This amounts to a £1 billion reduction in business tax per annum. (2) Amendments to income tax included a reduction for basic tax payers equating to £200 per annum. A number of tax hikes were revealed including an increase in VAT to 20% and an increase in the Capital Gains Tax (CGT) from 18% to 28% for high net worth individuals (40,000 per annum), CGT is to remain at 18% for basic income earners.

Osborne announced severe cuts in public spending with the 25% cut in budget of Department of Communities and Local Government being of most importance to the property market.

Another important measure is the bank levies, with stricter controls imposed on the banking sector. These include an increase in the bank levy to 0.07% which will come into effect from January 2011. This is expected to raise over £2 billion annually.

How Does This Affect You As a Property Investor?

Two out of three people feel worse off after hearing about the increase in VAT. According to Benham and Reeves, the increase in VAT scheduled for the 1 January 2011 will encourage property owners to renovate homes and purchase big ticket items before the 20% rate is introduced next year. The increase in VAT will primarily affect middle to low income groups eroding their disposable income and spending power. This may result in lower income groups no longer able to purchase their own properties thereby driving up rental demand. Furthermore, this may force landlords to reduce rent or find new tenants as current tenants might be unable to afford rent. The increase in VAT will also drive up management costs thereby increasing the cost of investment properties.

Many speculated that the Capital Gains Tax (CGT) would rise to 40 – 50%. However after the budgetary announcement investors were pleasantly surprised, with a modest increase for high net worth individuals (£40,000 per annum) from 18% to 28% with the rate remaining at 18% for basic tax rate payers. The amended CGT took immediate effect, a smart move by the coalition government to prevent a flurry of property sales. (3) Although the new CGT is a 10% increase on the prior rate it is nevertheless far below the 40% CGT set at the market’s peak. The 40% CGT was not a deterrent when the market was at its peak and therefore the current rate of only 28% is unlikely to have a substantial impact. (4)

According to Bill Dowell, tax partner of Deloitte, “individuals will need to consider the April 2011 bundle of tax cuts and tax rises together. Basic rate taxpayers will see a tax cut of up to £200 pa, due to the increase in personal allowances of £1,000.” (5) For property investors this translates to £200 less tax per annum on your rental income thereby improving the return on your investment. The increase in personal tax allowances raised from £1,000 to £7,475 is expected to have a positive impact on the property market with investors enjoying less tax on their gains.

According to Benham and Reeves, the 25% cut in the budget of the Department of Communities and Local Government is to have a positive impact on the property market. This is expected to halt several housing projects, aggravating the lack of supply in the UK market, which will in turn result in rising demand in the private residential sector from those who are unable to find social-sector home to rent or buy.

The stringent controls to be imposed on the banking sector are set to have the greatest impact on the property market. Analysts predict the supply of mortgage financing to shrink over the next three months, making access to financing difficult over the medium term.

Outlook

The outlook for the UK Economy is positive with the new budget expected to increase business confidence and market stability in the long term. (6) According to David Riley, head of sovereign ratings at Fitch, “if delivered upon, (the UK budget) will materially strengthen confidence in UK public finances and its ‘AAA’ credit rating.” (7)

The Bank of England is expected to maintain a loose monetary policy with robust GDP growth rates expected in 2011 and 2012. As a result low interest rates are expected to remain in the long term, which coupled with strong rental demand and low supply levels, will continue to support property prices. (8)

The 28% CGT is likely to be off set by increasing rents and property prices, especially among investors who have purchased in central London, who will continue to experience strong rental demand. As a result the CGT is expected to have a nominal effect on the housing market as returns on property investment remain historically higher than other investment classes. (9)

Over the medium term, the stringent controls to be implemented on the banking sector are set to have the greatest impact on the property market, by making it increasingly difficult for people to access financing. However costs of borrowing are expected to remain relatively low as the interest rate is expected to increase to only 1%.

On the whole the UK Emergency budget is set to have a positive impact on the economy and therefore the property market with the new measures ensuring that the UK will not follow in Greece’s footsteps. As a result, UK property is expected to remain and safe bet and good investment over the medium term.

(1) http://www.time.com/time/business/article/0,8599,1999268,00.html
(2) Deloitte – UK Budget
(3) http://www.marketoracle.co.uk/Article20512.html
(4) http://www.whathouse.co.uk/News/Emergency-Budget-2010-Property-Industrys-Response-156
(5) Bill Dowell – Tax Partner of Deloitte
(6) http://www.reuters.com/article/idUSLDE65L0RQ20100622
(7) http://www.tax-news.com/news/OECD_Hails_Courageous_UK_Budget____43955.html
(8) http://www.whathouse.co.uk/News/Emergency-Budget-2010-Property-Industrys-Response-156
(9) http://www.whathouse.co.uk/News/Emergency-Budget-2010-Property-Industrys-Response-156

Source : IP Global

Property prices have staged something of a rally in recent months, so much so that, according to Hometrack, the year-on-year price growth is now close to 0% (after being in freefall for much of 2009). Does this mean that property prices will continue to recover? According to an article that I saw in the Telegraph, maybe not.

There is evidence to suggest that the credit crunch could return by January 2011 which, in turn, could stifle the property market.

The squeeze on debt will begin to be felt in January next year, when lenders are due to start repaying £319bn borrowed from the Government during the original crisis in 2007 and 2008 – a quarter of the UK’s entire £1.3 trillion stock of mortgages. To pay the money back, credit-rating agency Moody’s said, banks and building societies may have to “limit their lending through tighter credit criteria” – in other words reducing availability and making mortgages more expensive.

Although credit is already tight, the prospect of a fresh mortgage credit squeeze later this year or during 2011 hardly inspires confidence in the durability of the housing market recovery.

Lobby groups have called on the authorities to delay the repayment timetable but, last week, Mervyn King, Bank of England Governor, confirmed that the main state-backed liquidity scheme, providing £185bn of funding, would end in January 2011 as scheduled. The full £319bn must be repaid by April 2014.

Echoing a warning from the Council of Mortgage Lenders (CML) that removing Government support will choke off lending and raise mortgage costs, Moody’s said yesterday: “If debt markets cannot take up some of the funding gap left by Government schemes, the impact on the UK mortgage market will be significant … The contraction will put pressure on house prices.”

The £319bn “funding gap” is the difference between the amount the banks hold in retail deposits and the sum they have lent. The gap used to be financed in the wholesale markets, which froze in August 2007. They have been replaced with emergency state schemes.

Illustrating the scale of the crisis, CML data shows that UK lenders raised £130bn in the markets in the 12 months before the crunch but just £11.5bn in the past two years.

Moody’s added that the benign environment of low interest rates and “other Government stimulus [which] have helped borrowers” may just have been “transitory”.

Rising bad debts would be particularly severe for building societies, which lost £7.6bn of deposits last year. Their credit ratings have also been slashed, effectively barring all but Nationwide, the largest society, from using the wholesale markets.

“Building societies have been the main victims,” Moody’s said. “Without access to cheaper Government-backed funding, many will find it increasingly difficult to survive.”

The UK commercial property market has been hard hit over the last two years but, at last, there may be signs of life as explored in the article here.

Have you noticed that fund managers will only launch funds if they think that there is money to be made? With that in mind, it is significant to see the level of activity seen in the property sector and another fund launch was brought to my attention last week. Details are available from the office – please get in touch.

I think everyone knows how weak the global economy is at the moment but I am starting to field calls about “what happens next…?” Unless you feel that we are in for an endless depression, the “what next” is likely to be a dose of inflation.

Given that the global authorities have embarked upon a deliberate policy of monetary inflation, it seems reasonable to assume that deflation (that we will probably see in 2009) will be short-lived. Where recovery is likely to be anaemic as well, it will be politically hard for governments to remove the current stimulative policies. As a result, the economic “accelerator” may remain pressed to the floor for too long creating higher inflation once the recessionary forces restraining prices have abated.

In that environment, one of the main beneficiaries will be property. 2009 is likely to be the year of the buyer.

Consider the following:

(i) Foreclosure opportunities. Many of these opportunities exist in the UK and the US and are packaged into funds for convenience. It is not uncommon to find good quality assets at 50% below peak values.

(ii) Medium term property developments. Developers are still building properties and are keen to unload these at steep discounts. Discounts of up to 25% are available and, where such developments have 2 – 4 years to run to completion, this also gives time for prices to recover.

(iii) Concentrate on quality, quality, quality. Understandably, investors will solely focus on price and price alone. However, there is so much mediocrity in the market and the rarity of really good property. The key is to cherry pick and to identify property which is rare to find in any market situation and then turn ones attention to price, and negotiate hard. A buyer’s market provides that opportunity and genuine sellers will be juicy targets for your Singapore Dollars, US Dollars and Euros.

Anyone who has been out shopping recently will have felt the true power that comes from being a buyer in a genuine buyer’s market. It is rare to have such a feeling of empowerment in the retail world and this can currently be experienced when buying anything from computers to beds through to cars and holidays. It is not just in the high street where a buyer holds the cards, but in almost every sphere, not least of all in the property market.

Markets and asset values are adjusting rapidly to reflect the excesses of the credit boom. With property values falling faster than at any time in history, analysts and commentators are now reporting on a return to affordability along historical patterns. What remains elusive is bank funding and there is a vacuum developing that only cash backed buyers can fill.

For a US dollar backed buyer the following compares the differential in dollar terms for a typical UK property from peak to present;

Jul-07 Jan-09 % reduction

Market Value
Sterling 1,250,000 850,000 -32%
USD 2,450,000 1,164,500 -52%

Finance Costs @ 70% LTV
Sterling 52,500 22,610 -57%
USD 102,900 32,845 -68%

*Cost of finance based on sterling loan domestic mortgage

We, and others we talk to, are seeing a growing number of investors who see the above scenario representing little in terms of material downside. Financing remains available to those with sizeable equity stakes (25%+) and whilst the cost of finance may not reflect prevailing base rates (particularly with the most recent reduction) borrowing costs averaging around 4% are still extremely low on an historic basis. So, with rental yields of 5% realistic, the above property example would yield an income of £42,500, or almost £20,000 net of finance costs.

Looking forward, Savills Research project that markets will return to nominal peak values by 2014 which is around a 7 year timeframe from peak to trough and back. This is similar to the timeframe between the peak of 1989 and return to peak values in 1997.
We subscribe to a 30% fall from peak values since the early part of 2008. Published market statistics tell us that we are only two thirds of the way there. However, realistic sellers will accept discounts and although there is risk in entering the market prematurely (before the bottom is being reported), holding a quality tangible asset for a year or so before it starts to materially appreciate in value is not such a poor strategy in an era where returns on cash are so meagre.

No one truly knows if the market will pick up this year or next, the key lies with the banks ability and willingness to lend. What we do know is that we can find quality opportunities in the UK and US at 30% – 50% below peak value and that these properties should be at the sharp end of a market bounce which history shows is to be anticipated when recovery returns.

Feel free to contact The Fry Group if you want to talk through any of these ideas.