Over the last six months you could be forgiven for thinking that the UK property market has fallen off a cliff. Unmitigated doom and gloom, pretty much all written by newspaper hacks who haven’t a Buy To Let property between them and think that the more outrageous their headline the more papers they will sell.

Time, I think, to look hard at the facts and see where that leads us. As professional property investors we know that there could be a right or a wrong time to be buying. The big question is about right now. Should we, or shouldn’t we, be in the market.

To get a perspective on this, lets look at a variety of facts and consider what is actually happening in the market.

Finance

This is the big bogey man. Yes, there is a worldwide credit crunch, caused no by those august institutions that tell us all the time how to manage our money – the banks! They’ve been packaging up bundles of risky loans and selling them off as ‘mortgage securities’ to each other. Only they weren’t so secure as the risks became apparent.

Now the banks don’t want to lend to each other, in case the other bank has bought a load of the rubbish securities and then gets into trouble and then can’t pay the loan back.

And because most of the banks don’t want to declare the real extent of their losses (or maybe don’t even know!) it makes lending to them a dodgy deal.
Hmmm! If we ran our affairs like the banks, then we would be told we were crazy, immature, taking huge risks and didn’t know how to run a business. But because it’s a bank… draw your own conclusions.

The big issue is what all this means, and how long it will go on.

You will have seen the UK government in recent days offer to pump up to £100bn of OUR money back to the banks in exchange for these dodgy mortgage securities. That will undoubtedly help, as will the passage of time.

My best guess is that it will be 12-24 months before there is reasonable fluid availability of funds again.  In the meantime the market (in the USA and UK at least) will remain tight and potential sub-prime borrowers are going to find raising loans extremely difficult.

The era of cheap and easy money is over… at least for now.

But here are some interesting facts about the world’s money supply. Not every country in the world is caught up in this. For example, the Middle East is awash with money. Even some eastern European countries like Romania haven’t been affected. Why? Because they never had a big mortgage market so they didn’t need to package up and sell their securities, nor did they need to buy them from other banks because they are making good profits in their core business.

And in countries like Brazil, there still isn’t a significant mortgage market so again they haven’t been touched by this scandal (and it IS a scandal!).

Bottom line – many countries in the world have loads of money available for various projects, property and commerce.

The really big issue for the UK (and for parts of the USA), is that money is the oil that enables the wheels of property purchasing to move smoothly. Most people need to borrow money to buy. So if the money supply gets more difficult, then some people are held out of the market. And that has a knock on impact on Demand.

Is A Tighter Money Supply A Bad Thing?

On a recent television program one person was interviewed about the problems he was experiencing in getting a mortgage. At 34 he lived at home with his parents and had saved up precisely zero money towards a deposit. Now he was upset because he couldn’t get a 100% mortgage.

I actually think this is a good thing. One of the basic lesson of investment, whether for your own use or for Buy To Let, is that the investor should have some ‘skin in the game’. By that I mean a personal stake that would be painful to lose. With a requirement for a 5% or a 10% deposit that’s exactly what you end up with. It’s more conservative lending, but maybe it’s the right thing for all of us.

The Government has been telling us for years to stop spending and start saving. If you have to save 5% or 10% towards your own property, then perhaps that’s the strongest reason of all to save.

In the UK we are fortunate in that we have a thriving rental sector, as well as owner occupiers. In many countries, like Germany, most people are happy to rent for their entire lives. It’s a good choice for them. Owning a property here is not a right – it’s a lifestyle choice that may mean some sacrifices elsewhere. One thing is for sure. You won’t want your home to be repossessed if you have £20,000 of your own money in the deal!

Has The Increase In Interest Rates Killed Buy To Let deals?

Look back over historical Buy To Let interest rates. They were rarely below 5%. Now we are at between 6% and 7%. Say 1.5% higher. You could take the view that it’s terrible. Or you could look around the world and realise than in many other countries, eg the Caribbean, rates of between 8%-10% are the norm.
Borrowing in the UK is still comparatively cheap, and if it means that marginal investment deals fall by the wayside, then I’m all for that. I only want to pick the best!

What’s Happened To Supply and Demand

Let’s go back to basics for a moment. The driver for property price increases over the last 10 years and more is absolutely fundamental. There are not enough properties to meet demand.

Of course demand has been driven by cheap money and financing to 100%. But it doesn’t alter the fact that there are more people than properties available. That’s why this government gave a pledge (looks rather weak now!) to encourage the building of an extra 100,000 homes a year. Easy to say, much more difficult to accomplish.

Where has all the demand gone? Nowhere. It’s still there. All that has happened is that the tight money supply, combined with the requirement for a small deposit, combined with the doom and gloom in our press, has frightened the living daylights out of most first time buyers, and a good number of property investors as well.
But the demand will come back – because the fundamentals haven’t changed.

And when it does, what about the supply side? Well, last week Persimmon, one of our largest builders, announced plans to stop ALL new projects. Hmmm! This replicates what’s happening across the UK. Builders are selling off existing stock any way they can (spot an opportunity here?) and are cutting back or stopping new projects.

So far from encouraging an extra 100,000 properties a year, 2008 and 2009 are likely to see the lowest new housing starts for a generation.
And as we work through the credit crunch and demand starts to revive, all those buyers are going to be fighting over even less property. Where are prices going to go then? That will be the start of the next cycle of capital growth.

Do You Buy On Strength Or Weakness?

I find it difficult to understand some investors. Here are three questions?

Guess what – some investors have a reason not to buy for every one of these scenarios. Investors? Give me a break. These guys need to understand they are in dreamland.

When is the right time to buy? If you are building a portfolio, then ALL the time is the right time to buy. Subject, of course, to finding the right deal.
And when is it easiest to get the best deal? When the market is weak – AKA NOW!

Discount And Yield

Here’s what’s actually happening in the market for Buy To Let properties as I write this at the end of April 2008. Developers need to clear stock and frankly we are their best bet.

Valuers, instructed by the Building Societies, are downvaluing property like you wouldn’t believe. Not based on any comparables, just because they have been told to take a conservative view. So one view of the market is that the building societies are actually creating price falls, specifically because of their instructions to valuers.

Interesting point, but on with the story.

Let’s say Axis finds a property at £150,000. We do our own due diligence and believe it is a fair price. The valuer comes in and says “£135,000”. Guess what – we go back to the developer, show them the report and then renegotiate the deal. Sometimes we can, sometimes we can’t.

If the developer says OK, then our new benchmark market price is £135,000. Less the completion reward we negotiate for our investors – typically 25% now. So the final net price is £101,000 on a property we believe to have a genuine market price of £150,000.

Please read the line above AGAIN. It’s just so important. We haven’t seen deals like this EVER, and they will only be available for as long as developers have current stock to shift. In fact at this level of price, some developers are now keeping stock and renting it themselves  - it’s just too much of a loss for them to take. Remember that their loss is your gain.

Now let’s see what’s happened with the rental yield. Suppose the yield on the full market price was 6%. That would be £9,000 a year on a price of £150,000. But we are buying for £101,000 – and can still expect the same £9,000 a year. What’s our yield now? 8.91%. Pretty astounding.
Most investors don’t get this critical point. As the price falls the yield rises. So even if you pay 7% interest instead of (say) 5.5% a year ago, who cares with this level of yield?

An the best is yet to come. Interest rates are probably around the top of the cycle now. So take a two year deal, and by 2010 when it’s time to renew, you can realistically look forward to a lower rate. Add in a couple of years of rental growth (it’s strong because people are renting not buying!) and you could be at a yield of around 9.5% with mortgage rates back at (say) 6%. That’s a pretty healthy cashflow.

Summary

I can’t believe I’ve written so much. Hope you enjoyed reading this and have some food for thought. If I were to summarize this into a few key points here they are:

 

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