We need new generals

UK property prices in 2011 - up or down?

So what is it going to be? A return to the bubble years, or a renewed property price crash?

Recent price developments haven't provided much guidance. As the chart illustrates, UK nominal property prices have been treading water for the last nine or so months. They have shown little inclination to go either up or down. Insofar as a trend can be identified, the market appears to be weakening very slightly. Since August, prices are down 0.5 percent. However, that is hardly the sort of decline that will give the nation's rapacious real estate agents sleepless nights.

UK property prices ended last year on a downswing. In December, the Acadametrics national index fell 0.2 percent, compared to the previous month. For the year as a whole, house price inflation was just under 3 percent, and therefore slightly lower than the overall inflation rate. In real terms, house prices fell by the smallest of margins.

Most predictions point to a further round of price declines in 2011. As always, much will depend on the future path of interest rates. If the Bank of England starts to hike the bank rate, the conventional wisdom is that the housing market will weaken.

However, we live in bizarre times where the normal rules no longer apply. In the short run, a rate hike from low current levels won't make much difference to mortgage affordability. Any homeowner with half a brain cell will have already locked in their super low rates when they remortgaged.

Ironically, a rate hike will signal improved economic conditions and an exit from the financial crisis. This will strengthen consumer confidence, which might spillover into the housing market. A rate hike will also improve the functioning of credit markets, which could also increase mortgage approvals.

However, if the Bank delays a rate rise, bad things will happen. It will prolong the pervasive sense of turmoil and weaken consumer confidence. It will also give further credence to the growing expectation of more inflation. If the delay extends into the second half of the year, higher inflation expectations could push long run interest rates upwards, and open up the possibility of a slowdown in GDP.

So how does this inverted story - where a rate hike buttresses consumer expectations and the housing market - fit into the long run assessment that property prices are overvalued? The 2008 house price crash was unusual. Prices fell in nominal terms, which is a rare event in property markets. In previous corrections, the downward adjustment was slow, with rising inflation and incomes doing all the heavy lifting. Homeowners are invariably reluctant to accept nominal price reductions, but seem prepared to absorb an inflation induced adjustment. The future correction is likely to return to a more normal pattern of seller denial, and a slow deterioration of home values as consumer price inflation outstrips house price inflation.

An early rate rate might affect the adjustment path, but it will not affect where prices will be over the long run. Within five or so years, the UK property market will have given up all those gains recorded during the bubble. A delayed rate hike, ironically, might actually speed up the adjustment path, since it will both weaken consumer confidence, and strengthen the growing inflation momentum that is now building up within the UK economy.

For what it is worth, and it is not much, I think the Bank of England will delay the rate hike. Accordingly, house prices will weaken during the first six months of the year. Inflation will pick up, and by mid-year some alarming consumer price index numbers will begin to be printed. At first, there will be denial within the MPC, but eventually there will be a panic rate hike, probably towards the end of the summer.

Once the MPC have come to their senses and begin normalizing the economy, a sense of calm will prevail. Overall, it will be a good thing, but as always, UK home owners will over-react. Towards the end of the year, house prices will temporarily stabilize, and perhaps rise.

So where will house prices be this time next year? It is only a personal view, but I think they will down slightly on where they are today. although I would not rule out the possibility that they are flat, should the MPC raise rates earlier than anticipated.

(Finally, just be clear, this my humble opinion, and it is for entertainment purposes only. If you are in the business of buying property this year, make your own mind up. I make no recommendation to buy, hold or sell.)

The bubble is back in town

Today, Bloomberg reported that commercial property in London is booming. Citing data from Real Capital Analytics (RSA), sales of existing commercial property in the U.K. capital totaled $13.9 billion in the first nine months of this year.

Dan Fasula, Managing Director of RCA was ecstatic:

"There’s a massive surplus of investment capital looking for a home, and the one thing in common is a desire for yield. London office property at a 5 or 6 percent yield looks fantastic against the alternatives. Negative real interest rates mean you aren’t going to buy government bonds, corporate bonds have already had an incredible rally, gold doesn’t give you a yield and the stock market is volatile."

To be fair to Dan, what he says makes sense. If the Bank of England engineers a situation where interest rates on government bonds and bank deposits are negative, investors will seek returns elsewhere. If, as Dan suggests, commercial property is yielding five or six percent, then the commercial property market will start a bubble.

The sad fact is that Britain, and the investors it attracts from abroad, are hopelessly addicted to property speculation. I used to think the recent crash in prices might provide an antidote, but I was wrong. The crash is merely a precursor to another bubble.

While I can't share Dan's excitement I suspect he might be telling us something quite important.

Credit rating agencies sow more havoc

Its those credit rating agencies again; with their recent downgrades of UK buildings socieites, they have thrown a spanner into the Bank of England's Special Liquidity Scheme. From today's Times:

THE Bank of England is locked in talks with seven British building societies to renegotiate crisis funding measures introduced at the height of the credit crunch. A slew of credit-rating downgrades for building societies last week threatens to breach the terms of the government’s Special Liquidity Scheme and force the societies to hand back cash to the Bank of England.

Such a move would reduce the amount of new lending they could make, dealing a blow to Whitehall plans to kick-start the housing market. Chelsea, Yorkshire, Skipton, Coventry, Newcastle, Norwich & Peterborough and Principality are the societies affected. All have recently passed stress tests imposed by the Financial Services Authority (FSA) and are not considered in danger of collapse. Nonetheless, they will now be charged more to use the emergency funding.

The Dunfermline - What happened?

We are becoming numb to financial scandals. We have seen far too many. So when a mid-sized regional bank fails, it barely registers.

However, the failure of the Dunfermline building society is scandalous. Yet again, the FSA failed to properly supervise an institution that was taking unacceptably dangerous risks. It was also an institution that had a highly paid but basically incompetent management team. The FSA missed it all. Yet again, the taxpayer has been lumbered with a huge bill to clean up yet another FSA supervisory disaster.

The FSA had a opportunity to step in when the Dunfermline building society prepared their Basel II Pillar 3 Disclosures 2007 document. This submission is supposed to outline the institution's exposure to various kinds of risk. This is what the Dunfermline management said about their commercial property risk profile.

Our commercial risk appetite is confined to loans secured on property where the Society is able to achieve an adequate return for that risk, where the commercial investment is in lower risk areas, and where the Society is able to take advantage of risk mitigation such as guarantees to limit its risk.

The Society seeks to limit its risk to any one area of commercial lending by imposing sector limits.

This wasn't a terribly accurate representation of the magnitude of their commercial property exposure. The Chancellor - Alistair Darling - picked up on this point on Monday when he was forced to explain why the Dunfermline failed.

"This is a building society that, unfortunately, took out over £650million in loans in commercial property. In the last couple of years, it bought some mortgages from an American company that had gone bad. It's had to write off some of its IT systems because of difficulties it's had and it needed between £60 million and £100 million to keep it going. When you bear in mind that the society has never made more than about £5 million or £6 million a year in the recent past, it couldn't even service that sort of loan, let alone repay it.”

Presumably, someone at the FSA took a look at the Basel II document and concluded that everything was fine. Yet if someone had bothered to look at the loan portfolio, they would have quickly realized that the Dunfermline was far too exposed to a commercial property downturn.

After all, as the 2007 annual report pointed out, the institution had assets amounting to ₤3.3 billion. It had ₤117 million in capital, giving it a leverage ratio of 28. Holding a £650million exposure to commercial property was a very precarious position for a bank like the Dunfermline. The FSA should have picked this up.

The Dunfermline debacle sadly reveals that the FSA continues to incompetently supervise the financial sector. In fact, it is worse than that. The institution is dangerous. With each bank failure, it pushes huge clean up costs onto the taxpayer. In summary, it has wrecked the financial viability of UK public finances. It has to be stopped before it does any more damage.

The silent property crash

(Click on the chart for a sharper image)

The commercial property crash is rarely mentioned, but it is just as vicious as the one currently raging in the residential market. UK Banks are dangerously exposed to commercial real estate. Declining rental values and property prices threaten to weaken already battered bank balance sheets.

Prices are already down over 40 percent since the peak in early 2007. They could fall further and easily outstrip the fall in residential prices.

Even the Duke of Westminster?

This is a crisis that has hit the rich the hardest. It might go south and ruin the rest of us, but at the moment, the big wealth wipeouts are happening at the very top of society.

Even the Duke of Westminister is having to talk nicely to this bankers.....

Britain's wealthiest landowner, the Duke of Westminster, is in advanced talks with his bankers to prevent his £2bn property fund business breaching bank covenants. Pressure on the multibillionaire duke has intensified with investors in his funds suggesting that his property managers failed to heed advice to reduce borrowings 18 months ago, ahead of the collapse in property values.

The developments mark a serious threat to the duke's private investment company, Grosvenor, and underline how the property downturn is embroiling the country's wealthiest aristocrats.

UK commercial-property firms need to raise $20 billion this year

Meanwhile, back in the UK property market.....

Jan. 14 (Bloomberg) -- U.K. real-estate companies may need to be rescued by shareholders this year to stay afloat. The largest commercial-property firms need to raise as much as $20 billion this year to restore their balance sheets at a time when financing is scarce, according to estimates by Bernd Stahli, an analyst at Merrill Lynch & Co. in London. The FTSE 350 Real Estate Index fell 7.3 percent, the biggest slide since 1987.

The five largest real estate investment trusts -- Land Securities Plc, British Land Co., Hammerson Plc, Liberty International Plc and Segro -- have combined debt of 19 billion pounds ($28 billion), according to their latest reports. About 700 million pounds of loans are due this year, research by Nomura International Plc shows. The banks that granted those loans may now be reluctant to provide more credit.

That could spur another year of losses for REIT investors. The FTSE 350 Real Estate Index of 18 stocks fell 46 percent last year, the most since the index was created in 1986. The worst performer was Liberty, which declined 56 percent.

UK commercial property - it is the crash that rarely gets a mention in the regular media.

Rent crash continues

Mayfair rents; the top of the market on the monopoly board. Now they are crashing.

For a decade it was the preferred location for hundreds of hedge fund managers as they deserted the City and set up shop nearer to their well-heeled clients. Making the move to Mayfair and St James’s, they would think nothing of paying more than £100 a square foot for a few floors inside a Georgian townhouse, driving rents ever higher as they bid against each other.

Property experts described the rents as “eye-popping”, but investors’ money was flooding in and fee structures were designed to capture 20 per cent of the profits, so managers believed that the bills could be shouldered easily.

(from today's Times)

Darling - VAT cut from 17.5 percent to 15 percent

Just checked the BBC website; fiscal irresponsibility is the order of the day. Darling is up on this feet delivering this pre-budget statement.

So far, Darling has:

Reduced VAT from 17.5 percent to 15 percent:

Raised the government deficit to £78 billion this year and £118 billion next year.

Working on the assumption that this year's GDP is about £1.4 trillion, and assuming that it does not increase next year, this means that these deficits are about 5.5 percent and 8.5 percent of GDP respectively.

Do New Labour really think that they are going to get away with deficits of that magnitude?

Dream on....

Riot in Iceland

The BBC reports that the Icelandic masses are on the move. Several hundred stroppy protesters gathered outside the city's main police station to shout and stomp at the injustices perpetrated upon them by the world financial system.

Lets be honest, Icelanders don't have much experience at rioting. These demonstrations are going nowhere. Brits, on te other hand, have centuries of accumulated know how of street protests and anarchy.

Can you imagine what is going to happen when Reykjavik-on-the-Thames finally blows up.

UK property - another 15 percent fall next year?

Two stories today that illustrate just how precarious the UK housing market is right now. The market may have slipped 16 percent relative to the peak. However, here are two stories that suggest that things are about to get much worse.

The first, from the Telegraph, highlights the huge number of empty homes in the UK. When prices were going up, it made sense for speculators to buy and hold properties rather than rent them out. It was supposedly much easier to time the market with a vacant house whereas a rental property would contain those awkward renters with their six month contracts.

"Almost 1 million homes are standing empty across the United Kingdom, and the vast majority – more than four out of every five – are believed to be owned by private landlords.

Some landlords might be actively trying to sell, or planning refurbishment, while many have simply given up on their empty properties. Whatever the reason, the Empty Homes Agency (EHA) believes that a staggering 85pc of empty homes in this country belong to landlords.

The EHA claims that there are more than 762,000 empty residential properties in England. Based on earlier figures, about 650,000 of these are believed to be owned by private landlords, and almost half of these are thought to have been empty for more than six months. Almost 1m homes are standing empty across the United Kingdom, and the vast majority – more than four out of every five – are believed to be owned by private landlords. The charity estimates that there are at least another 77,000 empty residential properties in Scotland, plus 50,000 each in Wales and Northern Ireland."

Meanwhile, the Financial Times reports an increase in voluntary repossessions in the UK:

"Banks are seeing an increase in the numbers of homeowners deciding voluntarily to hand back their properties because they cannot afford to keep up mortgage payments. Voluntary repossessions involve the bank selling the property at auction but this will not show up in official figures as a repossession because there has been no court order.

The phenomenon is widespread in the US, where it has been nicknamed jingle mail because homeowners often post their keys to lenders if they cannot make the payments and no longer have any equity in their homes. It was also common in the UK recession of the early 1990s when homeowners were in negative equity."

With huge supply and rising repossessions, it isn't too hard to imagine a surge in supply which will quickly lead to outright panic amongst speculative investors.

A further 15 percent fall in prices next year looks very likely.

Falling flat prices in the North West

Penny, who writes the wonderful rentergirl blog, asked me to post a few regional house price charts.

Here is the first of what I hope will be a series. Today, we are looking at flat prices in the North West of England, which includes Penny's home town of Manchester.

According to the data, average flat prices in the region peaked in the first quarter of 2007 at ₤111,000. Since then prices have fallen by about 19 percent. The latest data puts the average price at about ₤89,000.

As Penny's blog illustrates, the North West is the epicentre of the UK's buy-to-let inner city two bedroom new build speculative bubble. It will also be the epicentre of its crash.

I just wish Penny would post more often.

The end of mortgage securitization

Housing bubbles across the world were built on securitization. Banks bundled their high risk mortgages into bonds and sold them onto unwary investors. In return, banks received cash that allowed them to issue more mortgages. This recycling of loans created unprecedented levels of credit and fueled the extraordinary run up in house prices.

With the onset of the credit crunch, mortgage securitization has all but died. In October this year, residential mortgage backed securities issuance was just $10 billion; barely 5 percent of the March 2007 peak.

Without securitization, it will be impossible for housing prices to stabilize and recover. Without credit, there can be no housing bubble.

Alice's bubble wrap

Too Late For Me

Renter girl is moving out and moving on.

"My landlord is going bankrupt, and so I must leave. Somehow, he’s accumulated twelve buy-to-let mortgages, you see, and nine are in negative equity.Good job I packed, really."

Twelve buy-to-lets, with nine underwater? Who gave him the credit to create such a mess?

Do Fannie and Freddie hold the key to UK’s housing crisis?

First prize for dumbest question of the day.

UK going into recession, says EC

The Eurocrats must have enjoyed making this forecast.

Housing slide hits Barratt profit

Profit warning? I'm amazed that Barratt is still around.

Stagnation in Welsh economy continues

I haven't heard much about the Welsh property bubble.

Lehman shake-up as losses mount

"Troubled US bank Lehman Brothers has reported a massive third quarter net loss and outlined radical plans to strengthen its finances. Lehman said it made a loss of of $3.9bn (£2.2bn) between June and August, taking its losses this year to $6.6bn. To shore up its weak financial position, it has slashed its dividend and will sell a stake in its lucrative fund management arm. "

It doesn't look like a long term growth strategy; it is more like "can we last till the weekend" strategy.

Lehman Death Watch: Will Paulson Let Lehman Fail?

Naked capitalism thinks that the Fed and the Treasury might let Lehman sink. Not so about this one.

Lehman Brothers: Wall Street atom smasher set in motion

"The world’s most powerful balance sheet smasher was set in motion for the first time Wednesday morning at the start of an experiment designed to unlock the secrets of the investment bank accounting universe."

Lehman losses hit world stocks

Al-Jazeera's take on the Lehman crash.

Irish Nationwide disagrees with downgrades

"Irish Nationwide Building Society says it 'fundamentally disagrees' with recent rating downgrades from credit rating agencies Fitch and Moody's. Fitch said today that the downgrade reflects concerns about the uncertain outlook for commercial and residential property lending in Ireland and the UK. It said this has deteriorated further and faster than was anticipated in early 2008."

Pimco fund makes $1.7 billion in a day after bailout

The real reason behind the Freddie and Fannie nationalization.

Bill Gross Finds Communism

It is as if the Berlin Wall had never fallen.

Spanish PM unveils housing credit to combat slump

More state aid for the housing market.

Economic Breakdown: Result of Moral Breakdown?

"Today, people don’t seem to care so much about things like their reputation, honesty and character. The pursuit of money reigns supreme."

Judgement day is upon us; we had it coming.