It seems today in the UK, that you cannot go anywhere without constant reminders of just how crazy the property market is as we move into Q2 of 2015.
Whether it’s walking down a street and seeing several letting agencies within 100 yards.
Whether it’s the saturation of property related TV programming and daily news articles, either reporting record prices, or bashing ‘Buy to let’ landlords.
Or whether it’s the constant talk of property price speculation from the Baby Boom generation, or Millennials complaining about their extortionate rents. The signs of a late stage property bubble are everywhere.
The housing crash and subsequent financial crash of 2008 it appears is a distant memory. The lessons of the last financial crisis have already been forgotten in this new normal of ‘It’s different this time’ house price nirvana.
Why I’m avoiding this market:
Whenever you see a major excess or shortage of any asset, it’s always a clear indication of massive intervention in the free market, which leads to mispricing. And in this case of the UK housing market it’s no different.
Whilst you have to look at each individual market based on its own merits as an investor; there are 3 main attributes I look for when it comes to long term investments in these types of market.
- Do the fundamentals indicate future growth, are they sustainable or in-line with the current Net Asset Value (NAV) of the market?
- Is the market (based on historical measures) overvalued or undervalued?
- If I plan to sell these assets in the future, who will I be selling them too?
Let’s take a look at the UK housing market based on these attributes:
From my analysis, the underlying supply/demand fundamentals of this market that should give us accurate price discovery, have been completely decimated by out of control money creation through the likes of Quantitative easing (QE) & Fractional reserve banking (FRB). As well as other out of control government policies designed to exacerbate what is in my opinion, an already over valued asset bubble.
These policies have led to extremely low artificial interest rates, which has led to the impotence of yielding assets. This in turn has led to a perfect storm of yield chasing property price speculation, based mainly on the belief of ever increasing extension of credit, debt and low interest rates; in order to justify the current price valuations.
Does this look like well balanced government policy, or a desperate attempt to prop up an overvalued housing market that contributes a disproportionate amount to the UK GDP calculation.
If we took away all of the policies above and allowed the free market to determine price discovery, it is highly unlikely we would have the exuberant house price valuations that we see today.
In the event of a currency crisis and or market forces pushing interest rates higher from there record lows; are these valuations going to stand up to even a modest interest rate rise?
The reason I doubt this is because of the extreme divergence we are beginning to see in the Average House price: Average Income ratio.
Historically, house prices has found a mean of around 3.5X – 4X the average income, from data measured between 1983- 2000.
If we look at the average income now of £27,000 compared to the average house price of £195,000 (1) in Q2 of 2015, it shows a current ratio of 7.2X. This is around double the long running average and in some areas such as London ,South East and the South West we have seen eye watering ratios, ranging anywhere from 10X to 20X the average income.
We are beginning to see an undeniable large divergence between these 2 key indicators.
Where is the future support for this market going to come from? – A look at ‘demographics’:
Another key aspect of this market to analyse, especially when looking at the potential sustainability of the graph above is ‘demographics’.
Is the upcoming millennial generation going to be able to sustain the current level of artificially elevated consumption, in order to support the demand side of this market in the future?
In my opinion, there are 3 important reasons why this will not be the case:
First is the student debt bubble. Millennials are now leaving University with an average of £40,000 in student debt (3).It is highly unlikely this demographic will be lining up to buy £200,000 – £500,000 houses in the future, when they already have such huge debt burdens upon graduation
The first point is further exacerbated by the increasing automation of industries all over the world. From the property markets perspective; this is having unwanted side affects of increasing competition in the labour market and reducing quality jobs which puts constant downward pressure on wages.
Things like ‘Blockchain’ technology (decentralised public ledgers) , ‘Industry 4.0’ (4) and the advent of Decentralised Autonomous Corporations (DACS) (5), are also individually & collectively threatening a whole range of long standing professions:
The third reason that Millennials may not be able to support current property price levels going forward, is the general decline in ‘real’ productivity in the UK. Long extended periods of low interest rates has led to mal-investment and speculation rather than grass root SME development and Capital expenditure. The graph below shows the real world effects of this; as imports increase and exports decrease, the UK current account deficit hits record highs:
Rather than letting free market forces determine the right price of the housing market, it appears the government has instead decided to play an extremely dangerous game of blowing a short term house price bubble, as a means to support GDP figures.
This favours unproductive speculators & rent seeking activity and has the unwanted side effect of hollowing out the real economy; by punishing workers and wealth creators. Essentially, the government instead of the free market is deciding who wins and who loses in this economy and history has shown repeatedly that this can lead to massively detrimental outcomes in the long run.
It could be argued that the government (as well as the BOE who have failed to raise interest rates here’s why) have created an economic ticking time bomb, that requires an ever increasing extension of debt, credit, and low interest rates in order to sustain current price levels.
By partly tying the fate of the UK economy to the housing market and vice versa, I would personally not enter the UK property market today without being hedged with an allocation of sound money like Bitcoin or Bullion; to protect from potential currency collapse and tail risk in the UK and global economy.
Its unlikely big speculators and momentum traders are going to hang around in the property market once interest rates rise and the tide turns. Eventually every market corrects to fair market value.
Personally, I am more focused on what I believe to be undervalued assets with huge growth potential at the moment, such as precious metals and cryptocurrencies.
Whilst these assets are in no doubt still risky to hold, they potentially offer a Risk:Reward perspective that is much more favourable than the current UK property market, especially to millennials, many of which will never even get close to raising the capital required for a mortgage down payment.
It’s not impossible to rule out further nominal gains in UK property prices. However, it’s becoming harder to see in real terms, where future gains in this market are going to come from.