Mortgage & Housing

13 March 2007

Reader Writes:

I read your thoughts on the housing market a few months back and wondered if you had any views on whether or not the interest rates will have an effect on the prices immediately.

It's always difficult to remain unemotional about a decision, especially when there are so many variables, that it's difficult to know if you are fully informed. The market has been under pressure for some time, in that soaring prices will eventually take its toll on the economy. Wage inflation is one example of a difficulty it causes.

Those who can't buy, demand higher wages, and when the economy is virtually in full employment, it's easy to see how those wage demands impact the consumer. Managed unsuccessfully, its easy to see how we can get to the boom-bust scenario especially when the housing boom has encouraged lenders to treat your home as an ATM machine. The stretch in debt is such that it puts further pressure on wage inflation through resultant wage demands.

The latest findings from the Standard Life Savings & Investment Index (“the Index”) show that interest rate rises have had a significant impact on people’s belief in property as an investment category. This is no surprise given the impact that rates have had in the U.S. 1.

Rates typically take 18 months to have their full effect but the evidence is there now that the bite is on.

In the U.K, confidence in people’s own homes as a savings vehicle for their financial future has fallen by just over 19% since October 2006 while confidence in buy to let has decreased by almost 27%. 1.

Commercial property is no different, and the FSA this week announced that consumers need to be very careful about such arrangements as the market may be about to boil over. 2.

A leading commercial property fund manager has stated that the last few years have been exceptional and to expect less than cash as a return for the next five years. Why on earth would you do that? The only reason you invest is to outperform cash. 2.

Moreover there are other issues to consider. Unlike cash investments, property can be very illiquid, in that it is very difficult to sell in a market downturn. If you are trying to leave a property fund for example, the manager can put a six month hold on giving you your capital back!

What happens when everyone tries to sell their property at the same time? If a fund doesn’t have the cash, they will be forced to sell holdings cheaper than they need to and the effect is an increase in supply at a cheaper price which means falling prices.

Why then was over £1.1bn pounds poured into property funds over the last quarter of 2006? Why indeed? It’s the equivalent of watching the price of a Xmas present soar during the year only to purchase on Christmas Eve at its highest possible price. 2.

Think very carefully. I have seen a number of people encouraged to come out of with profit funds and into property - normally by the unscrupulous individual who put them there in the first place. Why on earth would you be in with profits anyway?

Property funds and with profits are very similar in two ways; Their risk is highly disguised until it hits you right smack in the pocket; also the valuation of your fund is amazingly down to the actuary of the fund - they can basically value your fund whatever way they desire as they control that.

The issue with risk is that most advisers measure property funds in terms of risk by volatility. The truth is, they are not volatile. They just flatten out. They are such a cumbersome asset that there is little movement in sales. When they go flat in sales, there is little activity and unlike a share price the market price of property isn't quoted. The only way you will know is if you try and sell, and in downturns in the market you may not even get a buyer. So be very careful as sentiment has turned and that is often too late. 


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Source 1. Standard Life Savings & Investment Index 02/03/07
Source 2. Financial Times 09/02/07 http://www.ft.com/cms/s/96002c68-b862-11db-be2e-0000779e2340.html

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13/03/07