We recently highlighted the unfortunate knack some investors have of misjudging when they move into illiquid assets. That article, Best laid plans, had been published on The Value Perspective for all of five minutes when, leafing through the latest Financial Stability Report from the Bank of England, we spotted some scary little charts on the ultimate illiquid asset.
We use the term loosely, of course – pedants, economists and, particularly, pedantic economists will no doubt be able to come up with more technically illiquid assets. Nevertheless, for most people, the facts they will only ever own one house at a time – to live in – and the transaction costs are so high mean property is about as illiquid as their assets get.
These days, concerns about the UK’s residential property market’s overvaluation surface in the media with every new house price survey that is published. Certainly, as you can see from the chart below, house price inflation has only moved in one direction over the course of the last two years – and particularly so in London.
Annual Halifax and Nationwide regional house price inflation
Sources: Halifax, Nationwide and Bank calculations, June 2014
The obvious question of how much further house prices can rise is also a difficult one to address because, relative to share prices, say, there are few reliable metrics and the associated costs can vary to a far greater degree. Still, you could at least think in terms of what someone might pay to buy a house in London and, since most people would have to borrow to do so, what that borrowing would actually entail.
So how much more could a potential London owner pay? Well, take a look at the charts below. The one on the top shows that, prior to 2003, the instances of loan-to-income ratios of more than 4.5x made up such a small fraction of total lending that the category did not exist. Yet the chart on the bottom shows that approaching one-quarter of all new mortgages advanced in London now fall within that category.
New mortgages advanced for house purchase at loan to income multiples at or above 4.5
Sources: FCA Product Sales Data and Bank Calculations, June 2014
New mortgages advanced for house purchase by LTI
Sources: Council of mortgage Lenders, FCA Product Sales Data (PSD and Bank calculations, June 2014
In order for London house prices to rise significantly from current levels and so count as a good investment, therefore, you either have to be able to envisage people becoming even more leveraged – and at a ratio that barely existed even a few years ago – or else their incomes rising so dramatically that prices would go up at a static level of leverage.
In other words, while property can be hard to value at the best of times and – as we saw in Best laid plans – investors have shown themselves well capable of ignoring valuations, the metrics that would allow UK, and especially London, property prices to rise much further require either imprudently higher leverage or much higher earnings to lever. At present, there appears little sign of either.
Full disclosure: Your author has recently pulled the ejector-handle in the London house-price rocket, and has landed out in the sticks. There is every chance that he is suffering from a choice-supportive bias.