Peter J. Cooper’s Weblog

Remarks last weekend by the British finance minister Alastair Darling that the economy was in its worst state for 60 years, sent the pound sterling into free fall this week. House prices are also down by more than 10 per cent over the past year, and open to offers lower than that. So is this a good time for dollar-earning expatriates and Gulf citizens to look at buying real estate in the UK?

It is easy enough to see that property buyers are getting a better deal now than a year or so ago: the dollar buys more pounds, and the pound buys more square feet. But I think the market is a very long way from reaching the bottom: both for sterling and property, and that therefore a little patience will pay huge dividends, and rushing in to buy would be an expensive error.

During the 1991-3 housing slump I had a ringside seat as the business editor of Building magazine, the award-winning business journal covering the sector. In late 1990 I wagered the construction correspondent of the Financial Times a good lunch that UK property prices would fall by 20% in 1991.

At that time UK property prices had not fallen in living memory, and it seemed a cast iron bet against a foolish young journalist. But 12 months later the Financial Times expense account was taxed for a lavish lunch as we drowned our sorrows after a very painful year for house prices.

We neither of us had much call for celebration, both being home owners with big mortgages. At least we both kept our jobs and houses through the 1991-1993 housing slump, many did not. And I decided to put my money where my mouth was in early 1993 after the pound’s exit from the ERM and bought a Docklands house.

Then my well-informed colleagues thought me completely mad, and I had to stretch my by then very limited finances to do it. But it was down 38.2% on its original selling price, a perfect Fibonacci series re-tracement in fact although I only calculated that many years later. Indeed by 1998 I had sold out for slightly more than the original selling price. Far too early as it turned out, prices boomed for another decade.

This might not make me the ideal person to judge what is happening in the UK today. But experience has its place and there are some parallels with what happened in 1991-3. Earlier this year the market was in a state of denial.

Landing back in the UK in March after an absence of six months in my home Dubai I mainly met a refusal to admit anything was wrong. Despite five months of falling house prices, record numbers of homes on the market and London agents reporting a 10 per cent fall in selling prices, everybody I saw maintained that in their area prices were stable.

Denying the obvious facts in front of your face, let alone taking even a guess at what the future might hold is ridiculous. But by this summer denial had turned to realization and even desperation.
Mortgage finance is much harder to come by and mortgage approvals are down 71 per cent on a year ago. The once universal confidence in housing as an investment class has crumbled. And it is even worst in commercial property where value falls have been far quicker and more dramatic.

So we have a very large supply of property up for sale and a declining number of people with the finance to pay super-high price levels and few willing to buy in a falling market. And let us not forget that UK house prices have tripled in the past decade and are 50% above most fair-value models.
To start with the sellers held off lowering their prices in a state-of-denial. This left an illusion that the market was not so bad, with high nominal prices still in tact. But now some people are actually having to sell, and cutting their prices to do so.

This will open the floodgates and prices will tumble, just as they did in 1991-3. It is not an overnight phenomenon like stock markets can be. This is a painful drip-by-drip price decline until a market bottom is found. It can take at least a couple of years.

Markets generally overshoot on the way down, and so my forecast for 2008-10 is for a 61.8 per cent decline from peak price levels, as house prices are 50 per cent overvalued - a higher Fibonacci sequence re-tracement than in 1991-3.

The problem is that the collateral damage to the British banking system, which has grown fat and lazy on the back of a 15 year housing boom, will be cataclysmic. We have already seen the first bank failure in over 100 years with Northern Rock. But what is in prospect is a UK version of the US sub-prime crisis with bank mortgage lending in crisis, and negative equity for millions.

Higher than normal inflation levels and the devaluation of the pound will offset this debt misery – inflation lowers the real value of fixed debts - but it will not be enough to prevent a very long and painful recession. As Alastair Darling, the UK finance minister said in an interview last weekend this is arguably the worst set of conditions to face the British economy in 60 years.

The housing market bust is one thing, but it is combined with a global banking crisis and a global recessionary economic outlook. In 1991-3 the housing crash was largely a domestic UK affair and the US escaped recession. That is a very different scenario from today with the US, many parts of Europe and Japan all going into recession after a tripling of oil prices.

For the patient expatriate or offshore investor, there is most certainly going to be a golden opportunity to buy UK property, both residential and commercial, within a few years time. By then absolute prices will be significantly lower than they are today, and the exchange rate could be far more favorable.

Pity the expatriates that jumped in early last summer at the peak of the market with the pound at two dollars. They got the worse of both worlds. However, if prices drop by 61.8 per cent as I am forecasting and the pound declines to the sort of level it has reached in past UK financial crises, and I can remember parity between the dollar and the pound, British real estate will shift from being one of the most overvalued asset classes in the world to being one of the biggest bargains, at least for dollar buyers.

How long is this going to take? Much as I hate to preach gloom and doom for my home country you have to say that the longest period of economic growth in 200 years – for that is what recent history comprises – is likely to be followed by a considerable slump over quite a number of years. In the 1990s you could have bought five years after the initial crash and still have found a bargain. I doubt it will be different this time. Whether the recovery will be as strong is quite another thing.

Many British expats living in the Middle East are contemplating whether to buy property at home now that the UK housing market has crashed. But the same investment opportunity is also available to other nationalities who are all allowed to own property in the country.

This correspondent bought a house in Surrey Quays in London Docklands in 1993 at the bottom of the last housing slump and made a tidy profit selling out in 1998, far too early as it turned out as the housing boom continued through to last summer.

One item that caught my eye in the British press this week was the sale of a three-bed house in Surrey Quays at auction for $350,000, exactly 50 per cent down from the price its owners were trying to get a year ago. This is an extreme case but the RICS reports that transactions in the housing market stand at a 30-year low.

Is this then the moment that offshore buyers have been waiting for, the long awaited correction in UK property? The easy answer is yes. However, the market has probably not hit the bottom yet, and trying to catch a falling knife in any market is dangerous. Besides, many of the houses you see in estate agent’s windows are priced unrealistically – that is to say they reflect what owners hope to be paid rather than true market values.

It will take some time for sellers to become realistic about prices. But there is an air of capitulation about the UK housing market. The quick sale of UK mortgage firm Alliance & Leicester to Bank Santander of Spain this week shows how times have changed; Alliance & Leicester gratefully accepted an all-paper deal worth half the offer made by Santander as recently as last December.

Expatriate buyers have another problem. Getting mortgages as an expatriate has become very difficult. It is a swing back to banking practices of over a decade ago when expats were considered a poor risk. These days even an expat person with a good job will be required to put down a 40 per cent deposit.

UK house prices are one thing but obtaining credit is another. Market analysts contend that this is the most powerful force driving prices lower at present, and until the market bottoms even cash buyers should keep out. The only buyers these days are people who have no choice, or have not thought through the basic economics of their decision properly.

Just consider the position of owners who bought a year ago in the UK. The nominal value of their home is 10-20 per cent lower, perhaps already wiping out their deposit, while interest rates have been edging up. A young couple told me this week that it would cost them 40 per cent more to buy than rent.

Will the average house buyer be any better off this year, assuming that they can find a mortgage lender to suit their financial circumstances? It is hard to see how saving 10-20 per cent could be sensible when a fall of the same amount again is perfectly possible, and if auction prices are a guide that amount should be considered as the minimum likely fall.

This was certainly the lesson of the early 1990s when I was the business editor of Building magazine in London and had a ringside seat reporting on the housing market crash. I can remember advising one colleague to buy a year into the crash and being proved terribly wrong. Two years later he left with his wife for Australia and handed back the keys to the Alliance & Leicester which must have repossessed the flat at a loss.

In fact the tight mortgage market may be doing expatriates a favour in keeping them out of the UK housing market at this stage. Recessions test all the old rules, and there are no magic solutions. For example, the idea that the centre of London would be immune to house price crashes is proving completely wrong, and what has gone up most is coming down with equal velocity.

One of the best pieces of investment advice I ever had was from Dr Marc Faber who contends that buying into any asset class after a recent crash is never a good idea. His view is that calling a bottom and waiting for a recovery takes time and is at best uncertain. Look at the Nasdaq stock market crash in 2000, prices are still 60 per cent lower today.

This could also prove the case for UK house prices which became highly overvalued on any valuation yardstick. It could be that prices get so depressed like the Nasdaq that confidence in housing as an investment is broken for a generation.

In any case, I am not confident about a quick recovery in the financial sector which was not in nearly so much trouble during the housing recession of the early 1990s. Without mortgage finance house prices can not recover, and potential overseas buyers of British property would be well advised to wait for some indicator that the cost of buying a house is becoming cheaper before they rush to buy.

My signal in late 1992 was the pound’s exit from the European Monetary System. After that interest rates came down, and buying property became cheaper. But it was still three years before prices moved up meaningfully. So I would wait to buy or invest in precious metals which have a much better short term outlook.