In a recent interview with The Telegraph, hedge fund manager Crispin Odey shared his thoughts on what challenges 2016 could pose for investors. He listed a few expected suspects: Rising US interest rates, rising US wages, the slowdown in China. However one statement really stands out: “And has Europe, including the UK, only rediscovered the housing bubble route to economic growth that got them into trouble in 2007 and 2008?”
According to the UBS Global Real Estate Bubble Index, London is at the highest risk in the world of a housing bubble, followed closely by Hong Kong
The threat of a housing bubble, or rather a bubble bursting again, has been looming in the minds of investors since 2008. House prices have since been recovering off the back of renewed confidence and dramatic stimulus packages, but there is mounting concern that this will end in a fall, and possibly soon.
Odey isn’t alone. In July last year, Moody’s Analytics warned that the European Central Bank’s quantitative easing programme could be creating a bubble in Norway, Germany and the UK. The author of the report, Anna Zabrodzka, said that house price rises are particularly noticeable in the region’s big cities, such as Oslo, Munich, and London.
London is a particularly illustrative example. According to the UBS Global Real Estate Bubble Index, London is at the highest risk in the world of a housing bubble, followed closely by Hong Kong. The UK Housing Market Observatory report compiled by Lancaster University came to the same conclusion in their 2015 Q4 estimate, that London prices are entering an exuberant phase, although the UK broadly is not. It warned however, that a drop in London prices could have a national ripple effect.
House prices in the UK are expected to keep rising. In a December report, The National Association of Estate Agents and the Association of Rental Letting estimated the average house price in Britain would rise to £419,000 by 2025, an increase of 50 percent. Mark Hayward, Managing Director of the National Association of Estate Agents said that house prices will only continue to go up.
“Ongoing house price inflation, combined with low wage inflation, tighter lending restrictions and a shortage of affordable housing, means owning a home will continue to be a distant dream for many. Increased rental costs will also make it more difficult for current renters to save for a house deposit; as much of their income will be eaten up in rent.”
It’s a similar story in mainland Europe. Bankers in Norway have been tentative about cutting rates further to prevent housing prices growing out of control. Norges Bank halved rates in 2015 as growth was threatened by rapidly falling oil prices. Norway’s financial watchdog warned in November that the low interest rates are increasing risk taking, as household debt hit double disposable income.
Sweden is in a similar situation, with central bankers being forced to weigh up what to do with interest rates given the current climate. Current negative rates have made credit cheap while straining the property market, however, raising rates would destroy the work done to improve inflation. Instead, bankers have announced that they are prepared to step in to lock the currency’s exchange rate.
The difficult thing with property bubbles is that they’re only obvious in hindsight
Moody’s research points the blame at quantitative easing and negative interest rates. With credit cheap, people are willing to spend more. Weak returns in all other asset classes have also made property an enticing option for investors.
David Hutchings is Head of the European Investment Strategy Team based in the Cushman & Wakefield Cross Border Capital Markets group. He works mainly in commercial property, and agreed that there has been a renewed interest in property from investors.
“Every investor has got their own reasons for entering the commercial property sector. Some people like it for the long-term, inflation matching credentials, and so on. But underlying everything, the biggest reason is that investors are searching for a real income yield, given how low interest rates are, how low bonds and income producing assets yields are.”
While property prices are certainly increasing, Hutchings said that current quantitative easing programmes and low interest rates are not yet prompting growth that is unsustainable.
“There are obviously segments of each market that could be overheated, for example the very high end of the London market, but if you take housing in general, certainly commercial property in general, no, there isn’t yet any sign of a bubble.” While Hutchings said it’s possible for a bubble to develop given the liquidity of the market, there are two key elements of a bubble that have not appeared yet.
“One is higher levels of debt against the market, and whilst we do have a significant improvement in particularly the bank finance market over the last two to three years, it still very well underpinned. There’s very little lending, for example, for new development, and the lending is on secured properties. It’s at a more sensible land value ratio that it has been in the past. The debt side is improved but certainly not yet provoking any sort of bubble.
“And the other side is overdevelopment, which can lead to a situation of falling prices, and again there are certain segments of certain markets that might have got more building going on, but the generality for commercial and residential is that there is not yet an oversupply of property being developed.”
For the future, Hutchings sees a potential for an increase of commercial property rents of three or four percent for good quality properties. For the last one to two years, rents have only increased one to two percent.
The difficult thing with property bubbles is that they’re only obvious in hindsight. Predicting one is also a reasonably safe bet, as prices are virtually guaranteed to eventually fall, it just becomes a matter of when. Hutchings said that trends are very polarising.
“What normally happens with property – in residential as well as commercial – it starts in one area but it tends to move throughout the entire market. What we’re seeing now though is much more selective, due to a whole host of reasons about where people want to live, where they’re working, how they’re working. All this is actually meaning that some areas of the market are seeing more demand and will see values rise, but in a lot of cases other areas are actually declining so it’s a zero sum gain.”
The lesson for investors then is to keep aware of property markets at a local level, as sweeping predictions will never give a complete picture. Property value and demand is very locally driven, and guesses at property trends at a scale beyond a national level is a hard task. While the threats are there for a massive crash in property prices, other figures suggest the complete opposite. Still, the case for cautious buying remains. This year looks like a year to stay alert, but not alarmed.