Real Estate & Property: Valuation and Investment - Essay Example

Real Estate & Property: Valuation and Investment The UK property market has generated a lot of discussion over the last few decades. A dramatic hike in the property prices noticed during 1998-2007, has led to an increase in the equity of the existing property or house owners. However, abnormal increase in price also made impossible for majority to people to own a house. The figures available from the Office of National Statistics (ONS) states, that the average price of houses in UK in the beginning of 1998 was about £78,469, while by the end of 2007 it rose to £219,865. This shows that the property prices rose three times more than its initial value. This growth remains consistent by approximately 11 percent every year. However, with the commencement of global recession, the property prices fell suddenly and significantly in UK. According to ONS, the average price of property fell to £190,930, which represents a drop of 13.2 percent from the peak prices during 2007. In 2010, UK property prices started recovering and the average price increased to £210,599 in the middle of 2012, but still the prices are 4 percent below what it was before the recession. So it can be depicted that boom and recession are integral part of the property market and they are bound to show the effects. Figure 1 States the Gross Domestic Product (GDP), the growth of the annual property prices, and the disposable income of the household. Since the property prices has followed the same pattern, so it rose in good times and fell in bad times. This also depicts that the volatility of the property prices depends on the economic cycle and it has a larger impact that the GDP or the household income. Figure 1: The Cyclic Pattern of Property Pricing in UK Source: (Office for National Statistics, 2012) This study aims at scrutinizing the UK property market, its current state and also the prospects of growth in the future. Keeping in mind the objective of the study a discussion on the effect of property prices on the economy, housing bubble, prices, mortgage and projections for future growth in this industry would be done. The pro-cyclic effect of property on the economy of UK led to an increase in the prices of the houses, which also increased the wealth of the homeowners in UK. That is why they felt less need of saving money and spending them. The increasing property prices also led to increasing demand for homes which further improved the economic condition and supported growth. Similarly the lending frequency of the property buyers would also increase, but sudden fall the prices would reverse the economic growth by affecting the whole cycle adversely. A significant mechanism by which the householders boosted their spending is through montage equity withdrawal. It was stated by Bank of England, as can be seen in Figure 2, that till the late 1980s, the mortgage equity withdrawal rate reached about 8 percent after calculating income tax. However, in 2003 the rates cross 8.5 percent. Throughout this period of time the householders were taking the advantage of increasing household prices. Though the government of UK preached of developing a saving culture in the country, but the households have already developed a different culture, which can be also called a borrowing culture. Figure 2: Mortgage Equity Withdrawal (% post Income Tax) Source: (Bank of England, 2007) Mortgage finance is one of the most important components in the property debt market. It was seen that by 2009, the household mortgage debt sector in UK amounted to £1.53 trillion, among which about 78 percent of the debts were secured, which was about £1.19 trillion. A comparative study with the other countries revealed that the household debt ratio of UK compared to the income was more since 2002, as can be seen in Figure 3. UK was renowned because of their high level of mortgage lending, which was showed as a percentage of their GDP (81 %). The concentration of the mortgages was mainly towards residential property than the business or personal property. Figure 3: Mortgage Debt of Household (% of disposable income) Source: (OECD, 2011a) The statistics from the UK’s official records reveals that a 100 percent hike in the liabilities compared to the disposable income was seen in 1997, and further increased to 166 percent in the year 2007, but it again reduced to 157 percent. The mortgage debt amplified from 73 percent to 125 percent, which again reduced to 122 percent, as can be understood from Figure 4. The disposable income in 1992-93 was about 4 percent which increased to 19 percent in 2007. However, then it shrunk to zero. It rose subsequently and in 2008 it remained between 8 to 16 percent, but in 2008 again the savings collapsed due to the perseverance of household spending, rising energy prices, and the onset of recession. The mortgage lending scale in 2000s depicted that the property market was becoming a bubble. Figure 4: Household Liabilities (% of disposable income) Source: (John Dye, and Sosimi, 2010, p. 216-217) After analyzing the situations that led to housing bubble, the discussion would focus on the housing bubble and it’s after effects. In simple terms, housing bubble signifies huge fluctuations in property or property prices that negatively affect the economy of the country. It is a situation when the property prices increases unsustainably than the other economic variables. According to the Nationwide Property Price Index, the average prices of the house in UK increased from £51,367 to £160,319. This means that the prices trebled, and it gives a sign for the formation of the bubble. Another alternative method for detecting house bubble is to draw a comparison between the prices of houses and the general level of the prices in the economy of UK. Figure 5 presents the real prices of the houses since 1953 on the basis of the data derived from Nationwide Property Price Index. It also includes a trend line from the period of 1953 to 2010 stating the assumptions of the real property prices over the time. The trend line shows an increase of 2.64 percent in a year. Figure 5: The Real Property Prices in UK Source: (Nationwide Building Society, n. d.) It appears that UK has gone through four housing bubbles in the past 60 years; first took place in 1970s, then the next one was relatively small by the end of 1970s, the third one was in 1980s, and the extension of the third housing bubble in the 2000s, as can be accessed from the marked areas in Figure 6. The green ring depicts the unsustainable increasing property prices in UK, which led to creation of housing bubble. Figure 6: Housing bubble in UK in Past 60 Years Source: (Nationwide Building Society, n. d.) Figure 6 revealed that the biggest housing bubble was that of 1973, when the real property prices were 43 percent over the trend line. In 2000s the real property prices were 34 percent above the trend line. The property prices are also assessed on the basis of the household income because the purchase power of the households depends on their earning capabilities. A nationwide average property price analysis of the first time buyers would assist to make similar measurements of all the property prices. In 2000s the nominal rate of interest had made the houses more affordable to the people in UK, which is why the demand increased for houses leading to an increase in the property prices. Another method to gauge the housing bubble of UK is to draw a comparative analysis between the house prices and the rents because renting houses are considered to be the nearest substitute to market property. So as the prices of house rises, rents would also be affected. It was noticed that in between 2000-2007 rents rose by 35 percent, which was even faster than the rate of inflation, but the house prices rose by 124 percent, as can be seen from Figure 7. It was evident that UK has faced 3 major housing bubbles in 60 years. Figure 7: Comparison between UK Property Prices, Rents, Mortgage Payments, and Earning Index (in %) Source: (HM Treasure, 2010, p. 9) Several theories have been put forward for stating the cause of housing bubble in UK. It was heard that the past government of UK believed that due to the shortage property or houses, the prices were rapidly increasing in 1990s and 2000s (Barker, 2004, p. 3). However, other was not much convinced with such reasons. Another theory was that the increasing price was due to the shortage of land, strict norms and planning restrictions in UK due to which the supply of property has decreased. However, these stories disappeared when the prices of houses started decreasing abnormally. It was a clear that the housing bubble in UK was due to the easy credit terms for lending. In 2007, there were about 15,600 various mortgagee products in UK presenting the fact that property was one of the best forms of investments, while in 2000s a new twist was added to these combinations and these products were promoted for buying houses or property for renting. The probable causes for housing bubble and the current situation of the property prices has been discussed. Now the drivers of property prices would be analysed. This means that now the discussion would direct towards the factors that are responsible for the supply and demands of property in UK. As stated by Schmuecker (2011), the supply of houses in UK is less than required. The rates of building new houses were 136,000 during 2009-10, which was less than that of the rate in 1970s, that ranged from 200,000 to 350,000 per year. The decreasing rates depict the decrease in provisions of the state such as the local authorities. This condition remained same since 1970s, which led to a shortfall in the supply. The shortfall ranged from 50,000 to 180,000 since 1980s. The current scenario in UK is that life span of the people has reduced. They live in nuclear families and due to the increasing wealth, the demand for larger and second property have also increased considerably. Barker’s review in 2004 on UK property is considered to a benchmark. She found that there was a connection between the rising real property prices, undersupply of houses and household growth. It was also stated in her report that from 1971 to 2001, the property prices in UK rose at a much faster pace than the other European countries. HM Treasury estimated that the real property price increased by 2.4 percent, while Barker estimated that from 1984 to 2001, it increased by 2.7 percent. These statistics reveals the increasing pressure of property prices in UK, but it was seen that during 2000s the rates increased to double digits that is in 2002, the property prices increased by 22 percent. The property supply of UK grows slowly at even less than 1 percent per year. This is reason why is has a weak relationship with the total demand. The receptiveness of supply in UK to the increasing level of demand is low in comparison to the international standards. The volatility of the residential land market in UK has intensified the poor responsiveness. A cyclic pattern of bust and boom can be drawn from the land prices of UK since 1980s. It was noticed that the land rates have increased even more than the property prices (OECD, 2011b, p. 183-185). It has rose by 173 percent in 2000s and during 2008-09 it fell by 40 percent. The unresponsive supply was the effect of the changing demands that were reflected through the price changes rather than increasing supply. On the basis of the Barker report, it can be said that shortage in supply was also a cause of increasing prices, so the property prices were totally demand determined. The commercial property market did not endure similar levels of distress as the residential sector. It performed relatively well from 2004 to 2006, and appreciated by 32.9 percent. This high capital return motivated investors to real estate sector. This led to increase of inflation in the country because the scopes were limited and the demand was high. In 2005, again the property market appreciated by 4.8 percent, as can be seen in Figure 8, which shows the return from the property market. Figure 8: Return from Total Property Market Source: (Investment Property Databank, 2012) The base rate of Bank of England during 2001-03 fell from 6 percent to 4 percent. This in turn affected the swap rate and the lending rate for commercial property also fell to 5 percent. Though growth is seen in the recent times, but the euro crisis had already flattened the growth of commercial property market. The whole real estate industry is suffering due to financial crisis and apart from this the fear of housing bubble has not relived the commercial property sector too. Reports have depicted that the commercial property market of UK has faced fall in demand considerably. Further negative reports revealed that slumping confidence of the customers and the decreasing profits from the commercial property holders in central London and other major areas in UK is also a signal of alarm. Another reason is the huge drop in the retail sales, which is leading to the decreasing demand for commercial space or property. Moreover the housing properties are also not much in demand due to decreasing purchasing power of people. It can be seen that whether it is property for commercial purpose or for personal usage, confidence among owners or users are critical and projection for improvement are made, but practically future is uncertain. It has been noticed that despite rising probability of housing bubble, economic slowdown or recession, the UK property sector has shown a positive return, like the traditional models. An income of 0.6 percent was recorded in this year. Though economists have forecasted that there is a probability of decreasing trend in income in 2012, but by 2013, an increasing trend would return by 2013. It is also proposed that a total return of 7 percent during the span of 5 years that means till 2015 is expected. Other than this, it is also proposed that Central London would present the best performance in terms of revenue generation from commercial property market. The investors who do not want to take much risk would like to invest in the primary property. With this preview, banks have also started releasing prime and secondary stocks through sales or directly. It is being expected that the prime property segment would enjoy increasing demand, but the non-core property demands would not be increasing. Moreover, the debt crisis would create uncertainty and it can be expected that UK falls back to technical recession in 2012. So the investors would prefer risk adverse investments. The financing sources might not be able to fill the gaps in the real estate segment in UK, which would take the UK commercial property market into a period of deleveraging which would further put pressure on the capital values of the non-core real estate sector. References Bank of England, 2007. Financial Stability Report, Issue No 22. [online] Available at: < http://www.bankofengland.co.uk/statistics/Pages/calendar/default.aspx> [Accessed 3rd December 2012]. Barker K., 2004. Review of Housing Supply: Delivering Stability: Securing our Future Housing Needs. Norwich: HM Stationery Office. HM Treasure, 2010. Investment in the UK Private Rented Sector. [online] Available at: < http://www.hm-treasury.gov.uk/d/consult_investment_ukprivaterentedsector.pdf> [Accessed 3rd December 2012]. Investment Property Databank, 2012. IPD UK Monthly Property Index. [online] Available at: < http://www1.ipd.com/Pages/DNNPage.aspx?DestUrl=http%3a%2f%2fwww.ipd.com%2fsharepoint.aspx%3fTabId%3d921> [Accessed 3rd December 2012]. John Dye, J., and Sosimi, J., 2010. The Blue Book: United Kingdom National Accounts. Great Britain: Palgrave Macmillan Publishers. Nationwide Building Society, no date. Nationwide House Price Index. [online] Available at: < http://www.nationwide.co.uk/hpi/default.htm> [Accessed 3rd December 2012]. OECD, 2011a. Economic Household Wealth and Indebtness: OECD Key Economic Tables. [online] Available at: < http://www.oecd-ilibrary.org/economics/household-wealth-and-indebtedness_2074384 74384 74384 74384 74384 x-table18 18> [Accessed 3rd December 2012]. OECD, 2011b. Housing and the Economy: Policies for Renovation’, chapter from Economic Policy Reforms 2011, Going for Growth. Paris: OECD. Office for National Statistics, 2012. House Price Index. [pdf] Available at: < http://www.ons.gov.uk/ons/dcp171778_275550.pdf> [Accessed 3rd December 2012]. Schmuecker K., 2011. The Good, the Bad and the Ugly: Housing Demand 2025. London: IPPR. Read More