Analyzing the London Residential Property Market for Potential Foreign Investors - Case Study Example

 Analyzing the London Residential Property Market for Potential Foreign Investors TABLE OF CONTENTS 1.1 Introduction 1.2 Overview of the London Housing Market 1.3 Environmental Analysis of the London residential property market 1.4 Conclusion and Recommendations to Potential Investors 1.0 Introduction Transaction costs economics and the new institutional economics have provided ways in which traditional economics model on the assumptions of maximising behaviour by individuals can be used in understanding the relationship between institutions and the reform process (Craciunesco, 2006). Changes in investment activity, employment, and prices may be a recurring and frequent manifestation of economic development in a competitive and dynamic economy. In today’s economy like in the past, housing has profound and often unappreciated impact upon the lives of the citizens of each country. It affects almost our entire lives, from the quality of our lives, our health and well-being; it determines not only our choice of transportation means but also our choice of work, and status (Baker 2003). Housing also affects our economic wellbeing, family structure, choice of friends and status in the society. It is with no wonder that, Abraham Maslow classified it under basic need of shelter in his social pyramid. Most often, investors see valuation as the first step toward intelligent investing. It has been argued (e.g. Penman 2003) that an investor can make informed decisions about where to invest once the value of shares are determine based upon the fundamentals. This is so because, without this value investors can either buy high or sell low. Investors who trade on these stocks are often forced to ask themselves whether they are buying or selling at the right price. (Penman, 2003). In the face of this situation and their quest for an alternate answer, investors turn to various media including internet chat rooms, printed press, “talking heads” on television. ). In addition, investors consult investment analysts who provide an almost endless stream of information and recommendations to sort out. There are often claims that some shares are undervalued and vice versa. (Penman, 2003). Against this background, the aim of this paper is to carry out an analysis of the United Kingdom London residential markets so as to enable investors make informed decisions as to a buy, a hold or sell decision. The next section provides an overview of the London residential markets. 1.1.2 Overview of the London Residential Market Property prices in United States, the US began falling in 2005 making sub-prime mortgage loans more risky as the borrowers are normally expected to exercise their options to default. Consequently, the US subprime mortgage market is suffering from foreclosures arising from falling real estate prices and borrowers exercising their options to default. (Schumer and Maloney, 2007). Investment banks such as Merrill Lynch, Goldman Sachs and CitiGroup all fortune 500 companies have witnessed significant declines in profits, share prices and are planning to lay off workers as a result of the sub-prime crises. (Ellis, 2007).   With regard to the United Kingdom UK particularly London, large empirical literature examined the determinants of the two booms experienced by home prices in the early 1970s and the 80s. Findings from these studies provide tentative evidence in support of the view that speculation on expected future house prices must have been an important force driving actual house prices (Muellbauer & Murphy 1997). Concerns over an ongoing house price bubble in the UK have been repeatedly raised by both the press and policy makers. Over the last thirty years, UK house prices have risen in real terms by around 2 ½ % a year and according to HM Treasury (2003) report this stands in contrast to other European countries such as Sweden, France, and Germany where real house prices have decline or remain relatively constant. In a study conducted by HM Treasury (2003), it was postulated that low housing supply responsiveness must have contributed in greater trend increase in real house prices here in the UK. Figure 1 and Two From Figure one above, an increase in the demand for houses from D1 to D2 has not been matched by a corresponding increase in the supply for houses. Houses are not like ordinary commodities. This has forced up price for houses from P1 to P2. This is because with the present state of the UK housing market, higher demand is translated into higher prices than supply. With the government weak housing supply in the previous years, and it inability to assume responsibility to increase the number of houses, prices will continue to increase As supply becomes more elastic over time, assuming the conditions of demand remain unchanged, we expect to see downward pressure on prices and a further increase in the equilibrium quantity of houses bought and sold (Brace and Henderson (1922). Baker (2003) argues further that, whilst the property market across central London has been affected by lack of confidence, a new east-west divide emerged, with Midtown and the City faring much better than Docklands, whose dependence on the financial sector based at Canary Wharf has resulted in a greater fall in prices. Figure two above represents a very short run position. Here factors such as rapid increase immigration with the formation of a common European Union Border, cultural preferences for home ownership combined with local policies and norms have encouraged ownership such as the right to buy and the right to acquire (HMR Report 2003). In the past, owners of houses benefited from generous tax treatment. In the HRM Report (2003), Baker in this report argued that amore competitive financial/ lending market resulting from liberalisation, the perception of housing as a valuable asset and investment were some of the contributing factors behind higher prices and higher demand for the UK housing markets. Baker, (2003), went further in this report to postulate that other factors behind this include the inefficient allocation of government resources in the past years, the role of competition, skills shortages, technology and finance in the house building industry. In 2001, the constructions of new houses in Britain fell to its lowest level since world war two (HMR Report 2003). Other factors responsible for the current situation include. Expectation of future rise in prices, pushing consumers into a rush for houses now. Changes to the system of taxes on rents Growth of real income and consumer’s confidence. When an economy is enjoying sustained growth and rising prosperity - improved confidence raises the number of home buyers and shifts the balance of power in the market towards the seller if properties are in short supply. Is this like the state of our economy? 1.1.3 Environmental Analysis of the London residential property market Meen (1990) postulates that, the UK mortgage markets have undergone major structural changes in the past few years, resulting in mortgages no longer being rationed. However, the period following Meen argument proof to the contrary. The ending of rationing has implications for the specification of empirical models of housing demand. Housing models have never adequately resolved how to incorporate unobservable mortgage rationing (Meen 1990). Meen (1990) further argues that, conventional proxy methods are particularly unsuitable, when rationing ceases. Meen (1990) echoes that, Although rationing has long been recognized as a feature of the UK mortgage market, empirical models have failed to provide adequate measures of mortgage rationing and have almost invariably relied on proxy measures. Despite crude physical housing surplus in some western countries in the 80s and the undoubted improvements in housing conditions, of late there have been an increasing problem of housing affordability in the UK in general and London in particular (Short 1993). Short (1993) further postulates that, the evidence of housing un-affordability is only too apparent in central London’s street. Short (1993) argues that, most successful countries such as France, Germany, and the Netherlands are those with a mixed of housing stocks, a strong welfare state, private investment, continuing of policy. According to the researcher, housing policies in the UK unlike the countries mentioned above have been dominated by party politics to a greater extent and in most situations, increasingly characterized by policy revolutions. This was the same position earlier aired by Harllett (1993) when the researcher argues that in the UK, doctrinaire legislation on housing has been devised without reference to the work on expert bodies, been rubber stamped by a parliament which has effectively ceased to act as a legislative, proved unsatisfactory in practice and repealed by the next government (Harlett 1993). Price to Income Ratio (PIR) is often used as a yardstick for affordability. The UK government and the general public are very much concerned about the high price of commercial housing in the cities which is considered above the reach of the average citizens. Housing affordability is not a new term. It use date back in the 1960s in the UK, and has been repeatedly used to summarize the difficulties individual face in accessing decent and adequate housing (Li & Lau 2002). Within the UK housing market, the concept is used by the government to help people who are in great need while moving towards a market oriented system of housing provision (Hui 2001). According to Hulchanski (1995:471) “one weeks pay for one month rents is an affordable standard”. Housing affordability becomes an issue once more than one-fourth of persons income is spent on housing. Thus, in the words of Hancock (1993:129), affordability is concerned with securing some given standard of housing (of different standards) at a price or rents which does not impose in the eyes of some third party (government) an unreasonable burden on housing incomes. The researcher went on and states that, under affordability, household should be able to occupy housing that meets well established social sector norms of adequacy at a net rent which leaves them enough income to live on without below poverty standard. In the UK Housing report prepared by Baker (2003), Baker argues that households in temporal accommodation have almost doubled between 1995-2003 from 46000 to 93000. Baker further contends that, in the year 2002, only 37% of new household could afford could afford to buy a property compared to46% in the late 1980s. The situation has higher repercussions on the economy as a whole, such as restrictions on labour market flexibility, hampering the delivery of public services, and reduction in quality of life (Baker 2003). House prices have risen at 9% per annum and the present situation is transferring resources from those outside the housing market and those entering the housing market to existing homeowners and landowners. Freeman et al (1997) argue that whilst rising interest rates will always remain a threat to housing affordability, the problem is now far more complex and it is imperative to address other key factors that have affected housing affordability such as income, influx of immigrant, more competitive responsive lending, and cultural preferences for home ownership, combined with policies that have encouraged loan ownership and above all the knowledge that housing is a good investment (Baker 2003). In a White Paper recently drafted by the UK Government: ‘a considerable body of research reveals a widespread and severe shortage of low cost housing in rural areas, which is recognized as not only a major contributor to rural disadvantage, but also as the principal engine of social change in rural England’. Emerging from this, analysts point to growing rural concentrations (Henderson & Hoggart 2005). Today, social housing issues pertaining to housing affordability is increasingly being heralded (Rural White Paper) by supporters as clear significant sign of “Joined up” policy thinking. Thus, today the labour government is working more than ever before to include affordability indexes with desirable economic, environmental and social objectives included (Nicholson 2002, Henderson & Hoggart 2005). Average house prices to income ratio, and the cost of housing for a first time buyer is increasingly being used as a measuring rod for affordability (Baker 2003). Baker (2003) further echoes that, UK house prices had risen in line with the European average since 1975, the UK would be £8bn better off. In the words of Baker (2003:2), for first time buyers, the report says each is paying an extra £32,000 in comparison to the European average. “We may need to take some radical measures, but it is a bit simplistic to say we should free up planning.” She added: “I'm not saying we should just slap anything up. That would be counter-productive. Today, Britain is now so short of new houses that an extra 39,000 need to be built each year just to keep up with the UK's population growth (Baker 2003:3). 1.4 Conclusion and Recommendations to Potential Investors This study was initiated to carry out an analysis of the London residential property market in order to be able to make informed judgments and advice to investors as to a buy, a hold and a sell decision. While the are ample evidence to support the hope of Estate agents that any drop in prices will call in new participants and allow others as first-time buyers to get into the market, although with mortgages harder to come by, that may not be the case; and, when prices are on the slide, there’s less incentive to get on the ladder. The foregoing captions revealed that, the population of London is growing and regardless of the economic cycle, London must accommodate a further 750,000 and above people over the next few years. Are all these people expected to buy new houses should prices remain very high? What will the situation looks like should supply remains unchanged? While the present market situations appear to disfavour consumers, investors appear to be better off. Today, the need to buy has increased as residential property is associated with some sort of identity. With the government weak housing supply in the previous years, and it inability to assume responsibility to increase the number of houses, prices will continue to increase As supply becomes more inelastic over time, assuming the conditions of demand remain unchanged, we expect to see downward pressure on prices and a further increase in the equilibrium quantity of houses bought and sold. Thus, the London residential property market remains a good investment for investors with higher risk higher return expectations. I will recommend a hold and a buy decisions for investors. References Baker, K., (2003). United Kingdom Housing Reports. Review of Housing Supply: Securing our future housing needs. Interim Report Part 1-3 Boddy, J., (1976). The Structure of Mortgage Finance: Building Societies and the British Social Formation. Transactions of the Institute of British Geographers, New Series, Vol. 1, No. 1, Houses and People in the City. (1976), pp. 58-71. Bhattacharya A. K., Fahozzi F. J., Chang S. E. (2001). Overview of the Mortgage Market. The Handbook of Mortgage Backed Securities. Eidted by Frank J. Fabozzi. McGraw-Hill Professional.  Craciunescu C., (2006). Interest and Prices: Economics, Journal of Management, and Financial Markets .2006 Vol: 1 Issue: 2 Ellis D. (2007). More pain than profits ahead for banks. A repeat of the third quarter bust is unlikely, argue analysts, but housing woes and credit market tightness should keep a lid on earnings. CNNMoney.com October 26 2007: 10:51 AM EDT.  Freeman, A., Chaplin, R. and Whitehead, C. (1997). ‘Rental Affordability: A Review of International Literature’, Discussion Paper 88, Department of Land Economy, University of Cambridge HENLEY, A. (1994). The determinants and distribution of household housing wealth in Great Britain 1985-1991. Economics Discussion Paper no. 9415, University of Kent at Canterbury. HM Treasury (2002) Reforming Britain’s Economic and Financial policy, Palgrave. http://www.fsa.gov.uk/ Muellbauer, John & Murphy. A (1997) Booms and burst in the UK housing market. Economic journal 107:1701-27 Penman S. (2003). Financial Statement Analysis and Security Valuation. Second Edition. McGraw-Hill. Schumer C. E., Maloney C. B. (2007). The Sub-prime Lending Crises. The economic impact on Wealth, Property values and tax revenues, and how we got here. Report and Recommendations of the Joint Economic Committee, October 2007.  Read More