Posted on Thursday 15 October 2009 by Ulster Business

Row of houses either up for sale or for lease on a Belfast street

The housing market in Northern Ireland has been one of the most obvious casualties of the global recession but after months of continual price depreciation, the market seems to have bottomed. But has it? Andrew Campbell from Davy Private Clients in Belfast takes a close look at the underlying fundamentals of a market close to all our hearts.

Current global financial woes in part originated in the US residential market due to extremely loose sub-prime lending standards. We remain bullish on a continued recovery in global equity markets, so with housing data on both sides of the Atlantic starting to improve it is timely to consider: 1) The factors that will affect the future trajectory of house prices. 2) Whether housing in the local market is fairly valued at current levels. Green Shoots? Data from Nationwide showed that UK house prices rose for the fourth consecutive month in August, increasing by 1.6% on a seasonally adjusted basis. Recent national data from Halifax showed a comparable 1.1% increase and data from Bank of Ireland/University of Ulster pointed towards a stabilisation in the local market. New buyer enquiries per the RICS survey have been positive for nine consecutive months through July. Confidence indicators have also improved, most notably for both sales and pricing outlook. The correlation between approvals and house prices has historically been very strong. Whilst mortgage approvals have climbed off their lows of recent months, they are still sharply below the levels seen over the past five years. Data indicates that while there is a significant increase in potential willing buyers, they are not able to obtain mortgage financing. So it would seem that from a very low base, demand for housing has strengthened, driven by improved affordability and low interest rates. It should be noted, however, that the low levels of transactions and thus sample size can lead to an increased risk of anomalous data - we are still far away from a 'normal' market. Obstacles Remain Several obstacles stand in the path of a sustained recovery in house prices. We will now look at a number of factors which will affect this equation. Supply While sales volume has improved somewhat it is clearly coming off a very low base. The scale of price declines combined with high borrowing ratios is likely to have created what have become known as 'zombie' borrowers - those that are able to meet mortgage payments but are unable to move due to negative equity. Given banks newly restrictive lending criteria, even those not in negative equity are likely to be restricted in trading up. A recent report from Fitch suggests that while less then 7% of borrowers in N.I are currently in negative equity (c. 10% across UK), those that are will be so to the tune of over £23,000 on average. In the existing home market the level of stock on estate agents books is close to an all time low (1); however, there is clearly the distinct possibility that more sellers add properties to the market once they believe prices have stabilised. Credit Conditions Credit growth has been a key driver of house prices across the world, helping to bridge the gap between prices and earnings. Now that the focus is on deleveraging, lenders have unsurprisingly been much slower to extend credit than in recent years and when they do so, the criteria is much tighter. The most recent credit conditions survey released by the Bank of England suggested that there had been a small increase in the availability of secured lending to households. What is clear is that it remains difficult for many buyers to obtain mortgage approval and the contraction of income multiples and LTV ratios has effectively capped the price that buyers can pay. Macro Economic While economic conditions have clearly improved since March there is no doubt that a number of economic factors will challenge the housing market. These include the potential for: a hike in interest rates, a further rise in unemployment, pay freezes, increased taxation. Demographics In recent years NI has seen strong flows of inward migration; however, the pace is now easing. Given rises in unemployment and a weak job market, Ulster Bank expects NI could return to net outflows as early as 2010 (2). Affordability Much has been made in the media about improved affordability for first time buyers and this is no doubt true in some respects; but low base rates do not automatically translate to cheap mortgages. Research from KBC shows that around 55% of borrowers are on fixed rate deals and so haven't benefited from falling rates. Furthermore, when these deals end the borrower is likely to move to a standard variable rate (SVR) or a tracker with a much heftier margin than was previously the case - around 3.5 percentage points over base seems to be typical. Valuation Metrics Despite their limitations, an examination of the commonly used valuation metrics can be of value especially when comparing different regions. Price alone doesn't necessarily tell us much about value, but if prices have risen rapidly and been matched by similar increases in incomes or rents then overvaluation is less of a concern. Price-to-Earnings Using data supplied by Nationwide, we examined the historic relationship between the price paid for first time buyers' houses and their gross earnings. The multiple of earnings paid in Northern Ireland had dramatically decoupled with the UK average from Q1 2006 onwards. This trend has now just as dramatically reversed, but looks to have further to fall just to bring the ratio closer in line with the comparable economies of northern England and Scotland. If the price to average earnings ratio in Northern Ireland were to fall from 4.2 to 3.3 (the average of the North of England/Scotland), it would represent a price fall of 21% from current levels. Price earnings data from the Halifax for all buyers is only available for Northern Ireland since 1997, but seems to tell a similar story. Price to rent (Yield) In theory, the price of a property equates to buying a stream of rents (for as long as you plan to hold it) discounted to the present. The opportunity cost of not owning a home is forsaking the potential for a return on that investment. But if rents are relatively static (3), not only is the potential for capital appreciation reduced, but it also may be more attractive in cash-flow terms to pay rent rather than interest. The industry expresses relative property value in the context of a yield on an asset; generally expressed as the annual rent as a percentage of the total property cost. Over the long term, the yield should approximate to the risk free rate (10 Year Gilt: 3.6%), plus a premium to reflect the inherent risks in property ownership (say 3%). Feeding this yield of 6.6% through into actual capital values, a typical large, well located two bedroom apartment in Belfast is available for around £800 per month. If we apply the above yield we arrive at a value of c. £145,000, considerably lower than a number of similar listings with local agents. In recent years investors have been willing to accept a yield that is lower than the financing costs of a property loan in the expectation that profits will come from capital gains over time. As capital losses become more prevalent, yield is likely to come back into focus as an evaluation metric for investment decisions. We would accept that this rationale is somewhat limited as non-investment purchases are likely to involve a number of unquantifiable inputs (such as proximity to family, desirability of area, personal circumstances) and there are clearly large variations between types of property and different regions. Conclusion In short, we find it hard to believe that there will be a sustained pick-up in house prices given the weight of factors that would support prolonged weakness. The level of debt that was previously acceptable has clearly reduced from the perspective of lenders and borrowers alike. This deleveraging process combined with increasing pressure on incomes is likely to seriously limit the price that buyers can and will pay. Globally, Ireland and the UK have had some of the largest cumulative rises in house prices over the last decade. This in itself doesn't necessarily equate to a prolonged downturn, but these rapid rises haven't been matched by equivalent increases in rents or incomes. While a number of the metrics would indicate that we are rapidly approaching the point of mean reversion, history shows that we quite often get an overshoot in both directions. An overshoot on the downside is clearly a possibility in the current economic climate.

(1) Davy, UK House builders sector update, Aug 13 2009.

(2) Ulster Bank, Northern Ireland Quarterly Economic Review, August 2009.

(3) “Performance of the private rental market”, University of Ulster/Property News showed that the average monthly rent in the Belfast Metropolitan Area stayed within a range of £578 to £597 between July 07 and Dec 2008.


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