What lies in wait for UK property in 2011?

For investors, 2010 resembled a scene from a Hollywood film, in which the survivors of a financial crisis tentatively left their shelters to survey the damage. Some quickly retreated feeling that the investment waters were still toxic, while others took advantage of the uncertainty, feeling that opportunity was knocking.

Those who headed for the stock market were treated to a volatile ride. Like a rollercoaster the FTSE 100 climbed slowly from 5,412 in January and hit a dizzying two year high of 5,825 in April, up 7.6%. However in the space of 10 weeks, it descended rapidly by 17.5% and hit the year low of 4,805.

The rollercoaster started again, rising and falling, until it settled on a steady upward  trajectory in September. As we head for the 2010 finish line the FTSE 100 looks like it will finish a staggering 22% higher than the year low, but a more conservative 11% higher on the year.

Coming off this rollercoaster ride for some the sense of relief is almost palpable and their faces filled with giddy smiles. I’m not too sure how many will want to ride it again in 2011.

So how did property fair?

The ride was altogether a more sedate affair akin to the Carousel. It could be said that returns were somewhat pedestrian with the market broadly staying flat. The latest data from the Land Registry showed that between January and October 2010 prices in the UK rose by just 0.31%.

Investors with sufficient amounts of cash would have invested in London which rose by 1.91%, however Central & South West London boroughs outperformed the market. The Royal Borough of Kensington & Chelsea rose by 4.6%, Westminster by 5.1%, Wandsworth by 5.9%, Hammersmith & Fulham by6.6% and Merton by 7.7%.

Like the Carousel, London property is a more traditional and resilient asset class which rarely disappoints and always leaves you with a smile. The numbers illustrate how it offers a profitable, safer and less volatile home for your cash.

Mortgage finance

Overall lending was down on 2009. The latest figures from the Council of Mortgage Lenders (CML)showed a 16% fall in the number of mortgages, and a 12% fall in thevalue of mortgages from October2009. The number of first time buyers also fell by 19% over the same period.

There are glimmers of hope in the data with the average Loan to value (LTV) increasing from 75% to 80% and the proportion of income spent on interest payments falling from15.1% to 13.3%. An indication that banks are improving terms for buyers. This view is further supported by The Bank of England’s (BoE) October “Trends in Lending” report. It stated that advertised two-year fixed mortgage rates for 90% LTV products had fallen by around 20 basis points during Q3 2010.

The report went on to say that competition among major UK lenders to meet their lending plans had put some downward pressure on mortgage pricing.

In our last edition I noted that property transaction levels were falling, which in turn would lead to price falls. Both happened so where are these buyers going?  Well, because buyers “Can’t Buy, Won’t Buy” they’ve been forced into the rental market.

The Royal Society of Chartered Surveyors (RICS) Lettings Survey for the three months to October showed that lettings demand was increasing at the fastest pace since the end of 2008.

Supply has continued to fall with new landlord instructions slipping again, marking the fifth consecutive quarter of falling instructions. The net result is increasing rents and better yields for landlords.

Nik Madan at John D Wood & Co in London said “According to our statistics rents have risen by some 9%” he went on to say that “we anticipate this rise in rents continuing throughout 2011”. This is great news for existing landlords and investors thinking of entering the market.

So what’s in store for property investors in 2011?

The key cuts included the loss of 490,000 public sector jobs, department budget cuts by an average of 19% over four years and £7bn in additional welfare budget cuts which includes housing payments. In addition it was announced that the retirement age would rise from 65 to 66 by 2020 and that the bank levy would be made permanent. Surely these cuts will affect the property market.

There’s no easy answer as it depends on where you are in the country. It could be argued that because the economies of London and the South East rely less on the public sector for employment, while not immune, they will be less affected by the cuts. Additionally government is expecting the private sector to replace the public sector jobs they are cutting.

Having gone through the pain two years ago when the crisis hit, the private sector should be in a better position to benefit from the economic recovery.

Therefore property prices in regions where the public sector is a major employer are likely to fall further due to rising unemployment. In those regions prices may fall to a level that become irresistible to investors, however “Caveat Emptor” (Buyer beware) should be the mantra as it is likely they will have to wait a very long time for their investment to bear fruit.

Inflation & Property

The BoE’s printing presses have been busy in 2010 creating an unprecedented £200bn in quantitative easing to help lubricate the economic cogs.

Although there is still a great deal of uncertainty as to what side effects of this radical treatment will be, most economists would agree that inflation will be first on the list.

Mervyn King, the Governor of the BoE has had to sit at his writing bureau more often that he would have liked this year. I don’t envy him having to pen numerous letters to the Chancellor explaining why inflation remains stubbornly above the 2% target.

Currently running at 3.3% and with VAT increasing to 20% in the New Year, I hope someone is generous enough to put a Mont Blanc pen and plenty of ink in the Governor’s Christmas stocking.

Many investors have been chasing returns in the bond markets, however the BoE Financial Stability Report warned that inflation could threaten bond yields and combined with Sovereign debt contagion, bonds could be “susceptible to a sudden reversal”.

So if bonds are facing a major correction, similar to the scale endured in 1994, where should investors move their cash?

Is property the answer?

Property has long been thought of as a hedge against inflation but empirical evidence is mixed. Fama/Schwert (1981) found there to be a negative correlation, others like Hoesli et al (2006) a positive correlation.

However a more recent paper by Demary/Voigtlander (2009) entitled the “Inflation Hedging Properties of Real Estate” found that property does provide a hedge against inflation but there are differences between residential and commercial.

The study found direct investment into residential property offers a hedge against both expected and unexpected inflation as rents are often indexed and quality housing stock cannot be substituted.

Commercial property had mixed results in that “Offices” only partly protect against inflation because worsening economic expectations alleviate the demand for office space. “Retail” on the other hand did not provide any protection as retailers found it difficult to shift inflation tocustomers.

Those thinking of an indirect investment into real estate will be disappointed. The report found that neither stocks nor real estate stocks provide a hedge against inflation. This also applied to residential and commercial REITs because in general stocks are not highly correlated with macroeconomic factors as expectations and corporate news are more relevant.

Perhaps this research confirms that direct investment into an asset like Prime Central London property (directly or via a specialist fund) could be just what the doctor ordered.

2011 Prediction

Before I share my thoughts on what lies ahead for 2011, let’s review the predictions I made in Dec 2009 of an increase of between 5-7%. The most recent Land Registry data shows that between Jan-Oct the UK market increased by 0.31% and London increased by 1.91%.

It seems our numbers were optimistic, however, if we take a closer look at the target areas for the Walls & Futures London Growth Fund we will find that prices increased by 5.98%. Based on this result I hit the nail on the head.

As for 2011 my prediction is specifically for the London market which broadly speaking I expect prices to be flat.

Final Thought

I was reminded by a friend of the old saying “Make hay while the sun shines”. Originally from the farming community it referred to the short time in which the hay would be ready to cut.

Reap too soon and the hay would be too green. Reap too late and you ran the risk of rain ruining the harvest.

In today’s investment terms it means to act while an opportunity exists and like farming, successful investing is about getting your timing right.

For those investors who didn’t invest and stayed in their shelters during 2010, this could be the time to come out because after all “You can’t reap what you don’t sow!”

Tags: 2010 Prediction, 2011 predition, Bank of England, FTSE, Inflation, Land Registry, Property Fund, Quantitative easing, UK Property, Walls & Futures