Property as an Asset Class 📊
The property market has similarities to other standard asset classes but due to its “dwelling” characteristics there are stark differences.
There are sub-sectors which account for various risk factors arising from dwelling/occupation type and geographical nuances.
Prices are influenced by the net balance of supply and demand (in turn driven by underlying incentive structures).
Prices are influenced by financial conditions (dictated by central banks and policy makers)
Prices are influenced by non-tangible elements such as an emotive-centred non-cash yield (i.e. inheritance, family benefits)
There is no property spot trading market, yet 👀
This publication will take a broad view of residential property price dynamics in the UK market, which itself is a tiny slither of the global property market.
Incentive Structures 🇬🇧
In order to understand how incentive structures impact supply & demand, it’s important to first know which market participants they belong to. In the UK residential market, the main players are non-exhaustively as follows:
Residential property investors
Banks (full spectrum)
The government
Homebuilders
Housing associations
Existing homeowners
New cash buyers
New mortgage buyers
Brokers
Tradesmen
Each additional unit of housing supply, each transacted sale and broader macro conditions will impact every market participant in some capacity. Understanding that this dynamic exists, goes a long way in deciphering the resultant contribution to demand/supply, and in turn price trend. It should be noted that given the complexity of the topic this publication serves as a tool to help discover market dynamics rather than a price predictor.
Market Participants ➡️ Incentive Structures ➡️ Demand/Supply ➡️ Prices
The societal significance of buying a house supports the incentives of existing homeowners while new buyers have a short term incentive that is inverse as they seek lower entry prices. Banks’ incentives are centred around transaction activity as they derive income from mortgage products and positive equity in the event of repossessions. This can be a moving target at times but steadily rising prices over time can be a sweet spot. As such, some argue that core bank incentives naturally enables demand and thus positively contributes to price growth in sweetspot markets. When you understand that humans are greedy it’s easy to see how this leads to super cycles pushing prices out of reach. Of course, banks are rational actors in theory so changes in financial conditions can cause incentive structures to change - remember, moving target. If house prices dropped significantly, that would likely be symptomatic of much worse economic conditions as it takes a lot for forced sellers to drive prices down beyond just a slowing rate of growth. Incentive structures beyond the scope of this blog would likely take precedence. Nevertheless, exploring current incentives is a great place to look for clues about how demand/supply dynamics will shift and consequently impact prices. This is just the tip of the iceberg in regards to incentive structure analysis.
State of Play (Financial Conditions) 🥶
Financial conditions when loose can be summed up as cheap borrowing costs and easy lending. When tight, expect the opposite. And during regime shifts, both can be in play at once.
Financial conditions impact economic activity and consequently the pace/direction of economic growth. Much of the previous decade has seen ultra-loose financial conditions as induced by central banks and policy makers. However, due to the following macro factors some of which are symptomatic of loose financial conditions, most have embarked on a tightening cycle to swing the pendulum back into balance. Or at least attempt to.
High inflation (stagflation in parts)
Central bank interest rate hiking cycles
Strong US dollar (weaker home/local currency)
Pseudo-recession (full blown in parts)
Low unemployment (masks cost of living crisis)
Negative real wage growth
Macro factors and the policies deployed to massage them impact asset prices due to the effect on future cash flow values and simultaneously demand & supply. For instance, against a backdrop of negative real wage growth and higher interest rates, affordability contracts and the cost of borrowing increases, both dampening property demand. It’s also important to remember that the wage-house price ratio is/has been at eye-watering levels which makes UK home ownership in the current form almost unattainable for huge segments of the population. For many on the cusp of eligibility, in spite of the pain it seems worthwhile to squeeze themselves over the line as the alternative rental market offers no solace.
Demand Side 🙋
Higher mortgages rates: higher interest rates seeping through to increased mortgage payments via mortgage rates may push affordability out of reach for tons of new buyers.
Higher cost of repayments: for prospective buyers (even with deposits), repayment costs in a higher interest rate environment could derail buying strategies making some segments hotter in demand and others much cooler.
Less foreign buyers: Russian sanctions have blown these buyers out of the market already but non-fx hedged investors distaste for a GBP denominated asset could cause a ruffle too.
Rental market: as the dwelling alternative is also expensive on a monthly cashflow basis, this will impact buyer timelines and overall strategies.
Tax cuts: does nothing for buyers who cannot raise deposits and perhaps softens the pressure on levered multi-homeowners to sell. Good and somewhat unnecessary for the cash rich.
Stamp duty restructure: some buyers save cash upfront but this could be offset by higher mortgage costs and reduced affordability - potentially eroding all initial cash savings. The pain is most acute at the margins - that is to say, a buyer who could just about afford a home prior to the change, will be one of the most impacted while multiple owners pitching for an additional get a cleaner uplift (or incentivised to ask for higher prices if selling).
Weak GBP: the UK imports a lot of goods, this will add upward pressure on inflation and the interest rate trajectory. Foreign owners of UK assets such as property will feel the pain here whereas those on the sideline could be circling for a bargain. USD cash rich investors with appetite benefit here.
Other Observations:
Lower real wages
Lower buyer enquiries
Lower new mortgage approvals
Insufficient earning power
Untenable wage-house price ratio
Macro implosion (QE+QT engaged simultaneously as pension funds become forced seller)
Renovation costs (inflation rife here too)
Tradesmen costs/availability (inflation rife here too)
Supply Side 🙇♂️
Lack of supply still has the UK in a chokehold with a new home building deficit annually. Remember, property has dwelling characteristics so the impact of this for investors and society are opposite. This in of itself represents a dire imbalance in regards to incentive structures and is not something that can be fixed in any short time period solely by economic forces. Developers have numerous levers they can use to influence prices, given they provide supply. In tough times, incentive massaging before reducing prices is one of them - i.e. providing all types of buyer perks except cutting the purchase price itself. Additionally, secondary property developers are incentivised to lean into that supply gap and often behave like sharks. On the materials front for actual house construction, there is precedence to pass through higher costs.
Points to Explore 🗺
Inheritance tax rebate of housing assets sold at a loss within 4yrs
Developer share prices reflecting lower prices in houses given house prices don’t mark to market
Follow the incentive structures, that will tell you how demand/supply will shift and therefore the impact on prices
Other geographies: prices dropping in NZ, Sweden, China, Poland, US
Data: pre-autumn, dataset, dataset, dataset
Strategy Primers 👽
Depending on how deep you want to dive, a useful exercise is to explore what each of the aforementioned market participants are doing. From an individual perspective/conversation here are some highlights:
Deal making in the forced seller space
Engaging foreign unhedged owners
Indicator watching
Watch and wait with intent
Adjust monthly cashflows
Reduce purchase budgets
Sensitise affordability across an interest rate curve i.e. what’s the max i can afford monthly if rates go to xyz
Panic
Head in the sand
BAU
Remortgage evaluation
Conclusion 😮💨
The residential property market in the UK is multifaceted and riddled with circular incentive structures. It can be described in of itself as an ongoing crisis. Naturally, price trajectory depends on the net effect of all such interactions which makes it a gargantuan task to dechiper. Intuitively, during ‘normal’ times the trajectory is upwards and during non-normal times, flatline or down sharply. For those fortunate enough to be in fighting shape, give thanks, drown out the noise and act in accordance to your risk parameters over as long a horizon as feasible. Given the proliferation of vested participants in the UK residential property market, both buying and selling strategies at a micro level could see success.