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What does it all mean?

Introduction

Falling property prices in the UK have become a fixture of the financial pages and news bulletins for much of 2008. Seen by some as a harbinger of doom for our ‘easy credit, easy spend’ economy of the past few years, the correction in house prices has been the introduction to what is feared to be an almost global recession, but is this really the worst thing that could happen?

For years, while buyers in the UK and overseas have been gleefully investing in property until the proverbial cows come home, market analysts have been warning that property markets are overheated and properties overvalued by as much as 30 per cent. First time buyers have been all but priced out of the market across the country, while banks who were lending money to all and sundry have now withdrawn huge proportions of the their product ranges from the grasp of buyers. Northern Rock was the first big fiasco of the handling of the credit crisis, but most expect there to be another banking failure before the economic slump is over.

But is this all really a bad thing for the housing market? Obviously in the short term, there is precious little activity for buyers or sellers, house builders are laying off staff in hundreds at a time, and job losses in other sectors are mounting as the residual work that came from the building trade dries up. In the long term however, things look reasonably positive, and looking at the arguments below, there is a distinct possibility that when we do emerge from the other side of the dark clouds, the property market will be even stronger and more robust than it has been in recent years. So, what does this all mean, and what could it bring for the future?

How did we get here?

Firstly, it is important to look at the terms that are bandied around the media and TV shows to make sure we are not confusing different issues to mean the same thing. The so-called credit crunch is what has resulted from the crisis in the mortgage markets in the US, but has come about because of a complicated system by which banks around the world trade debts. Mortgage lenders in the US began lending money to customers who would normally have not been able to borrow due to poor credit histories or previous defaults on payments. These higher-risk mortgages often defaulted in their turn, and caused the banks in question to suffer financially and be unable to honour their own finance arrangements.

The UK banking institutions affected by the sub-prime crisis became embroiled because of the way banks use packages of debt in the mortgage markets to trade with each other internationally. Defaulting customers in the US therefore damaged UK banks and led to the over-exposure of financial institutions here to the mortgage markets. Part of the problem is that there are so many of these packages of debt used in trading, no-one really had much of a clue as to how exposed to sub-prime mortgages they could be.

The result of this is that banking institutions are unwilling to increase their exposure to mortgage risk until they are sure of the effects of the sub-prime issues, thus resulting in a severe tightening of lending criteria, and a lack of credit to feed the property market.

There is some slight debate over whether we are technically in a recession at the moment or not, but few people doubt that we will be within months. The official definition of a recession is when the economy suffers negative growth for two consecutive quarters.

Much is made of the spectre of negative equity, and as an indicator of how the housing market is performing within the economy as a whole, it is an important figure. It is also something that causes banks and building societies which are already over-exposed to twitch at the thought of lending beyond their means. The term refers to what happens when the value of the property upon which the mortgage loan is secured is worth less than the value of the loan itself. This means that if the property was sold off under prevailing conditions, there would still be money outstanding. In particular, this effect can trap those who would wish to sell their property and move, as they would be unable to discharge their loan with the sale of the property and cover their debt.

Many people who are now suffering from negative equity in the UK bought just before the start of the credit crunch, when there were still plenty of 100 per cent mortgage deals on the market and property prices were at their peak.

First time buyers (FTBs)

It is somewhat too simplistic to say that FTBs will be the biggest winners in the drop in property prices. While those people who have been priced out of the property market for their first home should soon be able to find price that are closer to their level of affordability, the contraction of the mortgage market in the UK makes it harder for them to get the necessary funds to make the purchase. In this sense, many FTBs are finding themselves just as far away from being able to buy as they were at the heights of the property boom.

There will be effects for those FTBs lucky enough to have a finance offer in place. In addition to the fact that prices across the board seem to be on their way down, there is an increased availability of properties for them to buy. In contrast to the situation just a few short months ago, there are now several properties on the market for every buyer, giving greater choice along with less of a need to compromise to get the right property at the right price.

In addition to this, the slowing-down of activity in the market will lead to less competition for the type of property young buyers want to buy. In the past, the small terraces or two-bedroom apartments that make the ideal starter home are also the same properties favoured by buy-to-let investors as the perfect rental investment. With ready capital and, more often than not, no need to rush to buy a property, investors found it easy to drive prices up just enough to make sure the FTBs were seen off without too many problems.

The other logical consequence of the drop in prices for FTBs is the fact that the sellers in the market will not only be ecstatic so see someone interested in buying their property, but they will be more prepared to do deals to secure the sale. Think about offering cash on top of the offer for white goods, carpets or even curtains. FTBs are in a significantly better position to push for this kind of things as they have no chain to hold up the process – a considerable advantage in this inactive market.

Owners and movers

One of the biggest things about falling housing prices, and negative equity in particular, is that the majority of people are not directly affected. If you already have a property that you have owned for a few years, negative equity is unlikely to be an issue. If you are not looking to move home in the immediate future, a drop in property prices is little more than of passing interest.

If you are planning to sit tight in your property for the time being, the property crisis will give a good opportunity for consolidation. Many owners are using the opportunity to make alterations or renovations to their property, which in turn will make the property more attractive to buyers and with a higher value in the future. The advantage is also that the property will stand out from others of the same kind when it comes top be sold, hopefully putting it above the rest.

There is also an interesting point to be made about the demand and supply side of the market when the economy begins to recover. Once the banks begin to lend mortgage finance again and buyers have more confidence in the property market as a whole, there will be an increase in demand for properties of all types. For their part, the government is committed to maintaining its target of building over three million new homes by 2020. Given the fact that developers are struggling to sell the properties they have already built at the moment, and that house builders have cut back on their workforce by up to 40 per cent in recent weeks, there will be a gap between supply and demand once the market improves. This may well result in sharp rises in property prices for a period as buyers rush back to the market, and there are not enough properties in circulation to satisfy them.

The other benefit for owners in the current climate is for owners of holiday homes here in the UK. As the economic downturn continues to bite, one of the first things that people have to cut out of their budget is the family holiday abroad. The rising costs of fuel, as well as the expense of spending money, travel and accommodation leads many to stick to their own country as their holiday destination until things improve.

On the up?

The key to recovery in the property market is with the banks. When they feel confident enough to lend again on a larger and more general scale, there will be more freedom for buyers to pursue the properties they want. One thing is for sure though, it will be years before the general public are able to get credit as easily as we have for the past ten years – if ever again – and the economy will likely be all the healthier for it.

More pages

Page 1: Introduction

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