International investors have long seen the UK, and in particular London, as an ideal place to park their cash. A steady and reliable market, situated in one of the biggest financial hubs of the world, the flood of money into this city and country led to a widespread appreciation in property prices. With the house price to earnings (PE) ratio topping the level seen around the 2007 crisis, it is clear we have an affordability crisis thanks largely to speculative buying.
However, with Brexit we are seeing less money come into the UK, despite a weak pound. This is worrying given that the devaluation of sterling should make UK properties particularly attractive. With that in mind, it makes you wonder how Foreign Direct Investment (FDI) will be affected in the likely event of an appreciation for the pound. This shift away from investors and towards people that plan to live in the property being bought is a significant deleveraging in the housing market.
Second homes stamp duty and buy-to-let regulations
This brings us to the restrictive measures implemented under the last Tory leadership. Firstly, the new rules related to the purchase of second homes (or third for that matter) mean that all purchases will be subject to an additional 3% stamp duty on completion. Of course this can amount to a significant figure and will obviously alter the profitability of buying a property in a waning market.
We have also seen a raft of measures which will make it more difficult for landlords to write off costs such as the interest on their mortgage. Add to that the fact that the number of buy-to-let products on offer are falling sharply, and it is clear that there is an increasingly difficult environment for landlords.
There is a clear issue with affordability in the UK, with international investors moving out and residents finding their earnings squeezed. The decline of the pound has led to a sharp rise in CPI inflation, which coupled with a declining wage growth figure points to a fall in real income. The image below highlights that.
The decline in disposable income means that it will be harder for buyers to save money to purchase property, and owners to renovate. It is worth noting that house prices will rise sharply if the nation has disposable income that they are investing into their property, thus raising the value. Without renovations, we are losing a potential source of house price growth.
This points towards the potential for weakness in home improvement firms such as Kingfisher, owner of B&Q, Screwfix, and more. The monthly chart below highlights the decline we have seen over the past year, with this current month looking to provide yet another drop for the share price. Should that occur, we would have seen nine of the last ten months trading in the red for Kingfisher.
Crucially, this month we have created the first lower low since the financial crisis following the break below £3.00. A move lower from the next support level at £2.83 would likely spark another decline for the share price. Alternately, a rebound back into the £3.53-£3.67 region would look like a great area for shorts.
Interest rates have been subdued for eight years now, with the headline rate falling to 0.5% back in 2009 and only changing once when the BoE cut it to 0.25% in the wake of the EU referendum. This means money is cheap, and in particular mortgages are affordable.
The problem is that with affordability calculated by the ability to pay your mortgage around current levels, any rise in interest rates could have a detrimental effect upon the ability to pay for many, leading to a rise in repossessions and debt. We are still likely to be rather away from any meaningful rise in interest rates, yet with the BoE shifting into a more hawkish mindset given the rapid rise in inflation, it may not be as far away as we previously thought.
It is evident that with the housing market growth slowing down, this would be a risk for firms whose business model is based on selling properties. Despite this, we have seen the price of many UK listed homebuilders continue their ascent in recent months. The chart below shows the relationship between homebuilders and house prices (London). Firstly, it is evident that for now average house prices continue to gain ground.
However, the threat of sustained negative house price growth brings back the fear of another slowdown for the sector. It is unlikely that we are going to see another 2008-style crisis, yet there is little reason to expect a positive shift in sentiment and thus the current trajectory of house prices may not be over quite yet. There is still a big drive for new housing in the UK, and thus it is unlikely we will see a huge slowdown in the sector anytime soon. However, there is reason to believe that any further gains for the industry could be hindered by the lack of house price growth and negative prospects. But it is worth noting that house prices remain historically elevated and thus the margins remain highly conducive for the sector. Thus it makes more sense to look at potential weakness in areas such as home improvements.