Interest rates low for next three years

The Bank of England has announced interest rates are unlikely to be raised for three years(based on a test linked to unemployment). This ought to be good news for borrowers and bad news for savers.

The policy ties interest rates to unemployment. and makes official the reality that the Bank of England was always more interested than just inflation.

Impact on House Prices

Rental yields

The price of houses ought to be the equal to the discounted cashflow of rental payments achievable. This broadly that investing in property ought to provide a similiar return to investing in government bonds(actually slightly higher as there is slightly more risk). Otherwise people would choose to simply invest in government bonds instead.


Simplified Example

An investor ought to be relatively indifferent between a £100,000 worth of bonds yielding 3% and a £100,000 property yielding 3%. We will assume the underlying property price is unchanged, rents are flat across time, it can be sold without cots and ignore inflation and the difference in risk.


If interest rates fall to 2% then the £100,000 property is now more desirable than the bonds. People will sell bonds and buy property. This will lead to the price of the property increasing to £150,000

Situation 1 :
£100,000 bonds yield £3,000 year(3%)
£100,000 house yield £3,000 year(3%

Situation 2:
£100,000 bonds yield £2,000 year(2%)
£150,000 house yields £3,000 year(2%)

Affordability

Interest rates reducing ought to operate via a more simply mechanism and allow people to be able to afford larger mortgages and so be able to pay more for houses. This ought to increase demand and drive up prices.

Will it impact property prices?

I am not sure it will have much of an impact on house prices and I doubt that is what the policy is designed to do to. Interest rates are already low and cannot get much lower, and many people probably did not forsee mortgage rate increase in the next three years. But it is probably more a way of signalling that there is a lower chance of interest rates rising and so people can feel more relaxed about borrowing over the next few years.

Property prices are more volatile than interest rates and many factors feed into them: supply, affordability, tax systems, mortgage availability and future expectations.

This is probably good news for people on tracker or base rate mortgages as these are going to remain cheap for three years, which should allow people to either spend money on other things or make mortgage overpayments. Those on trackers will have enjoyed seven years of rates at 4.5% below the pre-crisis 5%

The bad news is that low interest rates will lead to the value of the pound falling. This is likely to increase the price of imported goods and so mean that inflation is likely to be higher over the next few years.
 

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Quick Sale

Selling houses is a time consuming process.

Even if things go well it can drag on. This is because a prospective purchasers needs to check that you actually own the land that you are trying to sell, they also need to get a survey to check the property is not about to fall down. Finally they need to somehow get the money to pay for this; normally this is via a mortgage(in which case they need to prove to the mortgage company they have the ability to repay) or by selling another property.

As we live in a Wonga era where people can get access to money instantly it is not surprising that firms have emerged that offer to unlock the equity in a property quickly. This is done by firms which offer to buy houses at a steep discount(10%-25%), they provide the money within a week or so and take the risk in selling the house on.

These firms offer a useful albeit rather niche service. I struggle to see why someone would be prepared to pay tens of thousands to save themselves a few weeks of stress or to get money quickly. But I guess there are some cases where this is valid or necessary.

The other option for a quick sale is via an auction. After an auction the funds have to be transferred with 28 days and a ten percent deposit paid at the time of the auction. The problem with auctions is that a limited supply of cash buyers means properties can go cheaply. It tends to be something that happens more with commercial or development properties, rather than residential properties. Repossessed properties are often sold via auctions as well, as the quick sale element ensures interest does not keep adding to the debt and mortgage companies have a duty to obtain the best price(an auction price is the highest available on the day).

The quick sale properties are being investigated by the OFT. It is an area which is probably under-regulated(a bit like Wonga) and where there is a degree of ignorance and desperation by sellers that could be exploited. The problems seem to mostly be that the companies suddenly drop the value they are prepared to offer, or that not much is put in writing. I suspect we will end up with a code of best practise being introduced.

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Shops into houses

The government has announced plans to turn shops into houses.

This is a policy that ought to kill two birds with one stone; increasing the supply of housing and also dealing with the problem of empty shops on the high street.

There are some problems. Firstly a lot of government policies get announced and then are abandoned when the details are found to be problematic or other interest groups are seen as getting hurt. In this case the risk is probably that many small towns may lose important shops and therefore their sense of identity. The alternative solution might be to allow rents on shops to fall so new business can afford to move it.

The other problem is the supply impact on housing might be somewhat limited. Empty shops are said to number 7,000 in London. But London's population is set to grow by 1,000,000 over the next decade. This means that at least for London converting shops to houses is going to only be a small part of the problem. And some empty shops are not always problem as you need some space into which new business can expand. There are probably other parts of the country where there are more empty shops, but there is probably less demand for housing too.

The idea of having mixed residential and retail does seem quite good and a lot of towns have been adopting it anyway. The benefits are probably more to do with regenerating town centres by increasing footfall and removing unsightly empty shops. In order to be truly transformational the density of housing would need to be quite high, perhaps by bringing flats of students into the town center.

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Good time for homeowners?

Nationwide reported today that prices rose by 3.9% in the past year.  The rise in July was 0.8%. This differs somewhat from the Daily Mail's claim that prices only rose 0.3% in July.

Inflation has risen by 2.9% in the year till  June so prices are rising a bit quicker than inflation, but we are still some way away from a boom. And adjusted for inflation prices are still below their peak.

However rising house prices will increase the equity of most homeowners, this is because they will have a mortgage that does not adjust in line with inflation. For someone with a £150,000 house the increase will have increased their equity by approximately £5,850. There is probably a greater expectation that interest rates will remain low for the foreseeable future.

It is hard to see much changing in the near term, government is keen to stoke up demanding for housing on one hand. On the other hand affordability is an issue and so prices are unlikely to accelerate. Homeowners are probably happy as low interest rates make a mortgage not much more expensive than renting. This means that weak demand and few transactions are likely to continue for the foreseeable future.

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Leasehold versus Freehold

There are two main types of land ownership in the UK - leasehold and freehold.

Freehold

A freehold means that you own the property outright and forever. You cannot do exactly as you would like to it, as there are laws and other parties have an interest in it. However there is no point in time in which ownership reverts to anyone else.

Leasehold

Leasehold property  means you have a right to occupy a property for a specified period of time, after this property will revert to the freehold. This is not really a problem in the case of 999 year leases which are sometimes granted, but when leases get below 75 years it becomes more difficult to obtain a mortgage.

Leaseholder often have to pay  ground rent charges to be paid - this is a fee each year.  It is generally quite small.

Finally leases may have restrictions - such as ownership of pets or size of trees, etc.

Leasehold are common in flats as it helps to deal with problems regarding who will repair the roofs or common area. These issues becomes a matter for the freeholder. In return leaseholders have to pay management/service fees to their freeholder.

Right to extend a leasehold

Once the lease drops below about 80 years the resale value of a leasehold property will fall. Leasehold can extend their lease, and this requires negotiation with the freeholder.This is a complex area and requires a solicitor.

Share of Freehold

Freeholders in flats charge leaseholders for repairs and maintenance. As they are able to pass on these costs they may not have a strong incentive to find the cheapest suppliers or insurance, or they may not carry out repairs promptly. Leaseholders have legal protections and right to see details of invoices.

Another option is for more than half the leaseholders to get together and purchase the freehold. They can then either set up a company or run it as a group of trustees. Each individual flat owner is said to own a share of the freehold. This is a complex matter, especially with a lot of flat holders. It requires legal advise and can be expensive.

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