Maskells Comment

Posted on Tuesday, October 11, 2022

Updated on

“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies”

Groucho Marx.

 

The reaction of the financial markets to the mini budget was fierce and immediate:  an intervention from the Bank of England, a collapse of sterling (albeit much of that was due to US interest rates hikes), political U-turns and mortgage rate panic.  Most importantly, the last couple of weeks have perhaps however brought to the forefront the truth about the UK economy.   We have a large balance of payments deficit (£51.7bn or 8.3% of GDP in Q1 2022) and public sector gross debt as at the end of Q1 2022 of 99.6% of GDP (source – ONS, release date 29 July 2022).  It was therefore clear that any measures announced by the new Chancellor that were additive to this figure was going to be a cause for concern.  A failure to have the numbers audited by the Office of Budget Responsibility was, in our opinion, gravely irresponsible and may have provided the Chancellor some cover: Economist are now contemplating whether much of this additional spending will be captured by income tax as static tax bands capture more earnings via wage inflation. However, the net effect of the mini budget is that UK borrowing costs have increased, mortgages rates have increased, and it therefore only follows that pundits are calling for a decline in house prices.

Earlier this year, we wrote a paper about the effect of mortgage rate increases where we raised our concerns about refinancing.  We examined a pool of mortgages from a high street lender where the average rate was ~1.8% and where the fixed rate period was ending in December 2023.  We contemplated how borrowers would react to refinancing at 3.8% (the rate for a 2 year at the time) which provided for a significant monthly increase in mortgage payments.  Fast forward a few months and we are now looking at a very different situation.  2-year fixed rate mortgages with reasonable LTV’s are now over 5% and 3 year just under 6%. The interest rate stress test being applied by Banks is now (TSB, for example) 8% for new clients and 7% for existing clients.  Added to an increase in cost of living, this scenario does not bode well for homeowners with a mortgage.  So, are we going to see a glut of foreclosures and a large decline in property prices?  Our opinion is not.

UK Finance estimates that there are 11 million outstanding mortgages in the UK against 29 million homes. We mention these figures to give context to the next set:  The number of mortgage possession claims has risen from 2499 in Q2 2021 to 3476 Q2 2022.  In the same period there has been an increase in mortgage repossessions by county court bailiffs:  45 to 770.  Of the cases in Court (a total of 41 currently) the total amount of time for the claim to go through the system has increased from 106 weeks to 110 weeks.  (Source: all from ONS 11/8/22).    Even prior to the current increase in mortgage rates, the legal system was not prepared to deal with a large number of repossessions.

Nor will the banking system want to deal with many repossessions:   Banks must allocate capital against each loan they hold.  The amount of capital allocated is based on the perceived risk of that loan not performing.  For mortgages it is based on Loan to Value Ratios.  If the banks start repossessing properties on an industrial scale, they will in effect push house prices down which in turn will increase the LTV for each loan they hold, costing them more capital, reducing their ability to lend and reducing their return on equity.   

These two points, In our opinion, led UKFI to maintain (in their mortgage arrears update August 2022) “Customers who are facing financial difficulties are encouraged to contact their lender early as they stand ready to help”.   Our read of this is that there is support for negotiated interest rate payment reductions and potentially holidays to avoid repossessions.  Naturally, each case will be judged on its own merits, and we will have to wait and see.

Therefore, whilst we don’t see a large decline in property prices, it would be unrealistic to expect prices across the market to remain as they are, given the increase in interest rates. Based on current mortgage rates and affordability at the time of writing we believe that a reduction of 3-4% per annum for the next 2 years would be realistic.

In our patch of Prime Central London (PCL), however, where the LTV is ~20% and many homes are bought without mortgages, we do not expect an immediate impact.  Particularly prices are being supported by overseas buyers who have resurfaced due to decline in sterling which has made property ~10% cheaper for them almost overnight.  As we mentioned in our previous report, there is likely to be a drag on prices in PCL due to an expected decline in the neighbouring higher LTV market in Prime London, but the price in PCL is likely to be supported by Vendors.

 However, whilst most homeowners in PCL may not be forced sellers, we must also bear in mind that a decline in property prices compresses the gap between price bands making the jump to a larger property that much more affordable. As such, it may be the case that we even see an uptick in activity.

With all that said our advice remains that each property and postcode is different.  It would not be advisable to mentally re-price your property based on what you read in the papers or what you see in the financial markets.  If you would like an updated opinion, please do give the team a call and they would be happy to help.  Ultimately, there remains demand and our viewing to offer ratio is currently 11 which is the the same number last year and much lower than the 30 viewing per offer we saw in 2019.  There is still strong demand for now.