Saturday, April 28, 2007

Abn Amro "won't Touch This", Comparison of UK and US housing markets / pdf

i disagree with the optimistic abn ambro view about the us houisng market. but i think they a correct view on the uk market. ugly!

ich stimme sicher nicht mit der zu optimistischen abn sichtweise in sachen us immobilienmarkt überien, baer ich denke das sie den uk markt extrem gut treffen. sieht übel aus!

thanks to "bobsta"


U can’t touch this
Dario keeps handing us sticks to beat him with. After telling us about his pink mountain bike last week, he recently revealed his most recent music purchase: MC Hammer. This makes his criticism of Rob’s musical tastes (the Pet Shop Boys and Abba) look pitiable. Obviously, this has very little to do with the subject of today’s Overnight Report, which focuses on the US and UK housing markets. Except that markets clearly believe it’s ‘Hammer time’ for US housing, while UK housing is ‘Too Legit to Quit’. But if you ask me, it’s UK homeowners who need to Pray’ (Perkins tells me these are MC Hammer song titles – we’ve hit a new low).

i can´t stand mc hammer so i´ve taken the "family guy" version :-)

Tim has outlined our view on the US housing market in previous Overnight Reports,so there’s little point in repeating the analysis. In short, we remain optimistic that the economy will prove resilient to problems in housing and the worst could already be behind us.
> very optimistic...i disagree
> extrem optimistisch. ich denke wir sehen gerade erst den anfang
Yet despite our upbeat view, we recognize why investors are concerned. If problems in sub-prime cause a broader credit crunch across the economy, we could end up looking pretty silly (a feeling familiar to some of us – Ed). Still, there seems to be an inconsistency here. Markets appear relatively relaxed about the UK housing market, which looks more vulnerable to a correction.

At this stage, I should probably clarify something. We don’t deny that US housing is overvalued. House prices will need to fall in real terms over the medium term. Yet given solid employment growth, rising incomes and – most importantly - unusually low long-term interest rates, it seems possible to rationalize where we are now.
>i think they left out speculation, excess, fraud, lax lending, creative financing ......
> denke die unterschlagen hier galanterweise spekulation, betrug, keine kreditstandtarts, kreative finanzierungsformen,......
In contrast, developments in the UK look harder to explain. Still, it hasn’t stopped some from trying. We are told the lack of spare land, rising immigration and demographic factors justify the premium on UK housing. But I’m yet to be convinced. These factors should boost prices and rents by a similar amount, as marginal buyers are forced into the rental market. Yet prices have risen far more quickly than rents over the last decade. The ratio of house prices to rents is now almost 50% higher than its long-run trend, compared with around 25% in the US. In fact, prices have risen so much faster than rents that rental yields are now below mortgage rates. In other words, property ‘investment’ is generating a negative cashflow. It’s only the expectation of further capital gains that is sustaining demand.

With house prices appearing more detached from fundamentals, the UK housing market could be more vulnerable to a correction than the US. There are also reasons to believe this could be more problematic for the wider economy. Owing to the lack of supply flexibility (economists call it an ‘inelastic’ supply curve), the burden of adjustment would fall on prices rather than quantities, the opposite to what we have seen in the US (see the illustration on page 2). This is how ‘spillover’ effects could occur. Falling house prices would depress household wealth and spending, especially as UK consumers hold a larger share of their wealth in housing than in the US. And given the concentration of default risk and sharper increases in household debt, the banking sector could also be exposed. While the latest RICS survey shows UK housing is still ‘Gaining Momentum’, we all know ‘This is the Way We Roll’: a housing market collapse will undermine confidence in sterling, preventing the Bank of England from cutting rates and prolonging the downturn.

It seems puzzling that markets worry about excesses in the US, but remain relatively unconcerned about the situation in the UK. The UK has experienced much sharper increases in house prices than nearly all other developed economies in recent years (Chart 1). Is this justified? We think not.
Numerous attempts have been made to rationalize the premium on UK housing. These arguments generally highlight the shortage of supply or a sustained increase in demand (due to immigration or demographics). Yet these trends arenot exclusive to the UK. The Netherlands and Japan have more acute land shortages, but have experienced less rapid increases in house prices

More significant, an increase in housing demand or shortage of supply should put upward pressure on rents, as well as on prices. Over the long-term, rents and house prices should grow in line with each other. Yet this has not been the case. Prices have risen much more rapidly than rents in recent years, suggesting UK housing is overvalued by nearly 50% compared with about 25% in the US (Chart 2).
Rather than fundamentals supporting the housing market, expectations of future gains and speculative activity seem to be driving prices higher. The level of rental yields is perhaps the clearest evidence of this. In the UK, rental yields have fallen below mortgage rates (Chart 3). This implies that housing ‘investment’ is generating a negative cashflow. With buy-to-let demand now accounting for 25% of all new mortgages, this illustrates how fragile demand could be to a shock to expectations.
This greater degree of overvaluation makes UK housing more vulnerable to acorrection than the US. It could also have more significant implications for the wider economy. Owing to the lack of land and inelastic supply, the burden of an adjustment would fall on prices rather than quantities. A given change in demand will generate a larger drop in prices (Chart 4). In regions where land is more abundant, such as the US, the adjustment primarily comes through quantities (i.e. construction output). A fall in UK house prices would depress household wealth, hurting consumer spending. It could also leave the banking sector exposed. If sterling then collapses, the Bank of England could find itself unable to respond.
lets hope abn is allowed to "stay" with their view after their takeover from the british barclays.......
bleibt zu hoffen das abn die selbe sichtweise auch nach der übernahme durch die britische barclays beibehalten "darf"

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4 Comments:

Blogger traderboy said...

I couldn't agree more. UK housing has lost touch with fundamental notions of value, such as rental yields or rising incomes needed to actually pay debt off. As far a I can see, mortage lending is done with discounted interest rates for the first 2 years, and then after 2 years the rate turns into about 2% over the Bank of England rates. BUT, this is ok for everyone, because once the 2 years are up, you just refinance your mortgage with another lender prepared to offer you another discounted rate. The crash will come when 1) Bank of England raises rates enough that even the discounted rates will be too high, and 2) when access to credit tightens and borrowers will not be able to refinance themselves, instead having to keep the original mortgage with much higher rates.

For example, Halifax, the UK's largest mortgage lender, currently offers 4.99% for 2 years, turning into its "Standard Variable Rate" of 7.25% for the remainder, usually 23 years. That variable rate to me looks like base rates + 2% (rates in the UK currently 5.25%).

Imagine a borrowers shock in 2 years time if the BoE is at 7%, and their mortage turns from 5% to 9%. If refinancing is not available, that will be some pain!

And the last 2 years have seen even lower interest rates, so plenty of people will have doubling mortgage payments.

I'm not even sure how the banks make money from this situation, sounds like some dodgy accounting somewhere to me. Given that you can buy 2y Government bonds at ~5.50%, why would you lend to the public at 5%, even with collateral? Very strange.

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