When I was younger studying to become a property professional at University, other than understanding the basis of valuations on a property, build structures and the like a major understanding was the economics behind markets.
While these were the days when the chancellor Gordon Browns fiscal policy was seen as some sort of genius level of economics, with significant basis of borrowing and retrospectively can be seen as significantly flawed. Lessons learnt from this time through to where we are now can be used as a solid foundation for going forward.
You don’t have to be an economics graduate or professional within details of an economy to understand how property prices fluctuate. Really not over complicating markets is generally the way where the vast majority of investors make money.
In my university days one of my economics lecturers would warn that if there was more than 8 cranes in the skyline you could expect a dip in values. While over simplistic what he was getting at was the most basic element of supply and demand.
At its heart, property is unique in that there is always a demand for it. Unlike investing in the stock market, where Facebook may become the new Myspace or Google may become obsolete like some of its predecessors, Volkswagen may fabricate emissions and lose a customer base or fax machines become superseded (I hope the banks catch on to this), people always have needed a roof over their head.
This is the primary understanding at a high level of property economics. If there are more people needing property to live in each year and there are not enough properties being built, property prices will increase. If there is an over-supply of property and too much competition property prices will stay stagnant and fall.
Current supply v’s demand in UK residential property
Parliament has suggested that the UK needs to deliver 300,000 new homes per year to keep up with the demand of a growing population in the UK. In 2017/2018 the number delivered was at its highest in many years achieving 74% of its target. Heriot-Watt University has put the number at 340,000 to deal with the huge under-supply in the UK.
Naturally this is a macro figure looking at UK property as a whole without consideration of the various cities. Naturally in economically powerful UK cities this number is magnified significantly over the needs of smaller towns and cities.
Taking Manchester as an example, a city which some investors have become nervous of the supply levels expected over the next 3 years we can look back at the numbers again. JLL suggests in their studies that 11,254 new properties are needed per year in the city to reach the demand required with 7,500 in the pipeline over the next two years. Manchester council in their March 2017 report suggested that a minimum of 25,000 new properties had to be built every year to even manage the issue of under supply in the city.
Using my lecturers example of cranes in the city, even with the minimum level of development needed by the city we would expect to see over 30 developments at one time, with significantly more under JLL’s suggestions.
Inner v Outer City Demand
While these numbers will affect the city overall and are mirrored with Birmingham and Leeds demand the inner city sees an even greater struggle meeting the needs of the people due primarily to sheer logistics and land.
As a rule of thumb the inner city tends to be within a ring road around a city. Most major UK cities in some way have a road around them which the inside of this is classed as pure city centre and the outer being development areas.
Naturally a buy to let investor will see an even greater demand on properties within the inner ring roads with the natural problem of supply and demand thirst which can almost never be quenched.
Naturally there is a finite amount of space which can be utilised in these areas which is increasingly been built on or land banked for future development.
These are areas of the city which there can not be significant additional supply leading to a constant competition for property there and a natural increase in property asking prices. With much of Manchester city centre seeing over £500 per square foot asking prices and year on year growth the question of the ceiling will not be desire but affordability.
Affect of average earnings on growth/ London Comparison
When we look at economic growth and comparisons with big cities in the UK it is impossible to see past the likes of London as an example of property prices slowing considerably. While there are still investors who will stick with the capital it is widely accepted that it will continue a slow to no growth for the next few years.
This may go directly against the supply and demand argument at the core of property prices but brings us nicely into the next point to consider, how much a city needs to earn to sustain the growth.
London is a prime example of several factors which both made investors incredibly wealthy, and the ripple effect this can have on other cities. It is in fact proof of the value of investing in the secondary cities such as Birmingham and Manchester with a caveat of knowing when you have hit the ceiling and to cash in on your investment.
Baron & Cabot are known for not only choosing the correct properties to buy now, but also when the best time to cash in your investment and look elsewhere with your profits.
One major driver is understanding where the ceiling is for your investment in a city and you will be able to roughly estimate your exit strategy.
As an example when we look at the likes of the City of London you would need 14.29 times average earnings to buy a property, come further out to Greenwich and 12.95 times earnings are needed for the average property (ONS Office of National Statistics link).
Compare this to the likes of Birmingham 5.59 or Manchester 5.74 and we can see there is some average growth available before we start to see a slow down in those cities for property growth.
Some other cities:
With an average salary in Birmingham of £35,500 we could expect average property prices in the city to grow to £350,000 before we would see a reflective London slow down, or £300,000 comparative to the likes of Reading.
Short of supply and demand and salary affordability the other intrinsic factor in property price growth is lending and affordability on property.
Since the last property recession banks have been very strict on lending criteria in terms of the amount they will lend to an individual for their own home and even more so for a buy to let property.
This has created a more balanced growth and is expected to reduce any issues should there ever be short term property drops in the future.
One important factor when looking at your own affordability is understanding the effect of a percentage changes on mortgage rates and your affordability.
With conversations surrounding Brexit, while there is no reason to suggest that there would be a sudden drop in housing demand, there could be interest rate implications on mortgages, which make it harder for individuals to afford a new home, or to move up to their next property.
Naturally this will improve rental demand for a buy-to-let investor, however can slow the growth of property prices.
How to use this information
When speaking to investors its generally been the most profitable to follow the trends of a city quite closely. If it has been growing at 5% per annum for the last 5-10 years and the properties are not getting to the top end of affordability you should see some strong growth.
As always to manage property fluctuations with interest rates its important to focus on a 5 –to 10-year investment plan whereby you are balancing rental income with capital growth.
While many investors can take advantage of short cycles and make quick wins, the main focus point should be at long term steady gains in rent and capital growth and as stress free as possible.
Property investment is not a complex algorithm, just looking at the basics, taking some good advice and dealing with the right people, while being sensible with returns will generally put you in a good position.
As always, feel free to speak to someone in Baron & Cabot to understand which markets other investors are looking at, and which may be the most suitable for you.