The sharp increase in UK property prices-predominantly but not limited to the London area- over the last year has led many to believe such a trend has become unsustainable.
According to Nationwide Building Society, Real estate prices registered an 18% annual change in London since 2013, while the average UK figure rose by 10,8% in April, double the meagre 5% increase in Northern Britain. However, soaring prices are not sufficient to demonstrate the presence of a housing bubble in the South-east, especially in London where the most expensive property is typically fought over by wealthy foreign investors, altering therefore the whole market data. What is surprising in the current situation is that the biggest price variations are not to be found in up-scale zone 1 areas, but in suburbs which are generally not sought after by foreign buyers. To name but a few, Hackney and Haringey, whose property prices went up by 23%, and Lambeth, by 30%, whereas Westminster and Richmond prices rose by 10% only.
Moreover, in a healthy market rent and property prices move together, while the latest data shows rent prices in London decreasing by 2% since 2013, and an average rental yield down to 2,8%, below inflation.
An even more worrying sign is the increasing unaffordability of London property, as shown by the 8x House price to earning Ratio (3x is generally considered safe, 4,5x is the current UK ratio), which is not reflected in the average mortgage burden (54% of Net income in Q4 of 2013, compared to over 70% in Q4 of 2007). Mortgages are becoming more and more affordable and prices are going up: could this be due to a combination incredibly low interest rates and the Help to Buy scheme? In our view, the answer is yes. But even more important, how long will prices continue to rise before investors and buyers react to low yields? The Bank of England seems to be taking the problem quite seriously: on the 1st of May, deputy governor Sir Jon Cunliffe declared that “it would be dangerous to ignore the momentum that has built up in the UK housing market since last Spring”, intensifying expectations of earlier interest rates rises to curb the demand for mortgages and interrupt the current trend.
Also, there are talks of curbing in some way the help to buy scheme in order to cool down the housing market, but while we wait for action by the BoE or the UK government, our analysis shows that there is a slight reduction already; several signs tell us that the trend may be somewhat reverting. Mortgage approvals for February and March were lower than both expectations and previous data, while the Hometrack and Nationwide observations saw lower variations in the house prices as well.
In this complex scenario, even though our view is that of a general slow down in the industry, we are cautious with regards to the implications these issues may have on the markets. Next week is a big one for the UK: we have the Rightmove House Price Index data on Monday, CPI-PPI and RPI on Tuesday, BoE Minutes and Retail Sales on Wednesday, and most importantly new GDP data on Thursday. It is most certainly going to be a volatile week, but the direction seems quite hard to forecast. This is why we suggest to implement a long straddle on the Mini FTSE 250 index (September expiration) whilst shorting Persimmon stock. Via the equity screener function on Bloomberg, we created a search for the stocks in the FTSE 250 and FTSE 100 that had the highest ATM 30d Implied Vol to 30d Historical Vol Ratio, and had 6-month Beta>1.2. By doing this, we can exploit the stock’s potential volatility and historical tendency to beat the market. Persimmon, a FTSE 100 building company, was one of the results yielded. We chose it because of its vast presence in the London market and its help to buy scheme related results, which could falter if the Government or the BoE were to take action to cool the markets down or/and if interest rates were to rise (both of which we believe will happen sometime in the near future, at least by the end of the year). Thanks to this set up, we may profit from 2 out of 3 scenarios:
-If housing data is weak but the rest of the data is good, we will profit both from our straddle and our short position on the stock.
-If housing data is better than expected and so are the GDP figures, we will gain from a rise in volatility and of the index prices, profiting on our straddle (But losing out on our short-selling). Though weak housing data and GDP figures would maximize our profits.
-The risk lies in this third scenario: Housing data may be quite good but economic indicators may not be surprising: Persimmon stock wouldn’t be drawn down and we would find ourselves exactly in the no-profit range of the curve of our straddle.
[edmc id=1730]Download as pdf[/edmc]