October 11, 2007 | posted by Michael Baxter in IABN |

Don’t panic. Sure, house prices are down; sure, the latest survey from the Royal Institution of Chartered Surveyors (RICS) has fallen to its lowest level for two years, and sure, enquiries from new buyers have fallen for ten months in a row, but as RICS spokesman Jeremy Leaf said this morning a “major correction in the market seems unlikely while economic growth is above trend and employment conditions remain buoyant.”

RICS is a part of an illustrious list including the Halifax, Nationwide, the Council of Mortgage Lenders, Rightmove, Hometrack, and a glut of estate agents who are predicting single digit rises in house prices this year, and seem certain that 2008 will merely see falling growth. Certainly, they aren’t predicting falls. Falls? Not here in Blighty.

Yet, the RICS data tells a sorry tale. Every month it asks surveyors whether house prices are up or down in their region. The balance forms the RICS index and for some time this index has proven to be something of a barometer highlighting changes in the market before they show up in our surveys.

The RICS index for August went negative for the first time since October 2005. Then in September the index dropped to -14.6, the lowest score for two years.

It seems inevitable, however, that as more and more people come off fixed rate mortgage deals, as the credit squeeze means mortgages go up in cost, and credit becomes harder to find, that the index will fall further. Much further.

RICS says more and more would-be buyers are turning to the rental market, as well they should. According to a recent report from Hometrack, renting is now much cheaper than buying. Hometrack calculated that in 2006 throughout England and Wales private rents represented less than two-thirds of the level of house purchase costs.

Hometrack also says that 24.3 per cent of young working households have little chance of accessing home ownership in their local housing market and that in some areas average house prices are more than 5 times income. It’s 9.23:1 in Kensington and Chelsea.

Presumably, if renting is two-thirds cheaper than buying, buy-to-let investors must put down a 66 per cent deposit before rent covers the cost of servicing the mortgage. But then, taking into account voids, maintenance costs and agency fees, presumably the deposit must be a lot higher.

That’s not to say buy-to-let can’t be profitable. In “stack ‘em high, sell ‘em cheap” type accommodation, likely to be popular with low-paid immigrants and students, it’s likely that rent to costs ratios are still positive.

But the Hometrack figures do seem to contradict the argument that as first time buyers stay away, buy-to-let investors will move in.

Furthermore, the argument that house prices will not fall as long as the economy is in good shape has been proven to be false in the US. In the country across the pond, the economy was in fine shape, and then house prices started to fall, dragging the economy down in their wake. The same causal relationship could occur in the UK, and to an extent the relationship worked this way round in the early 1990s when recession followed house price falls in some parts of the country.

PS

Recently we aired the argument that buy-to-let investors should not be able to offset rent against interest payments. The argument goes that a first-time buyer does not get tax relief on a mortgage, so why should an investor get this tax break? This is a valid argument, but it should be borne in mind that without being able to offset interest against rent it would be very difficult for a buy-to-let investor to offer deals that are competitive with the cost of buying.

Permit us a moment to elaborate.

Assume the rent on a property is exactly the same as the cost of taking out a 100 per cent mortgage on that property. Under those conditions you might ask, “Why would anyone rent?” Well, let’s ignore that point, because it’s not relevant to this argument.

Say the cost of either renting a property or buying with a 25-year mortgage is £1,000 a month. A buy-to-let landlord who can not offset rent against interest would find that income is £1,000 per month, the cost of servicing the debt required to buy the property would also be £1,000 per month. If it was not possible to offset one against the other, and tax was payable on the rent, at 40 per cent, then the landlord would find that with a 100 per cent mortgage it would not be possible to cover costs. In fact, at a tax rate of 40 per cent, it would be necessary to put down a 40 per cent deposit. If you assume that void and maintenance costs amount to, say, 10 per cent of rent, then for the landlord to break even a 54 per cent deposit would be required. If you like this article, why not register for our daily newsletter? Or if you already receive the newsletter, then start spreading the news and tell your friends and colleagues. To register visit this link

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