1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 5:  Property 5cis

2. Characteristics of the UK property market In the UK, the proportion of families who own, or are buying their home, is higher than in many countries in the European Union

3. Characteristics of the UK property market Over the past 30 years, the proportion of the British population owning their own homes has increased from about 50% to about 70%. A house is the largest single investment that most Britons make in their lifetimes

4. Home ownership in the UK BBC News, Wednesday, 13 February 2008 After rising from 57% in 1981 to a peak of 71% in 2000, the rate of owner-occupation has stalled and has now begun to fall slightly. In 2007, the number of owner- occupiers dropped by 83,000 to 14.54 million, taking the rate of home ownership down to 69.8%, its lowest level since 1998. The fall was particularly pronounced among younger age groups, with owner- occupiers aged between 25 and 34 declining by 322,000 between 2001 and 2006. Owner occupation in the UK boomed from the 1950s onwards, overtaking the private rented sector in 1961. It got a further boost from the right-to-buy policies granted to council tenants in the 1980s. The biggest fall in owner-occupation in the past few years has been in London. Between 2001 and 2006 the number of owner-occupiers in the capital dropped by 111,000, a fall of 6.3%. One factor acting as a drag on owner occupation has been the growth of private landlords using buy-to-let mortgages. This has helped revive the private rental sector, with about 10% of all new mortgages now being given to people buying a property in order to let it. But this has led to accusations that many would-be home owners have been priced out of the market by prospective landlords.

5. “As safe as houses” UK house prices have risen at a faster pace than average earnings since 1959. National average earnings have increased at an average real rate of 2.0% a year. The average price of a house has risen by 273% since 1959 in real terms (i.e. after allowing for retail price inflation), at an average annual rate of 2.7%. The average UK house price has increased in nominal terms over the past 50 years from £2,507 in 1959 to £162,085 in 2009. Source: Nationwide

6. UK house price trends – in recent years But if you had bought property at the peak of the market in 2007, you may be sitting on a large loss. Prices can go down as well as up…

7. Mortgages Mortgages are the most common types of secured loans A mortgage is a loan, secured on the property it is financing  If the borrower defaults (i.e. stops repaying the loan and/or paying interest), the lender can re-possess the property  The property is then sold by the lender (often at auction) and reimburses itself with the proceeds  Any money left over is returned to the former property owner Some people take out a second mortgage on their property to finance other investments:  Perhaps to buy a holiday home overseas, or to renovate or extend their home  If the borrower defaults, and the property re-possessed and sold, the first mortgage is reimbursed before the second Repossessions as a proportion of all mortgages remains steady at 0.09%. About 10,000 properties are re-possessed each quarter in the UK. When a borrower is failing to meet his/her monthly payment, the mortgage is described as being “in arrears”  At present, in the UK, 1.64% of all mortgages are in arrears

8. Repossessions Properties re-possessed in the UK, as percentage of all property transactions

9. Mortgage: a long-term, secured loan It is a long-term loan, designed to be paid off over the working life of the borrower  Most mortgages run for 20-25 years  Most home buyers aim to have paid off their mortgage by the time they retire  In Japan, property became so expensive that buyers had to take out mortgages to be paid off by their children Illustration of mortgage repayments on a 25-year, £150,000 mortgage with a 10% interest rate Most mortgages require the repayment of the principal sum borrowed as well as interest, over the life of the loan  Most of the interest is paid off in the first half of the life of the loan

10. Mortgage interest charges Variable rate  Borrower pays interest at a rate which varies with the market  The Bank of England base rate heavily influences the mortgage interest rate market  When rates go up, the monthly repayment will go up, and vice versa Fixed rate  The interest rate is fixed for the first few years (normally 3-5)  If interest rates in the market go up, the borrower is protected, and continues to pay the lower, fixed rate of interest  If interest rates fall, and continue to stay low, the borrower is stuck  The borrower can only get out of the deal by paying a redemption penalty to the lender o The penalty compensates the lender for the loss of interest payments  Fixed-rate borrowers are usually required to remain with the same lender after the end of the fixed-rate period. This is known as the “lock-in” period.  The borrower then has to pay the standard variable rate for a few years.

11. More mortgage interest rate charges Mortgages are profitable business for the banks  Mortgage brokers earn commission from banks by sourcing borrowers for them Capped rate  Capped mortgages protect borrowers from rates rising above a particular rate – the capped rate  Example: borrower pays the current variable rate of 6%, capped at 7% o If the variable rate falls to 5%, the borrower pays that lower rate o If the variable rate rises to 8%, the borrower pays just 7% Tracker rate  The mortgage interest rate is linked to another rate (usually Bank of England base rate)  Tracker rate is set at a fixed percentage above the BoE rate, say 1%  Tracker rate will increase and decrease as BoE rate changes o It “tracks” the BoE rate

12. Size of mortgage lending in UK Source: Council of Mortgage Lenders About 70% of all properties in the UK are bought with the help of a mortgage

13. Cash buyers are likely to include:  Retired people who have paid off their mortgage and are “down-sizing”  Foreign buyers (attracted by the weakness of the pound sterling)  Speculative and “opportunistic” investors  Sale and leaseback companies  Professional developers Cash buyers now account for c.30% of all property transactions Cash sales as % share of all transactions

14. Period Number of new BTL mortgages Value of new BTL lending Percentage of new lending by value 200993,500£8.5 billion5.9% 2008222,700£27.2 billion10.7% 2007346,000£44.6 billion12.3% Buy-to-let mortgages Buy-to-let lending represented only 5.9% of all lending in 2009 (10.7% in 2008), but the total value of outstanding buy-to-let loans still represented around 11.8% of the mortgage market despite the recent shrinkage in new business.

15. Mortgages Assessing the credit risk of a mortgage borrower A mortgage lender will consider each application for a mortgage loan in terms of the credit risk – the risk of not being repaid the principal sum loaned and the interest due:  Borrower’s income and security of employment  A borrower with a track record of changing jobs every six months would not be a good credit risk  Borrower’s existing outgoings – can he / she afford the monthly payments?  Utility bills, credit-card repayments, care-home fees for elderly parent etc, could consume most of the borrower’s disposable income  The size of the loan in relation to the value of the property being purchased  If the borrower is able to put down a 30% deposit, the lender has much more certainty that the loan will be repaid  If the loan is 95% of the value of the property, it would take only a 10% fall in property prices for the borrower to have “negative equity” Definition of negative equity:  when the size of the mortgage exceeds the market value of the property

16. Lending criteria Income multiples, loans for house purchase

17. UK house price-to-earnings ratio

18. At the end of 2008, house prices had fallen by about 18% from their peak levels just over a year previously. Negative equity: when the size of the mortgage exceeds the market value of the property Of those homeowners who took out mortgages from Q2 2005 through to the end of 2008, it is estimated that 900,000 - about 13% - had found themselves in some degree of negative equity

19. The absolute size of negative equity is currently small, with the value significantly less than £10,000 for two thirds of all borrowers in negative equity. Negative equity: when the size of the mortgage exceeds the market value of the property Regional variations in negative equity: peak-to- trough price decline, early 1990s and today Number of owner-occupiers with negative equity, by % degree of shortfall

20. First-time buyers, lending and affordability Average loan to value Average income multiple Proportion of income spent on interest payments November 2009 75% 3.09 14.4% October 2009 75% 3.08 15.1% November 2008 83% 3.12 18.2% Source: Council of Mortgage Lenders First-time buyers: initial mortgage payments as % of gross income

21. Repayment mortgages The most common form of mortgage is a repayment mortgage Borrower makes a monthly payment to the lender  Each payment includes an element of interest and capital (the principal )  The split between interest and capital will change over the life of the loan Key advantage of a repayment mortgage : if the borrower keeps up the monthly payments, the mortgage will definitely be paid off over the term  But interest rates can go up, and payments can rise significantly Mortgage repayments on a 25-year £150,000 mortgage with a 5% interest rate

22. Interest-only mortgages The other form of mortgage is an interest-only mortgage Borrower makes a monthly payment to the lender  Borrower pays only the interest  Borrower puts money aside each month to cover the repayment of the capital  Borrower may put the money into other investments, such as the stock market o Borrower may have decided that stock market offers better potential for capital growth than the property market o During the property market boom, however, the borrower had no intention of holding onto the property for the full term of the loan and was counting on the property market rising fast enough for a “quick turn”

23. Interest-only mortgages At prevailing rates of interest, initial capital and interest payments are roughly 40% higher than equivalent interest only products. Recent figures suggest that over a third of loans are on an interest only basis They can help first-time buyers get onto the property ladder First-time buyers: initial mortgage payments as % of gross income