Is the UK market in a property bubble?

A combination of rising property prices, news of the government’s ‘buy to save’ Isa for first-time buyers and the prospect that the pension changes will encourage retirees to venture into the buy-to-let market to fund their retirements has prompted speculation that the UK is approaching a property bubble.

The Halifax monthly house price index shows the average property price in the UK is just short of £200,000, with prices in the three months to April at 2.2 per cent higher than in the preceding three months. It reveals that house prices in the period were up 8.5 per cent on the same three months in 2014.

Halifax housing economist Martin Ellis points out the annual rate remains at roughly 8-9 per cent, which is where it has been since the start of the year and is below last July’s peak of 10.2 per cent.

As always with property, it’s a case of balancing supply and demand. Mr Ellis says: “Housing demand is being supported by a number of factors, including economic improvement, rising employment and low mortgage rates. At the same time supply remains very tight, with a general shortage of properties available for sale.”

Alan Sippetts, investment director at Heartwood Investment Management, cites the credit crunch to explain the lack of property in the UK. Property developers and owners who would have expanded their premises or built new properties in 2009-11 were unable to do so as banks stopped lending or the developers went bust, he recalls.

“All these years after the credit crunch where we’ve had rising values in fixed income, in equity and in physical property, we still don’t have enough of the right kind of quality sites and quality assets that the modestly growing UK economy is calling out for,” he argues.

What does this mean? “We’ve seen property values rise very strongly. You saw the IPD index have an almost record year in 2014, rising 20.4 per cent – that’s the UK physical property market total return index of the IPD,” he says.

“Even after that very strong rise in capital values, what we’re now seeing in the UK is rising rents as business and property investors want access to good quality property. But those quality properties are either not available or, if they are available, tenants are having to pay higher rents than they would have expected to get access to them.”

So should investors be concerned that we are heading for bubble territory?

Phil Tily, head of IPD UK and Ireland at MSCI, has some reassuring facts about the property market. “Property prices are still 20 per cent below their 2007 peak, and property still offers an attractive margin in terms of its pricing level against 10-year government bond yields and that margin is above its long-term average,” he suggests.

“The obvious questions that then need to be asked are what happens if and when bond yields do rise, and will that have an adverse impact on property yield levels? And yes it will.

“To compensate for that we’ll hopefully see a rise in the underlying economic fundamentals. Based on our numbers we’re seeing a strengthening in that trend, in that rental values have picked up in the past five quarters. So if this rental growth component continues to strengthen, this will support where property prices are currently pitched.”

Many believe several mainstream asset classes are approaching bubble territory, but it seems property is not one of them.

Mr Sippetts notes: “You’ve had consistently strong equity returns in all major and developing markets, you’ve had bond yields go to record or all-time lows, [so] it’s no surprise to find that another developed asset such as property is also enjoying material capital appreciation.”

One of the signs of a property bubble developing is whether rents are reaching never-before-seen levels, and he argues this does not seem to be the case.

“Rental levels in the 1980s, the 1990s and the late 2000s were at or above the levels we’re seeing in the majority of properties in London,” he says.

Looking at whether property prices will edge back up to their June 2007 peak, Mr Tily notes: “Because property prices appeared to be so overinflated in June 2007, I’d be surprised if we get back up to those levels in this cycle.

“Last year we were seeing capital values rise by 2.5-3 per cent quarter on quarter, and in the opening three months of this year values grew 1.6 per cent. So there has been a slowdown in growth but it certainly hasn’t come to a standstill.”

Ellie Duncan is deputy features editor at Investment Adviser