Is it foolhardy today to invest money in illiquid UK property assets? It's a debate accountant and Oxfordshire homeowner Accrual and I have had for 5 years. Which straightaway says something about the heat of the market.

Prices are spectacular. But so long as GDP growth remains sturdy and the labour market remains tight, from where will come the catalyst for significant declines? The chart below illustrates some trend data since 1984.

Exhibit A: UK House Price Trends, 1984-2004. Assembled from HM Treasury data.


The supports for prices are evident: first, the employment market is tight; second the leading indicator of consumer confidence is on the rise; and third, GDP growth looks robust.

Now, here's the thing. The psychology in the UK house market and the current US/UK equity markets is in some ways similar: strong prices have created a buyer's hesitation to commit, albeit tempered by a sense of missing-the-chance to cash in on a still rising market. Since 2001 it looks like fear-of-missing-the-boat has won out as double-digit annual gains have become the norm - perhaps assisted by the negative returns of offered by UK equities over the period 2001-2003.

But peering forward there are the forecasts of GDP to consider. Most independent pundits don't see it outstripping 2.5%-2.7% in 2005: the Chancellor of the Exchequer forecasts 3%-3.5%. If he's wrong there will be a major tax revenue hole (given Labour's spending commitments), tax rises and higher interest rates. And all that beginning from perhaps as early as the November 2005 Budget. The UK yield curve is already slightly inverted - this scenario at least keeps it that way.

How sharply rates might rise under this scenario determines the fate of UK property values in the medium term. Yet - although it's too early to be definitive on this - the expectation of rises already seems such that it's modestly cooling prices. If that proves to be the case it reduces the probability of a rate-hiking drama. So, short of a shock, a soft-landing appears possible. For prospective owner-occupiers planning to stay put awhile, this simplifies decision-making. And they are 80% of the residential market.

Investors, on the other hand, will want to think carefully about opportunity costs. Buying now means owning a pricey market where even gross yields in many areas are lower than the Bank of England base rate. In fact, not one region offers a net yield superior to the lending rate.

With uncertain weather on the economic horizon, that's poor odds.

UPDATE:
This from the FT (15 Feb 2005) reports lending to UK property investors dropped off significantly in the second half of 2004.

Useful reading and data on the UK and other international housing markets is to be found at the Investment Property Databank , the source for the yield data in this article.

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