Category: housing

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Just a minute?

Neil Collins in the FT today.

Just a minute Things are grim at Just Group, provider of annuities for those expecting short lives, but better known for its lifetime mortgages. These allow ageing homeowners to cash in on their property gains with loans where the interest is not paid, but rolls up with the debt. This latter business is relatively new, and pricing the risk that the house will be worth less than the accumulated debt at the homeowner’s death is exercising the Prudential Regulation Authority. It will want more capital from the lenders, and Just has already sacrificed its half-time dividend in anticipation, warning of a capital raise to follow. The shares have halved in four months, and at 74p are discounting a thumping rights issue to appease the PRA. Only then can the market price the risk that the mortgaged property will fetch less in 20 years’ time than its value today. It does not seem remotely likely. At this price, Just shares are discounting housing Armageddon.

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Deferment Price Less Than Spot Price? What Else Could It Be?

In a recent posting Guy Thomas takes issue with my new friends at the Prudential Regulation Authority on Consultation Paper CP13/18 which deal with the valuation of the no-negative-equity guarantees (NNEGs) in equity release mortgages. Dean has responded to Guy here, but I would like to stick my own oar in the water too, particularly on the issue of whether the deferment price on a property should be less than the current price.

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A bet on the house

In Asleep at the Wheel, I set out a base case No-Negative Equity Guarantee (NNEG) valuation based on a bunch of assumptions. Suppose I am 70 years old, have a house worth £100 and get an equity release loan of £40. Suppose too that the risk-free interest rate is 1.5%, the net rental rate is 2%, the loan rate is 5% and so on.

In this base case, my NNEG model comes up with a NNEG valuation – this valuation is the same as the cost of the NNEG to the lender – of £20.8, which is 52% of the amount loaned.

Remember too that we value the NNEG using information available now. As Dean and I have explained in various places (see here and here), our NNEG valuation is not dependent on a forecast of any future variable.
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Omnis Phoenix est

Kevin writes (28 August 2018)

A less extreme case is where the property is uninhabitable and repair would be uneconomic, but the land itself is valuable. Parts of Detroit come to mind as Dean has suggested here. You could then say that the net rental proceeds were negative for the current property, but this situation would not last. In this case, the property would be sold off and demolished, and the site redeveloped. A positive rental stream would then eventually be restored.

True, and the picture above (Charleston St, Detroit) illustrates this nicely. Many of the derelict streets in Detroit still look like the picture on the left. Houses abandoned or burned out, gardens reverting to the wild. But some parts have regenerated, getting new life by arising from the ashes of the old life, like the Phoenix. See the right hand part of the street in 2013.

The new houses will sell for a price greater than zero.

 

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Net Rental Rates and Deferment Prices

Character property with attractive open views and real scope for improvement

Kevin Dowd  28 August 2018

A number of our readers continue to be puzzled about why Dean and I have been insisting (see, e.g., here, here and here) that the net rental or q rates used for NNEG valuations should be positive.

This point matters because we are interested in how NNEG valuations are affected by deferment property prices.
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Population and housing prices

Source: Federal Reserve, St Louis; US census bureau

It is a truth universally acknowledged that the currently high price of housing in the UK, indeed most of the developed world, is due to housing shortage. The graph above shows (1) house prices in Phoenix and Detroit, 1991-2017, and (2) Detroit population 1820-2017. Beware of the differences in time scales.

It is clear that there is a similar pattern in the Detroit and Phoenix prices. They grow a lot in the noughties, peaking around early 2007. Then they collapse a lot, reaching a trough 2009-2012. Then they head back up again. You can see the same pattern across the US and in the UK (but not in Vancouver and Auckland, where they didn’t stop in 2007 and just kept heading up).

The rule of ‘same effect, same cause’ doesn’t always hold, but there is a suspicion that there is a single phenomenon underlying this. What could it be?

Well it can’t be housing shortage, at least in Detroit. Its population shows a consistent decline from its peak in the 1950s. Everyone has seen those pictures of whole areas that have reverted to countryside, because no one wants to live there. Clearly there is no housing shortage in Detroit. We could make a cautious inference that whatever common cause explains the upward and downward swings in prices is unconnected with population.

The population growth of Phoenix (not shown) since the 1950s has however been massive. One theory explains this by air conditioning. Detroit is a cold and miserable place in the winter. Phoenix is nice and sunny, and it doesn’t matter it is a bit of a furnace if you have AC.  That I mention the theory does not indicate agreement.