We are living in extraordinary times

I think it is very important that we remind ourselves from time to time that we are living in extraordinary times. Never before has the Bank of England base rate been as low as it is today. And this exceptionally loose monetary policy is being used in many Western countries.

As you can see from the chart above showing the bank base rate going back to 1694, the previous low was 2%, yet we are currently at 0.5%. This is unprecedented and shows the desperation of the Bank of England to stimulate the economy in what can only be described as a severe financial mess.

The chart clearly shows that the natural level of base rates is around the 5% mark. Normally the base rate is greater than the rate of inflation to encourage prudence and saving but at the moment it is definately not. Historically bank base rates have been around 3.5% above inflation and therefore we can conclude that interest rates, assuming CPI inflation of around 4.5%, should be around the 8% mark!! This would therefore mean that mortgage rates should be 10%, think of the carnage that would be caused if this was the case!

When the Bank of England eventually starts raising the base rate, and they will have to one day, that’s when we will finally see the correction in UK house prices which has been long talked about. And when this correction occurs, that is when some astute investors will pick up some absolute bargains in UK property which will set up them brilliantly for a life of financial independence. I hope I am bold enough to take advantage!

As an aside the gross yield, rent received over price paid for the property, back in the mid 90′s when the property market last bottomed was 9-9.5%. This was in an inflation environment of 1.5% though so the real yield was around the 7.5-8% mark. These days the gross yield is 7.5% but this is on a background of inflation around the 4.5% mark so a real yield of 3%. When real yields get back up to 7.5% mark that will be a reasonable guide to the housing market bottoming out.

When to invest in Real Estate

There is a lot of talk about when is a good time to invest in real estate.

The actual answer is anytime is a good time to invest. When the market is tanking, as a buyer you can negotiate fantastic discounts, 25%-30% off market value is what you should be aiming for. On the other hand, when the property market is rising you get the benefit of rising prices.

As it stands the property market in the UK is being artificially held up through the rock bottom interest rates. I think it will be surprising for how long the Bank of England maintain rates at this low level because they know any rise will knock the UK’s economic recovery. Ultimately though, the outlook for UK property is poor and at some point I think there will have to be some further declines. Whether these declines will be in real terms or nominal terms we will have to see.