Property Vision market report - Summer 2009

Downturn without a downside
It’s a funny world. We are now reckoned to be in the worst recession since the war with output down 4.9% since the beginning of 2008 and unemployment steaming towards two and a half million. Yet Goldman Sachs announced record profits, and house prices in Kensington have increased by between 10% and 30% since October last year – depending on whose figures you believe. This is as counter intuitive as particle physics excepting, perhaps, the news from Goldmans: the quip going round New York trading floors is that when the nuclear holocaust strikes, there will only be three things left – cockroaches, Keith Richards and Goldman Sachs.

There are mitigating statistics at least for the property market: unemployment is concentrated on those aged between sixteen and twenty-four – not big property owners. And there is the perennial UK issue of a crowded island with strict planning laws that create what can sometimes seem like a permanent shortage of property. But the explanation for this apparent paradox surely lies in the current ultra-low level of interest rates that are designed to produce no pain – and none is being felt unless you’ve lost your job or are a long-only fund manager. Someone once said of the Fauré Requiem that it was a requiem without a Last Judgement: at the moment the recession in London seems to be a downturn without a downside and nothing like the brutal squeeze between interest rates at 15% and falling asset prices that we saw in the early 1990s.

We are very busy – mainly in London, but more recently in the country as well. London has been characterised by plenty of buyers, many of them with dollars or euros in their pockets, but very few sellers at all levels. Our sub £1 million team has been particularly frustrated. Until June there was a pattern that would have suggested that the further you got away from London (and those dollar/euro buyers) and into sterling denominated second-home territory, the worse it was: Kensington was a sellers’ market but Salcombe belonged to a few brave buyers. So pronounced was this trend at the beginning of June, that there were only three houses (as opposed to landed estates) that had sold for more than £5 million over fourteen counties. This has now changed and confidence seems to have rippled out from London with deals being done everywhere – for the best houses anyway.

The nagging feeling is that this can’t be right with headlines as bad as we’ve had to get used to over the last two years. However, the argument goes – and it’s not lacking in logic – that when every other home for your money is volatile in the extreme, or paying you nothing, then property is as good a place for it as any. This has certainly been the case this year. Also, houses are things to live in and most people fall into the category of home owner rather than property speculator – something that is often forgotten when residential property is considered as an asset class. If ultra-low interest rates are the prop, then the big question mark must be over interest rates and where they go from here. But this is likely to be more important for the economy as a whole, and the national property market, than the rarified world in which we operate. As we have said before, spending 100% of your bonus on a property is a different call from borrowing 100% of its value.

On the interest rate front there are ominous rumblings on the horizon of the bond market where yields on both sides of the Atlantic have been easing upwards in the teeth of a headwind of ‘quantitative easing’. No matter how much the authorities may say that they will keep interest rates at their present rock-bottom levels, things may move out of their control as lenders begin to demand a higher return on their money in return for financing the awesome government deficits that are being run up in the developed world. As Bill Clinton’s advisor observed, the bond market intimidates everyone, and the authorities may well find that they become the skier behind the boat, not the driver.

Whatever happens to interest rates, lending to everyone is still at a relatively low level as banks shrink and repair their balance sheets for the inevitable next wave that will have to be dealt with in the form of the commercial property market and consumer debt. The commercial market is down 44% from the peak – which means, effectively, that any property deal done over the last five years is now under water, with the equity wiped out and the banks left holding covenants that are not in their interests to enforce. The banks’ P&L accounts are looking reasonable as long as the tenants keep paying their rent and interest is flowing. We also need to remember that banks are borrowing money for virtually nothing: as someone said, it’s like a car manufacturer not having to pay anything for its raw materials – even General Motors could make money in those circumstances. Their balance sheets are another matter and it is unlikely, in the circumstances, that the lending taps will be opened fully for the foreseeable future, no matter how much the Bank of England or the Government might wish it.

As we have seen this year, even if the green shoots turn brown, there won’t necessarily be a wilting at the top end of the property market. For every debtor just holding their head above water, there is a creditor with money in the bank and looking for a home for that cash – or a home to live in. As any private bank will tell you, there’s plenty of cash around and inevitably some of that will end up in the property market. As with most other markets it’s likely that volatility will be the name of the game – in activity as much as prices. When sentiment changes in response to an external shock, the market simply dries up with both buyers and sellers sitting on their hands if they can.

We will almost certainly see more of that over the next few years.