Keep up-to-date with the corona-virus and how it will effect the property market.
I’m going to spend this blog talking about what I think the effects of this virus could be on UK property investors. This blog is a ‘plan for the worst’. This could all blow over and be looked back on as media hype. Many educated people do not consider this to be a serious risk, but those same people will be ready just in case it is. If this turns out to be a fire drill, it will still be useful.
At the end I’ll finish with what I think is at risk, which is Serviced Accommodation (Airbnb), high-end luxury flats and those who of you are near breaking even month-to-month. I’ll then talk about where to find opportunity, should there be a dip. This is not a negative piece, there are challenges posed, those who rise to them may do well. There’s a lot to get through here, so it may be long. Any existing clients who want to talk about their portfolios, get in contact here
Last Friday, the floor of the London Stock Exchange was empty. One trader had come in with a cold, this was enough for the Banks to send their star employees home. The symptoms of COVID 19 don’t seem to have drastic implications for the young and healthy, but the economic impact of an empty trading floor for a month could be substantive. Equity markets (stocks & shares) are usually the first to signal a recession, so it was a fitting symbol for what may be about to hit home.
Property prices move slowly, particularly when you compare them to ultra-high-speed-equities, around 80% of which are now traded by supercomputers. Most property price measurements/indicators are lagging. It takes time for sales to complete. When there’s been a movement it can take you a few months to realise. This is why foresight matters, investors need to keep an eye elsewhere and be prepared to make judgement calls.
This Friday I had a meeting with a senior executive at a high street bank. This person rearranged our meeting to be over the phone rather than face to face. They apologised and explained a scheduling conflict, but did later say that the bank was cancelling all physical meetings and networking events. In the afternoon I noticed that the biggest European property network event, MIPIM in Cannes, had been postponed. This is the go-to event for all the biggest movers and shakers in EU Property, I see a pattern. In the last week the smart money has made adjustments.
To set the scene, we could do with some perspective on where we are and how we got here.
Above we have the yearly growth/decline of the British Economy. GDP is short-hand for everything we make or produce, it’s not a perfect measure but it’s what we have. You can see that generally that line stays above 0, but does vary quite a bit throughout the years. About every 6 years we hit a recession, sometimes it’s less than six and sometimes its more, but about 6 years is the rule of thumb. I started working in late 2006, 12 months before the one of the biggest recessions in history. I was at a sub-prime mortgage lender, I was in the team who set the interest rates and criteria. I remember the positivity of the time, you could expect a promotion once every six months. The financial models would assume only 1% growth as a worst case scenario. The firm went into liquidation 14 months after I joined.
The reasons for the 6 year rule are debated. I personally think psychology has a lot to do with it. When the last recession was a some time ago the collective memory fades. New ambitious managers can take over, some of whom weren't working during the last decline. Things get pushed too far, and then they correct. The same goes for investors. A new generation comes through who haven’t yet had their hands burnt
The R-word has been mentioned. I don’t personally think we will hit a Recession, rather a quiet few months. But let’s talk about them.
A recession is technically defined at two quarters of negative growth. Colloquially, it’s when the economy shrinks.
What tends to happen in recessions:
Our last recession was in 2008. Judging by the 6 year rule we should be overdue by now. However, 2008 was a particularly bad one. One of the worst on record, in fact. And since then it hasn't felt like we've been in boom years. It's all been a bit flat. I thought we were ready for a boom a couple of years ago, but this was dampened by Brexit's uncertainty. Then, with Brexit out the way we saw a flurry activity and prices rose almost immediately (I hate to brag, but I did make a bet this would happen back in 2018, I won five pounds, thanks Steve).
The other key point to remember about 2008's fallout is interest rates, they were set to historic lows. This kept mortgage payments low to encourage growth. The Bank of England will need to raise interest rates if inflation (price increases) gets out of hand. One thing that can cause inflation is a stimulus package, pumping money into an economy. And that's what governments to do when waters look choppy. So, a flat 12 years since the last recession, Brexit out the way, a sudden spurt of growth. Then, corona.
To keep it simple, a not very deadly virus which is extremely contagious. The deaths tend to be those who are already vulnerable, for the healthy it seems to be a bad flu for a couple of weeks. So the issue to me is, what happens if half the country is off sick for the next couple of months? China managed to contain the virus effectively, but China is a police state. At time of writing there are cases reported across the UK, including London, the cat is mostly likely out of it's bag.
In China, the first first part of real estate to feel the pinch was hotels. It makes sense, nobody was travelling with large parts of the country on lock-down.
Airbnb entered the UK in 2012. We have never had a recession with Airbnb, we do not know which SA properties will thrive and which will close in a downturn. I have heard from a few clients this week who are having cancellations. If you are a Holiday let landlord, I would consider dropping prices now, or finding a 'better the devil you know' option for the next few months. Knowing you can pay the mortgage will trump profits if things worsen. If you want to stress-test your portfolio, give me a call.
Where I live, in central Birmingham, there have been some very high end luxury flats developed over the last two years. Large penthouses with price tags around 3x those of a two bedroom flat. Many of them are sold to foreign investors, or to the children of those investors. Those properties will immediately loose value in a recession. For those investors who can wait, they could snap one of these up at a bargain price, and wait until the price recovers. Though this is a high risk strategy, and is the sort of thing to do if you have plenty of money to spare.
Thinking of Top End draws my mind to London. Prices in London seemed to have topped out some time back. Largely bolstered by foreign investment, rental yields in London have fallen to half that of other areas. I recently arranged a mortgage on a London rental property with a 3.2% gross yield. Some areas in the midlands yield 6-8%. Prices in London did drop by a small amount in the run up to Brexit, if you dig deeper you can see that most of this was flats, which dropped by a huge 10% in the 12 months prior to the deadline.
By 2009 the Development Finance market had shut down entirely (Development Finance are speculative loans on new property developments). It was only 2012 when it quietly reopened, and another few years before new developers were able to access it.
I know a person who put his Net worth into an old airfield with potential for development in 2006. The individual unfortunately lost most of their wealth, only for a shrewd investor to pick up the same plot 18 months later at a fraction of the price. That person sat on it, and resold it on for a large margin in 2013.
“Buy Land, they’re not making any more” – Mark Twain
In a serious recession I would expect development activity to stop. Parcels of land ripe for development will therefore be worth less. However, Land is one of the safest bets you can make. There’s only a certain amount of it, if inflation is 2%, you can bet land values increase by at least that amount. There are theories that suggest property values are really a reflection of land values. This is why I tend to see leasehold flats as higher risk, there’s less that you own.
I suspect the government will need to enact some sort of stimulus package to soften the effects of Corona. Often, these packages have very complex descriptions, but effectively boil down to printing or borrowing money. This drives inflation up. Land prices tend to track inflation. If your money is in the bank, it won’t track inflation. If inflation is 4% and your savings account is 1.5% your wealth is effectively diminished by 2.5%. If it’s in land, you’re ok.
Those investors that are currently making a small profit on sections of their portfolio may see those parts become loss makers. If inflation increases the government will need to increase interest rates to slow it down, mortgage payments could rise and we have been accustomed The last couple of years have seen a new generation of ambitious young entrepreneurs enter the market, using social media and innovative rental strategies to derive profit. It is these people I am most concerned about.
Bank’s belts tighten in a recession. If you think you are short of cash to cover potential vacancy and need to borrow some, I would do it quickly. Whether this us or elsewhere, if you are short on contingency money this is worth worrying about.
In all adversity is opportunity. Some people do extremely well in a downturn, I would hope Uplift can play a role in this. If you have an ongoing purchase which has not completed, I would wait. You may be able to negotiate a reduced price. If you have free capital, I would be ready to get a bargain. The corona virus may create entirely new markets for entrepreneurs, so lets’ be ready for profits when they present themselves.I, nor anybody else, knows what will happen tomorrow. However, if running through a ‘fire drill’ now is not useful for corona virus, I have no doubt this will be useful whenever the next recession hits. A few months ago I read a study by Bloomberg; those businesses which do not plan for a recession fail or shrink, those which do plan take large up chunks of the market.
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Disclaimer: the views expressed in this blog are the opinion of the author and do not represent financial advice. If you want financial advice, please contact the relevant professional.
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