Updated: Aug 18, 2022
Black Swan Buying Opportunity
(LUDGROVE APRIL 2020 NEWSLETTER)
"Don't Wait to buy Real Estate. Buy Real Estate and Wait"
Six weeks ago we reported on a Prime Central London (PCL) property market that after 5 years in the doldrums was finally beginning to regain its mojo. The return of much needed political certainty and the spectre of long term pent-up demand was likely to lead to upward price pressure for the first time in many years. A large number of PCL agents reported new buyer registrations in January up an astonishing 50-100% y.o.y with a lack of stock being a significant concern.
Fast forward to today, and what was once regarded as an obscure virus that would be contained to China and the Far East, has (at least psychologically) ravaged the world. In the space of 6 weeks the FTSE 100 index declined 33%, the domestically orientated FTSE 250 -41%, crude oil -63%, interest rates have been cut to their lowest level on record, Government bond yields around the world have collapsed and fiscal and monetary stimulus has entered overdrive. Former stock market trader and author Nassim Taleb would call this a "Black Swan" event: an event so far outside the normal range of expectations that catches almost everyone unprepared and one that has enormous implications.
What then does this mean for Prime London property market and is this an opportune time for Buyers to capitalise on any potential weakness? Our short answer is yes.
The performance of the Prime London property market will be driven first and foremost by the shape of the economic downturn and subsequent recovery. Our opinion is the downturn is set to be a short and sharp, characterised by a steep but temporary rise in unemployment, the unfortunate bankruptcy of a number of highly exposed businesses (airlines, hotels, pubs, restaurants etc) and a swift recovery in the second half of the year. The shape of downturn outlined by the excellent team at Capital Economics is the broad view we subscribe to. Helpfully the graph below puts their V-shaped outlook in context, alongside the Financial Crisis:
Precisely how this downturn unfolds will be informed by greater medical understanding of Covid-19 (and especially the fatality rate), the spread of the virus, the success of lockdown measures and how pragmatic the UK Government responds at the end of the initial lockdown.
Impact on Prime Central London Property
For the Prime Central London property market, historic price falls have almost always been preceded by long periods of booming prices, excessive financial leverage, speculation, City hubris and an influx of overseas buyers for lifestyle or safe-haven reasons. Few of these factors have been present leading into this current crisis.
On the contrary, as highlighted in our 2019 year end Newsletter, there are a number of supportive fundamental factors and many of these remain just as relevant today. These are:
PCL prices have already fallen to levels where they have historically troughed and then recovered in past cycles. Real-terms prices fell -28% from the peak in Q1 2014 to the trough in Q1 2019. This is similar to the inflation-adjusted falls seen in 1989/92 (-34%) and 2008 (-26%).
At 5 years in length the recent PCL downturn is by far and away the longest on record (and compares to the 3 year downturn in 1989-92 and the 1 year fall in 2008). A bounce back was long over-due before this crisis.
Prime London property is usually first out of the downturn. If the usual playbook stands (and given the already depressed starting point), the area could be primed for a strong recovery when the recovery comes.
Long recessions tend to shake out the speculative, 'loose-holders' of assets and many of these speculative holders have already been purged between 2014 and 2019.
The recent safe haven flight to the US dollar has returned Sterling to the bottom if its 40 year trading range, making PCL prices c45% cheaper (in nominal terms) compared to the peak of the market in 2014. Sterling is also fundamentally cheap trading at a 14% discount to fair value (Purchasing Power Parity at GBP/USD 1.42 vs 1.22 spot). Furthermore there are a number of dollar-pegged Overseas regions that favour Prime London property. These include Hong Kong, Malaysia, Singapore, Qatar, Bahrain, The UAE and Saudi Arabia. The introduction of a 2% Stamp Duty Surcharge for Overseas Buyers due in April 2021 should also encourage these Buyers back to the market in the second half of 2020.
Mortgage costs are at all time record lows and although higher value LTV mortgages have been withdrawn in the wake of the crisis, there is good mortgage finance availability at more modest LTVs.
PCL is cheap relative to the mainstream London property market trading at a 173% price premium to mainstream London (in a 10 year trading range of a 155% premium to 250% premium).
PCL rental yields are relatively attractive, trading near the top of their 10 year range. In comparison yields on cash, the mainstream UK property market, the bond and equity markets (where dividends will inevitably be slashed) are at or close to their 10 year lows. Yields on cash and bonds are also negative in real-terms.
A 5 year bear market has created an underswell of pent-up demand (clearly evident in January and February of 2020). After years sitting tight, we sense there is a significant number of Buyers who have outgrown their properties and are desperate to move.
PCL rents have been on an upward trajectory driven by a lack of supply as private Landlords have exited the market following changes to buy to let taxes. Rising rents tend to support capital values.
In addition we would make the following points:
If China is the playbook/lead indicator for our economy, it is noteworthy property sales have almost returned to normal levels now:
At times of crisis, Prime Central London benefits from safe-haven buying. In this context PCL prices increased 89% between Q1 2009 and Q2 2014. Clients may also find our note "PCL: the World's Best Performing Risk-Adjusted Asset Class" worth a read at this juncture:
PCL homeowner leverage is low. We estimate the average PCL Loan to Value is around 30%.
Prime suburban, commuter and rural properties may well see a renewed interest over the next few years as Buyers look for more spacious properties to work from home. In this context, Prime suburban/commuter markets that have been hit particularly hard over the last 5 years such as St George's Hill (-40% from peak) and the Crown Estate in Oxshott stand out as excellent value. Clients may also find our recent note "Where to Buy in Prime London" helpful in this regard.
As an asset class, it is possible that real estate values may re-rate (or become more valuable) relative to equities. This is because the Coronavirus Crisis is likely to lead to the corporate world having to hold higher levels of cash and inventories on their balance sheets in turn depressing Return on Equity and therefore corporate valuations (P/E Ratios). Property is unlikely to suffer the same fate.
Corporates are likely to view healthcare provision as a more significant factor when deciding to expand or invest in certain regions of the world. In this context, our National Health Service should help attract talent to London and the UK.
Some of the best opportunities over this period will be seen by bulk buyers of new build residential blocks from distressed developers. Indeed our Professional Investor clients are active, using this as an excellent chance to gain sizeable exposure and we have access to a number of off-market properties in this space.
With physical viewings currently impossible during the lockdown, the PCL housing market is effectively frozen and minimal transactions will provide scant evidence of where the market is actually trading. Low volume markets are notoriously skittish and unreliable, so an accurate reading on prices may not be possible until well into the second half 2020. We regard any weakness as a Buying opportunity.
It should be said for the mainstream London property market we are more cautious. Here the market has been principally driven by First Time Buyers assisted by Help to Buy, parental assistance and high LTV mortgages. With lenders removing high LTV mortgage offers and the Bank of Mum and Dad's savings having been depleted in a stock market rout, equity and debt availability has suddenly been significant curtailed. A large number of First Time Buyers over the last 5 years have also bought new build properties at premium prices (due to these properties qualifying for HTB) and we feel there is a higher risk of downward price pressure and negative equity in this segment of the market - especially if a more protracted downturn materialises.
Of course PCL will not be immune from the current crisis and some weakness is to be expected in the short term. However for the reasons outlined above we would regard any sell-off in the coming months as an excellent long-term buying opportunity. The deep and protracted PCL bear market that has preceded the Corona-Crisis is not the typical backdrop for a sustained fall in prices.
Fraser Slater Chief Executive Ludgrove Property Ltd Tel: +44 (0)207 889 2860 Email: email@example.com Web: www.ludgroveproperty.com Biography: Fraser Slater is the CEO and Founder of Ludgrove Property. Prior to Ludgrove Fraser spent 20 years in The City. In the course of his career he was a Real Estate Analyst, the Fund Manager of a £6bn Equity portfolio for USS Ltd and the Founder and CEO of WDB Capital, a London based Fund Management business. In 2008 WDB Capital outperformed its peer group by +52% making Fraser's portfolio one of Europe's best performing Funds during the Financial Crisis. In the same year his Fund was nominated New Fund of the Year by EuroHedge. After leaving The City, Fraser started Ludgrove with an ambition to be Prime London's leading Property Buying agency with an emphasis on original research and delivering a highly value-added service to clients. Disclaimer: Ludgrove Property Limited is not authorised or regulated by the Financial Conduct Authority (FCA) and we do not provide any financial or investment advice. We recommend that any property investor seeks appropriate professional advice before entering into any contract, and we would also advise that the value of any investment can go down as well as up and that you might not get back what you put in. You may have difficulty selling a property investment at a reasonable price and in some circumstances it might be difficult to sell at any price. We would urge you not to invest unless you have carefully thought about whether you can afford it and whether it is right for you, and if necessary to consult with a professional advisor in accordance with the Financial Services and Markets Act 2000. All information is provided strictly as a guide only, is subject to change without prior notice and does not constitute an offer of investment. The Ludgrove website should not be regarded as an offer or solicitation to conduct investment business, as defined by the Financial Services and Markets Act 2000. Investors who are resident in or citizens of countries other than the United Kingdom may be subject to local restrictions. In particular, no offer or invitation is made to any US persons (being residents of the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof), who are excluded from the services offered in this site. The information on this website and our publications has been obtained from sources which we believe to be reliable and accurate, but without further investigation this cannot be warranted.