London Property & the Bank of England Failing Again

Stats, Facts & Points of Interest

- Members of the NAEA have reported the highest number of sales to first-time buyers since it started recording the data in 2000. (Property Industry Eye)

- Many parts of New York are now more expensive than London, e.g. Greenwich Village is similar to Notting Hill. However, asking prices averaging £1,599 per sq.ft. for a two-bedroom property compared to an average asking price of £1,440 per square foot in Notting Hill. (Lonres)

- ResPublica, a think tank, has proposed a National Housing Fund backed with £10billion of investment by the Government each year over a decade using Treasury gilts.

- Qatari Diar has been granted approval by Westminster Council to turn the US embassy in London into a luxury hotel.

- CapitalRise, a London-based property investment platform, is launching its third deal with the chance for everyday savers to invest in a development of five townhouses and four apartments in Knightsbridge worth £106 million. The website has reportedly raised £1million for each of its first two offerings on property developments in Eaton Square, Belgravia, and Grosvenor Square, Mayfair. (Crowdfund Insider)

- Research by Halifax based on ONS figures found the total value of privately owned housing stock in the UK has grown in the last decade by £1.9 trillion, or 51%, to an estimated £5.6 trillion, beating the 33% increase in the retail price index.

- In the past year alone, the value of private housing stock grew by £337 billion, mainly reflecting average house price growth of 12% in the year to August.

- More than half, £1.1 trillion, of this rise is accounted for by London and the South-East. (Property Industry Eye)

  It’s Not Different This Time!

This report has been inspired by the Bank of England.

Don’t worry, this does not mean I am going to bore you with platitudes and dull analysis of questionable data.

No. I have been inspired by their power of foresight: Yet again their predictions of weak UK growth have been confounded and they have had to revise their forecasts of the UK’s performance upwards once more.

So, I am going to make a couple of predictions and you are probably not going to like them because they are far more bold and brash than the BoE. However, I think I need to make a big prediction as I keep talking about the property cycle and how reliable it is.

In last month’s report I stated that property prices would continue to rise significantly outside prime central London while PCL would still do better than many expect.

Today I am going to go much further:

In 2019/2020 there will be a significant stock market crash (the FTSE & S&P having surged over the next two years) and a recession.

There will be much gnashing of teeth and wailing. The press will equate it to 2008 and view it as a cataclysm which will change western economies forever. There will be dire prognostications of years of penury.

However, this will not be a land price crash although property prices will fall slightly – think 2000/2001 rather than 2008/2009. Consequently stock markets and world economies will bounce back quickly and we will see huge price rises in property and shares until we have a massive crash that will be similar to 2008.

This will be a land price crash which will cause banks to fold and is likely to make 2008 look like a tea party.

 BUT THAT CRASH IS YEARS AWAY AND PROPERTY PRICES WILL BE DOUBLE WHERE THEY ARE TODAY IN 9 YEARS

I did warn you that the predictions would be bold and brash.

But they are not as mad as they first appear because history gives us a very clear picture of how the property cycle repeats:

At this stage any positivity is looked upon as being naïve because the financial anguish of 2008 is still fresh in the memory. Consequently most forecasts are pessimistic or cautious because that is the safe option to take. It is what the consensus believes and any opinion that is hugely optimistic is seen as blind hope.

But this is the danger of “Groupthink”. It is safe but it doesn’t make it accurate. You only have to look at 2008 and the Queen’s question “Why did nobody see this coming?” to see that economists get it completely wrong during positive times too, i.e. they stick with the herd until they have charged over the precipice.

Indeed the economists are almost always wrong about the big calls which would suggest that they are looking at the wrong figures when they come to their conclusions.

But it is easy to understand why they and almost everyone else are largely pessimistic: at the moment you can look at house price to earnings ratios, the fact that there is more debt in the world than ever before, property taxes have increased and there is political uncertainty with Brexit, Trump and elections in Europe.

Basically, there is plenty to be worried about. But then you would be hard pressed to find a time in history when there wasn’t something to worry about. So ask yourself this – would you rather be living now or in any other decade?

Now obviously I would love to be in my twenties again – for one I was a lot more interesting at parties back then - but the Nineties was hardly a glamourous decade and I look back through the decades and there aren’t many that would appeal.

Yet prices have kept increasing while the standard of living has also risen despite what media reports would have you believe. This is true globally. Yes, the gulf between the wealthy and the poor is as wide as ever (although Pareto’s Law shows why this is a natural phenomenon).

Nevertheless, poverty levels are being reduced while life expectancy and literacy levels are rising throughout most parts of the world. Don’t get me wrong; we are far from utopia and a lot more could be done, but we are making progress.

All this is being ignored which I find particularly odd as we are already seeing exponential advances in technology and medicine, a trend which is accelerating and will bring huge benefits for mankind as well as new challenges.

But despite all this the pessimism is understandable because it all comes down to human psychology. Indeed I got it wrong in 2009 and 2010 because I thought it was “different this time” despite the fact that I should have known better.

In brief – in 2005 I met a client who wanted help acquiring a 6000 square foot house in Kensington. He said to me “Jeremy I am ringing the bell at the top of the market”.

As I knew about the cycle, I told him not to worry and that “there would be huge price rises between 2005 and 2007 followed by a crash” (Most of our members at the time asked the same question and most bought properties as they decided to follow my other key piece of advice – never be a forced seller).

Nevertheless, I was an idiot because although the cycle indicated that 2009/2010 would be the best time to buy, I didn’t take action. I thought the market would fall further than it did.

I fell into the trap of looking at what the mainstream were focussing on: the amount of debt governments had accumulated, the fact that QE was a short term solution and various other factors rather than sticking with what I knew. Basically I focussed on the wrong facts because although I knew intellectually what to do, I let my emotions get the better of me.

Shamefully I went with the herd – I still kick myself although not as hard as Serena does; she packs a mighty punch for someone who is 5ft 2in… - It’s a mistake I now guard against. Of course, it is especially hard to extricate yourself from the herd when it is in full bull or bear mode.

Just think of the dotcom boom and then bust or the euphoria of 2006 and 2007. This is why full blown booms and busts happen – everyone gets sucked in until there is no-one left to buy. Prices get bid up to levels that are genuinely unbelievable and then the euphoria subsides to be replaced by concern and then panic.

But then when everything seems terrible and everyone is telling you that you would be mad to buy property, shares, art, etc, it is almost invariably the best time to buy.

Of course you will not time the exact bottom or top of any market, but you can get close.

Where are we in the property cycle?

Well we are nowhere near the euphoria seen in 2006-2007. Those huge price rises are yet to come. Right now, there is simply far too much money sitting on the side lines and the herd is cautious. We are currently climbing a wall of worry.

So a crash like 2008 will simply not happen at this stage because there is too much money that isn’t invested, i.e. there is a definite floor so the market has corrected but it won’t crash. You just have to look at Savills’ figures for the last quarter to see the increased activity on sterling weakness. A lack of money is not the issue.

At the same time the banks in the US & UK are actually on a pretty solid footing and are nowhere near as extended as they were in 2007/8. Indeed they are aggravated by the restrictions currently imposed upon them.

And Brexit cannot cause a crash because it will not affect credit creation. In fact an ugly Brexit (which is not as likely as people seem to think) is likely to precipitate massive injections of QE or some other piece of financial wizardry. This can only lead to higher prices in sterling terms.

So although I understand why most people think that the day of reckoning is near, they are wrong – unless we have another world war, as the only two times the cycle has failed was during the two World Wars.

But why will prices go higher?

After all to say prices will double from where they are in the next ten years seems mad (it always has seemed mad throughout history and yet prices keep rising).

Well if prices increase by just 5% per annum then prices will have doubled in just over 12 years. If it is 8% per annum which is the long term average in PCL then that reduces to 9 years – that is the marvel of compounding.

So what will make this happen? Basically we will repeat some of the old mistakes and find new ways of making the same mistakes too. Remember we are humans who are far more driven by emotions rather than logic. Let’s look at just three factors:

1. Global wealth and money supply is increasing.

2. We are about to see a period of huge infrastructure investment.

3. Human nature doesn’t change

Global Wealth - There is a vast amount of money in the world. M2 money supply in the UK has increased 60% since 2007. More importantly lending has been severely restricted during this time due to increased banking regulation.

However, lending criteria will be relaxed and more credit will be allowed into the system. This has happened in every cycle throughout history. The government will want easier credit conditions as it will stimulate growth which makes the probability of being re-elected much higher.

Trump is already setting the wheels in motion. Meanwhile consumers will demand access to more credit as confidence grows and they want to be able to buy more/invest more.

THE KEY TO REMEMBER IS THAT THE MAJORITY OF THIS MONEY WILL FEED INTO PROPERTY PRICES:

Probably the most complete study of bank lending data to be undertaken shows that:

“To a large extent the core business model of banks in advanced economies today resembles that of real estate funds: banks are borrowing (short) from the public and capital markets to invest (long) into assets linked to real estate…

The intermediation of household savings for productive investment in the business sector – the textbook description of the financial sector – constitutes only a minor share of the business of banking today, even though it was a central part of that business in the 19th and early 20th centuries.” The Great Mortgaging - Oscar Jorda, Moritz Schularick and Alan Taylor (2014)

As I say, this is nothing new although the trend has accelerated since 1950. Indeed even if the banks are not allowed to lend as freely as before (highly unlikely), disruptive technology and new business models will take their place, e.g. crowd funding and peer to peer lending.

Infrastructure - Right now governments are in the process of stimulating growth by investing in infrastructure projects. This always feeds into higher land prices and therefore house prices – just think of the effect of Crossrail, for example. Indeed a general feelgood factor will be generated as more jobs are created by the infrastructure projects and the improvements they bring.

Which brings us to human nature - The more money people have the more they are willing to spend on living in the best areas. After all if you can afford it, why wouldn’t you want to live in the best part of town.

Equally those priced out of the best areas move further afield bringing more money to those areas and then those areas improve. This is the essence of gentrification. Despite what the press would have you believe this is not a modern phenomenon. It has been happening for centuries.

The difference now is that it is a truly global phenomenon especially as money can move jurisdictions quicker than ever before. The difficulty for most British people to understand is that sterling is now the weakling in the room while other economies are also generating wealth at a much faster rate – a real double whammy in terms of purchasing power!

Now, chalets on the best slopes and villas on the best beaches can sell for fortunes as long as they are accessible, secure and have generally good infrastructure around them.

This is why there are a few global super cities that command what seem like eye wateringly high prices. The world’s richest want to live in the best areas of the best cities.

And when you consider that there are 187,500 people with a net worth of over $30m excluding their main residence (Knight Frank/CapGemini), it begins to make more sense.

And this number is growing. It is also estimated that one million people have a net worth of $10m. That is a lot of spending power and this is while credit is restricted! What do you think is going to happen when lending criteria are relaxed? Exactly, prices are going to explode.

And if you don’t think that this will happen then I am afraid you will be left behind because

 IT IS NOT DIFFERENT THIS TIME.

It always happens and you want to be ahead of it. Now I am not suggesting that Trump’ review of Dodd Frank will open the flood gates immediately. I expect that there will only be a moderate relaxing of the rules initially.

But that is how it begins. You can watch it unfold: They will open the credit tap a tiny bit just to check that everything is ok. That initial trickle will have a positive effect so then they will turn the tap once more. Interest rates will probably rise at the same time giving the (false) impression that everything is ok and that the central banks are in control (ha,ha,ha).

Then 2019/20 will be ugly in the stock markets (less so in the property market – think 2000/2001) – possibly due to Brexit but I expect there will be another shock too. This will be the excuse that the politicians and central bankers require: Interest rates will be dropped, more stimuli will be injected into the system and then we will see a repeat of the last boom.

This will be massive. And then there will be another bust and the cycle will start again – wash rinse and repeat…

But don’t be worried about that crash as it is years away and there will be huge price gains between now and then. So, for example, if you had delayed buying from 1994 to 2005 because you knew there would be a crash in 2008 would that have been a good decision? The same is true now.

It is amazing the number of people I meet who say, I wish I had bought in 1994, 2000, 2005 or whenever it was they first thought about buying. Many still have not bought a property.

They all think they have good reasons not to buy and yet the market continues to prove them wrong. Indeed I was speaking to one such person recently – he is very successful, clearly good with numbers and he said the biggest mistake he has made was not buying a property in London 20 years ago.

And yet he is still very hesitant. I expect the 2008 crash wasn’t big enough for him and he is hoping for a bigger crash to take prices below the lows of 2009/10, i.e. he wants his hesitation to be justified. He is not alone, but I am afraid this is delusional thinking.

That is not to say it’s impossible – there could be a world war or a massive cyber-attack on the world’s biggest banks which erases vast wealth. In either case the price of a house will be the least of your concerns. But how likely is it that either would happen (and if it’s the latter then you would probably rather have a hard asset to which you have a clear title which is recorded on paper)?

In fact, if you think that the property market is going to crash from here what you are saying is that centuries of evidence is wrong and that you are happy to bet against human nature, i.e. you think that fear and greed have been eradicated while technological progress will slow or reverse.

How sensible is that?

And by the way if you don’t believe me when I say that we will find new ways to make the same mistakes and drive property prices to previously unimaginable highs, you might want to read this from Forbes Magazine:

“Want to buy a piece of New York’s Empire State Building, One World Trade Center or The Shard, the tallest building in London? Anthony Gahan is committed to making such dreams a reality.

The London-based banker has spent the past three years planning the International Property Securities Exchange (IPSX), which claims to be launching the first marketplace where shares in individual properties, rather than in the companies that own them, can be traded.

The venture’s application for a recognised investment exchange licence was submitted to the UK’s Financial Conduct Authority in July 2016 and approval is expected by May 2017, clearing the way for the new exchange to launch by the end of the second quarter of the year.”

Now he may not gain approval immediately but this is a sign of what is to come.

Meanwhile, if you are waiting for a host of distressed sellers to enter the market because of Brexit, you are going to be disappointed. It simply will not create a wave of forced sellers.

Firstly this is not a credit issue. If anything more money will be pumped into the system if things look uncertain.

Secondly, how many people will keep their families in London and simply commute to Frankfurt, etc. Wouldn’t you rather rent in Frankfurt and spend your weekends in London? (the flight is under two hours).

Thirdly, you are counting on a hard Brexit which is far from a foregone conclusion and we are seeing more and more conciliatory comments from both sides.

Of course, you can use Brexit and all the other worries as reasons not to buy, but if you look back at the last 60 years, is what we are experiencing anywhere near as bad as 2000-2001 or the seventies and early eighties when the UK was the sick man of Europe and there were regular IRA attacks?

Clearly not, yet prices in prime central London continued upwards. So if you are keen to buy in London but are hesitating to take action is it because you are following the herd and relying on press reports for your information?

As you hopefully know by now, the statistics quoted by the press are far too general to be of any real use to you. All you should be interested in is that one great opportunity, because if you buy well then you will be protected from any minor corrections.

For example, we acquired for one of our members an apartment in Marylebone in 2014 which was the peak of the market if you believe the press. In December 2016, they sold it for 7% more than the purchase price having carried out no work to it in that time. This is in a market that is down 12.7% according to the press.

And they are right, the market is down in general, but you shouldn’t care about the herd. If you buy best in breed at a good price then you will outperform the market.

Did you enjoy that marvellously unsubtle plug about how good we are? Well, I am so confident about the service we offer that I actually guarantee it, so you can test it at no risk. If you are serious about acquiring a property and would like to know more, please email veronika@mercuryhomesearch.com or call 0800 389 4280 (+448003894280).

On that note, I would like to point out one misconception that a number of people have mentioned recently. We advise a select group of members on their property acquisitions and many of these are at the “super-prime” level.

However, one of the many reasons I founded the company was because I was fed up with the poor advice and service I was receiving from the estate agents as a buyer. After all they are legally obliged to achieve the highest price possible for their client, the seller.

Unfortunately a large majority of agents also seem to look down their nose at buyers who are not at the super-prime level (even though their budget will probably buy a property that is bigger than the estate agent owns or rents…).

We do not; whatever your budget, it will be an important sum of money to you. Now we cannot help everybody as we only specialise in certain areas and price ranges, but if we can’t help we will be able to recommend good firms who specialise in your target areas.

So, whatever price range or area you wish to target, if you want to acquire your ideal home or investment on the best terms possible, contact Veronika on 0800 389 4280 (+448003894280 from outside the UK) or email veronika@mercuryhomesearch.com to arrange a consultation.

Best regards,

Jeremy