Neil Lewis's Blog

Expert commentary on global property investment issues and the factors that affect property markets...

UK Property Investing: Is now the right time?

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Thursday, April 16, 2009

So, that was it then. The great property price crash of mid-2007 to the spring of 2009.

'Britain's housing market reignited', says one recent (and typical) headline.

'Applications for US home loans surge' reads another.

UK House Price Recovery Sales of new homes in the US bounced back from a record low in February. They rose for the first time in seven months as buyers returned to the market. New home sales were up 4.7% month on month, after collapsing by 13.2% in January.

Back in the UK, the Nationwide price index rose 0.9% in March - the first rise since October 07.

Even the prices of flats in Manchester's city centre - which have utterly collapsed - may have reached bottom, according to auctioneers. And quite a bottom it is, with some flats selling at up to 60% off their peak value in 07.

Bank of England figures on new mortgages approved in February rose by 20% month on month

So, are you convinced that the property market has reached the bottom?

We're not.

What is possible, though, is that we may now, for the first time, be able to see the probability of what is ahead. And this suggests that house prices still have some way still to fall.

The fact is that any upturn in asking prices, as reported by the Nationwide, needs to be put into context. First, it's only one month; second, it's only asking prices; third, very few housing downturns show consistent month-to month falls in prices. This rise needs to be sustained to be meaningful.

The data from the US housing market, again, is interesting; but, again, it's one month and comes after a month that recorded a catastrophic low.

Most encouraging was the news from the Bank of England that UK mortgage approvals leapt by 19% to 37,937 during February.

It's a big leap in lending and not one that's likely to be repeated month-on-month; but it does show that the single key cause of the house price crash - the drying up of finance - may have started to ease.

The context is this, though - and it may provide a very worthwhile clue as to when the market really will reach its nadir.

It's been calculated that in order for property transaction prices to stop falling consistently - not to rise, you understand, just stop falling - lending must increase by approximately 100% from its present paltry level.

Now, a jump in lending like February's 19% just isn't going to happen each month over several months. But, if we assume a steady but more modest monthly rise - which again is somewhat unlikely - then the earliest we can imagine prices stabilising will be around the autumn. But autumn is, traditionally, a dead season for property, so we're probably looking at early 2010 as the most likely bottom of the market - and perhaps (just perhaps), some very, very modest growth.

There are some other telling factors to consider.

Prices as a % of income. Since 1983, data from the Halifax shows that rate to have been an average of 19.62% In Q4 2008, it was a significantly lower 18.31%.

Then there's the house price to earnings ratio. Based on Halifax figures again, this peaked in recent times at 5.84 in July 07. The long-term average is 4 and last month it was 4.42.

None of this, of course, can be treated as an equation the result of which comes up with a definite forecast of when the market will stop falling.

And anyone making forecasts about market bottoms more specific than our 'probably around the end of the year' one above, is either a fool or they're selling something! But, what is increasingly clear is that a further big collapse in prices is starting to look less and less likely.

For the investor, then - especially the investor with equity - the greatest UK buying opportunities are probably from right now to the end of the year.

We say that not because we believe the bottom has been or is about to be hit - we simply don't know with any certainty - but because we can start to see some added stability in the market that probably indicates that, while prices may still fall further, they won't collapse again.

For the long-term investor - and 10 to 15 years-plus is now the only sensible way to view investment in the UK market - the risk of some moderate price drops over the rest of 2009 is of little concern.

Far better to buy an excellent property, with a healthy yield and long-term intrinsic value than to try and hang on and call the bottom; or, indeed, to buy based ONLY on price. The property that seems the greatest bargain based on price has got to that position for a reason. Think of those hugely over-supplied Northern, city-centre flats.

But let's not get carried away. There are still big clouds on the horizon. And while the credit crunch may have been the initial trigger for the price collapse, it has now caused a chain reaction in the economy. Unemployment and the fear of unemployment is now likely to prove the biggest drag on any recovery in the property market.

The Organisation for Economic Co-operation and Development forecasts that one in 10 workers in ALL advanced economies will be without a job next year with 'practically with no exceptions'. Hardly conducive to a dramatic upturn in the market. But for the investor with sensible, long-term expectations, this is opportunity knocks time.

More are seeing it that way too. The Association of Residential Letting Agents reports landlords are now buying more properties than they are selling for the first time in two years.

THE key hurdle for nearly all investors, though, is not the economic argument, it's that great property buys - property with long-term intrinsic value and healthy yields - are becoming extremely hard to track down.

With that in mind, here are some tips for those with buying in mind:

Look for locations in economically strong towns, those towns - or areas within cities - served by recession-resistant industries and businesses. Property here will not be the cheapest, but it will hold its price better in all points of the property cycle.
Generally, avoid locations economically dependent on one industry or employer.
Be cautious of everything, but especially oversupply of a certain type of property, rising unemployment locally and areas that have had a transient workforce due to the nature of the industries there
What to buy - this depends on location. But good-quality, well-located apartments will do well (provided there is no oversupply in the immediate area). Larger, family suited apartments also. HMOs (houses of multiple occupation) provide strong (but management-intensive) returns. The supply of good quality HMO property has fallen off a cliff, or is being priced up, assuming a 14/15 year rent roll, so driving down yield.
It may feel like stating the obvious, but remember that a cash investor now has negotiating powers that didn't exist during the last ten years of easy finance.
Forget all about Below Market Value in this climate. It is meaningless. A price from 2007 has little to do with today's value. Even a sale price of a few months ago is often no longer a valid comparable. Focus instead on yield and long-term growth potential based on supply, economic growth and job creation in a property's catchment area.

Property Secrets and sister company i-PropertyAssets can find property on your behalf, to your brief and at the right price. To learn more about our property sourcing service, call Martin Grainger on +44 (0)1270 539576 or email him here.

Biggest Investment Bet Ever

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Friday, December 12, 2008

As investors we are facing a choice - the decision of which will determine how we invest now and the long term outcome for those investments.

The world is heading for deflation (at least the developed world is) or alternatively, the world is heading for a boom in inflation.

It is one or the other - but the middle option of a reduction in prices with low interest rates is no longer a viable scenario.

The moderate inflation with low-ish interest rates was a feature of the expansion of credit that accompanied the largest growth in world trade that any generation has ever seen. That period and that environment is now a thing of the past.

Central banks across the world are slashing interest rates aggressively - the UK down to 2% (1% cut), the ECB cut rates to 2.5% (0.75% cut) and the Swedish central bank cut rates an unprecedented 1.75%!

Why? The central banks are all scared stiff of deflation - that horrid situation has prevented Japan from delivering any meaningful economic growth for over 10 years.

Therefore, as the risk of deflation increases, so banks cut rates more aggressively,

But what happens when interest rates reach zero? How do central banks keep the money in the economy moving? Not by cutting rates below zero, that's for sure!

Well, this week the answer to this scenario has begun to appear - the solution is for Governments to hit the printing press! That means, print bank notes - new currency - and push it into the economy.

Of course, printing money is the number one 'must never do' for any central banker - but when faced with the risk of deflation, the inflationary risk is worth it - so bankers will do it!

At the same time, the world's capacity to produce and compete is being massively reduced - not only banks, but manufacturing, distribution and service businesses are going bust faster than ever. This is happening now not just in the developed world but across the emerging economies too - and in those economies where so much was done to keep the price of manufactured goods down (such as China).

Equally, the cost of credit has gone up so businesses need to raise prices to cover the increased cost of borrowing and that will put further pressure on inflation.

So, less competition in the global economy means that businesses will have (ie over the coming months) more latitude to raise prices.

Indeed, the very fact of being an incumbent in a market place will strengthen existing (or those remaining) businesses - in that any potential new competitors will now need to raise finance in a newly harsh lending environment.

Lastly, central banks are going to start to print new money.

All of this points to a strongly inflationary environment - in which the real value of debt falls very quickly and the value of cash collapses. In this environment, as I have argued in this blog previously, the smart investor will hold assets - be they properties or commodities.

Of course, the cost of loans will go up rapidly too - so, I think it will be the right move to switch to fixed rate loans in the next 6 months to avoid a sharp rise in the cost of your borrowing in a year or so time.

Look also at the effect of the tax changes in the UK - temporary cut of 2.5% of vat - this is temporarily reducing inflation only to give it a large kick start in 2010.

But what if I am wrong?

Well, that is a very good question. If I am wrong and we don't avoid deflation - then the last thing you want to own are assets and debt - for the same reasons but in reverse - in that the cost of a loan, in real terms, goes up! This would encourage more lenders or borrowers to cancel loans - which will have all sorts of truly horrible consequences.

I believe that central banks are so worried by the deflation scenario that they will do almost anything to avoid it. This is the right response, but it doesn't guarantee that they can avoid it!

Take your bets ladies and gentlemen

Therefore, we need to take our bets. You can either bet on a deflationary environment - in which case, liquidate everything.

Or you can bet on an inflationary environment - in which case, load up on cheap fixed rate loans and assets.

There will be no middle ground.

The choice is yours. If you choose right, you will make a large amount of money. If you bet wrong, well...

The 'Worst of the Worst' is nigh

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Friday, December 05, 2008

The worst of the worst is near (which is a big improvement on the recent 'The End of the World is Nigh', but sadly not quite so catchy).

Commentators, such as hedge fund manager Barton Biggs, writing in the FT says that he thinks the deleveraging process is about 80% complete.

What does this deleveraging mean to us mere mortals?

Essentially, customer cash withdrawals from hedge and unit trust funds are nearly done. To enable customers to get their cash back, the hedge funds have been selling equities to release the cash and will soon be able to re-invest remaining cash if it is no longer needed to meet the reduced level of withdrawal requests.

As a result, investors are now sitting on 'awesome' cash piles - and with interest rates heading to zero that is going to have to move into something.

Biggs' view is that the end of the worst may mean a sharp equity rally, however 'whilst the consumer spending collapse we are experiencing may be short-lived, that doesn't mean a consumer boom is coming either', he said.

The UK's chancellor reckons he'll need until 2015 to balance the UK's books. That is after two further general elections and more than a lifetime away for most MPs.

The hidden message in the UK's stimulus package is that taxes are now on the rise - sharply for high earners - and whilst the cost of living in the UK will reduce this year and next, the quality of living is likely to fall for the next 7 years - schools, hospitals and public services will take a massive hit from 2010 onwards.

Austerity Britain here we come!

So, a stock market rally is due, but after that it will be a long and slow climb.

Hungary - the barometer of central Eastern Europe

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Friday, November 28, 2008

So Hungary's economic problems now place it as the key to what may happen in the rest of central Europe.

The first critical comment is that the bank crisis has now turned into a currency crisis as investors seek US Dollars and Yen instead of Euros, Pounds, Danish krona and Hungarian Florint.

The ECB (Euroland bank) is pumping cash into a non-Euro currency - amazing!

Therefore, analysts are drawing the conclusion that the Euro area will expand quicker than expected as weaker currencies seek the safety of a bigger currency and, of course, the Euroland attempts to protect the economies of its key trading partners (and therefore to protect its own economy).

Hungarian interest rates rose 3% to 11.5%.

Budapest has - on annecdotal basis - 40,000 empty properties after years of speculation.

We are seeing (theoretical) discounts of 30% on completed property.

With the Florint crashing, this makes property very cheap from a Euro (but most especially a US Dollar) perspective.

Cash rich investors holding US Dollars will find big bargains in Hungary now.

Something similar is happening in the Baltics - where the minnow currencies are really hard to trade and so quite protected against speculation - but at risk anyway.

These countries with a Euro peg may well simply jump into the Euro area.

Lastly, major devaluations in these countries will reduce the cost of labour and goods - and as these are export markets - this will make them stronger in the mid to long term - which make them even more attractive to cash investors using US Dollars.

Heads you win a lot, Tails you do not lose much

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Friday, November 21, 2008

This article (http://www.ft.com/cms/s/0/99db094c-96f1-11dd-8cc4-000077b07658.html) backs up the value investing approach very powerfully which I outlined in my previous blog.

There are two quotes that I want to highlight in the article:

1. Benjamin Graham's value investing is...an asymetric bet; heads you win a lot, tails you do not lose much.

2. It is now plain that we are living through what history will almost certainly call the second great crash in stock markets.

The key here is that this is a method that has worked over time - although it needs to be applied differently at different points of the cycle.

And that stock markets and property markets now offer some asymetrical bets where the only way is up.

However, I must temper this with the view than in some countries - UK, Spain, the US - the 'way up' is likely to be very slow and disappointing.

Therefore, value hunters in these countries need to be especially patient and careful.

The smarter move for investors is to look for countries that still offer the asymetric bet, but also have a strong upside story (ie. growth prospects).

This leads us back to Central and Eastern Europe - especially countries such as the Baltics, which have fallen hard and fast and once through a year or two of pain will start to offer a very attractive upside on a low historic price basis.

Investing in uncertain times?

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Wednesday, November 19, 2008

These are massively uncertain times for all investors.

Many of the old debates about where you should put your money may seem obsolete.

To many people it has felt over the last year or so, and especially right now, that there is no longer any basis for rational investment decisions.

Why?

Because uncertainty breeds the emotion of fear, and fear leads to irrational responses and decisions. Rather as greed can do!

I want to explain in a moment why this is fundamentally wrong and that there IS indeed a way - and a PROVEN way - of making rational decisions about how and where to invest.

I also want to explain why this time of confusion and uncertainty is actually when real investment success can begin.

Is this blind optimism?

I don't believe so, and nor do some of the most successful investors of all time.

But first I'd like to make something clear: I am not looking to persuade anyone by argument here.

What I want to do is to make our position clear and invite similarly minded investors to join us. If you disagree with our investment framework, then fair enough. You must simply take the approach you feel is best, and I wish you luck.

I say this because this is not a time to spend trying to convert people by argument - there are more viewpoints around than ever, all busily guessing the near future, what will be affected by events and what will go up and what will go down in price - market price, in other words.

Few of these people are doing anything other than focusing on a few aspects of the moment. Some of them are no doubt very informed, very savvy.

But, the fundamental difference between this approach and the Visium way is that we do not focus on the moment. We do not focus on market price, but Intrinsic Value. That's why we're different.

So, to reiterate, there is really no real time for debate as far as we're concerned because the opportunity is Now and it is unlikely to be around for long.

At the moment there is over-reaction in the market for every asset class - seemingly bottomless pessimism, swiftly followed by groundless optimism.

Neither perspective represents real or intrinsic value. The reason for this is these assessments are driven by fear and greed. And at such times the overwhelming tendency is to follow the flock, seeking safety in numbers, whether the driver is fear or greed.

Here's how one 20th century Wall St colossus, Benjamin Graham, put it: "Prices are subject to irrational and excessive fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed."

And the more fear or greed there is, the more extreme and further removed from intrinsic value these emotional responses to investment will be. And the harder it is for an investor to know the intrinsic value of assets.

This is what economists call asymmetric information and a good example of this is the toxic debt in the US that no bank wants to hold: it's almost impossible for a potential buyer to know its real, long-term worth.

The solution then is to strip away emotion. Strip away all the froth or the terror - all the emotion, whether it's positive or negative - and focus on fundamental drivers. This is what our analytical framework does with property markets.

This does not mean that the property markets we focus on won't be affected by cyclical factors - of course they will. Cyclical factors include poor sentiment, interest rates that are higher (or lower) than a historic average, short-term over or under-supply of product.

These are important but temporary factors that impact on a market price, but not fundamental drivers of value.

To find these we need to step back some distance and focus on key elements.

Look at this:

Growth in relevant disposable income X Jobs X Credit growth

VERSUS

Growth in relevant supply

Stripped to essentials this is how to measure intrinsic value in a property market.

These elements need to be placed in context, of course.

For example, we need to look at the potential (and probable) growth in credit markets by comparing with more developed markets (and then we need to divorce our projection from the fact that credit growth may be slowing because of currently higher interest rates because this is cyclical.)

Why then is property especially fitted to the Intrinsic Value approach?

· Because there is a forecastable need for homes as a result of steady demographic changes (although prices may rise and fall) - in nearly all cases.

· Because it has an enduring value (so long as it remains habitable).

· Because there is predictable supply - land availability, planning laws, and construction costs typically ensure demand is stronger than supply, in nearly all cases, over time.

What the intrinsic value framework does is to provide investors with the greater certainty of the long-term potential for price growth so that they can make better decisions.

Classically, investors are lulled into selling their best investments (be they shares or properties) and keeping their worst because it feels like they are making a profit.

Instead, they should sell the weakest investments and keep those whose potential for future growth (based on a sound understanding of Intrinsic Property Value) are the strongest.

There is one factor here though that is absolutely essential, without it, the intrinsic value framework does not work - You!

You need to be an investor and NOT a speculator.

If you want to speculate, be my guest. But speculation is the equivalent of taking your investment and putting it on a roulette number. We see this approach as fundamentally unsound and certainly as wasteful when so much investment potential lies in taking the intrinsic value approach.

Here's the key to our investment principles - real, sustainable wealth is delivered via long-term and consistent growth. And to deliver that it is necessary to look for markets in which we can see the obvious long-term, intrinsic potential.

And, you know what, this is not rocket science. And it certainly is NOT a formula - we don't believe in them!

This is about a set of investment principles that require only clear-sightedness when all around most other people will be driven by an emotional response to events - back to fear and greed.

The more we can remove these elements, the better and more logical our analysis will be and the more accurate will be our assessment of intrinsic value.

And remember: there is a HUGE difference between price and value. This lies at the heart of our investment approach.

Price fluctuates wildly due to market conditions and cyclical events. Intrinsic value can be plotted over time by analysing fundamental market drivers.

Here's another thing - if you take the long-term, intrinsic value approach, you also don't need stratospheric returns to become very rich indeed.

£100,000 becomes £6.5 million in 30 years if you achieve an annual return of 15%. This may seem a high return, but bar in mind it's not an example of simple compounding, it would include some leverage. So, if we have £100,000 and borrow a further £100,000, the total return needs to be 7.5% for an investor to achieve a 15% return on investment.

Now, I'm not suggesting that you will hold all investments for 30 years, but this is the time horizon that's worth considering for a personal portfolio.

Why do we choose a 30 year time frame? Simple, the wealthiest investors in the world are old - they are not burnt out Young Turks from the London financial trading centre. Success comes with age and with time.

And certainly any individual investment should always be considered as a ten year hold - enough to remove the effects of cyclical events on our analysis. Over a 10 year period the cycle of fear and greed will have worked through.

Whether you actually end up holding for ten years or are able to take profits much earlier is a separate issue - our approach is to PLAN for a ten year hold.

Fine theory. But does this approach work?

Well, it has for the world's richest man and arguably the greatest ever investor: Warren Buffett. Here's what he had to say:

"Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.

"Price is what you pay. Value is what you get."

A time of confusion and uncertainty is, as all great investors tell us, an excellent opportunity to make extremely smart investments - so long as they are based on a careful assessment of intrinsic value.

Buffett again: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

But, bear in mind, we are NOT looking for 'cheap' buys here.

This is about buying into great quality developments, great investments with strong intrinsic value. But, during a depressed market, one that is, for example, temporarily over-supplied, buying below intrinsic value is possible, which represents a superb opportunity.

This period is especially attractive - or should be - to high net worth individuals able to use their higher purchasing power to leverage the best prices.

And this is where residential property has an advantage for high net worths - residential investments that are at all attractive to funds, of, say, more than £4 million, are rare and nearly always over priced. So, large funds are often generally excluded from such markets.

A great time to invest then - IF your time horizon is sufficient (ten years minimum) AND you are prepared to do the analytical work to ensure you are buying into a market at a price that is at, or preferably below, intrinsic value.

As I said, you don't need the IQ of a Nobel prize winner here, BUT you do need to be prepared to put in the work to apply the framework of principles and then look at the analysis and base decisions ONLY on that.

And an investor certainly needs to be careful where they invest.

Look at the UK, Spain and Ireland right now - all markets with plummeting property prices; prices in all these markets as now being described as 'cheap' by many investors.

But 'cheap' relative to what? Relative to their previous prices, which were over-blown and part of an asset price bubble. Cheap is really not worth considering. It has nothing to do with intrinsic value.

What we need to look at instead is whether there is good intrinsic value in these markets. Are there wonderful assets?

Well, not if economic growth and therefore job creation is weak and credit availability is likely to shrink for the medium to long term - perhaps even permanently.

Look at Germany - it's certainly 'cheap' compared to comparative markets in Western Europe and has been for a long time - but there is little intrinsic value in an economy in which there is no increase in disposable income and no growth in jobs - Germany has spent the last ten years increasing production and competitiveness by cutting real wages.

Such things are the fundamental drivers of property markets, the determiners of intrinsic value and NOT subjective conclusions about whether a market is cheap based on a comparison with another market.

And this is why we favour specific CEE markets - because our analysis tell us that CEE markets - not all, mind, but some - can offer market prices at or near Intrinsic Property Value (IPV) - but with very strong and long term IPV growth potential. Plus, we have strong property rights and the reassurance of EU membership.

In these markets, and others, we are constantly examining the growth rate in Relevant Supply (meaning supply to the sector of the market we are analysing, NOT the whole market), relative to the growth of cash available in the same market segment.

To do this we need to look at RELEVANT disposable income, relevant jobs and the availability of credit to the relevant sector.

Now, once we are able to establish these parameters, we are able to determine what price we need to buy at in order to build in a safety margin. This is crucial. It's not especially complicated, but it does require a great deal of research and number crunching.

The bottom line is that we will not invest where our analysis shows us that property prices have risen at rates significantly above intrinsic value.

So, yes, all this requires effort, it requires a framework and it requires strong investment principles in order to squeeze out the emotion.

But it does not resort to some magic formula, it does not look to achieve quick gains and it does not rely on perfect timing in a market - because we are looking are fundamentals and NOT cyclical factors that can be discounted over a ten year time horizon.

And it may well be that our analysis reveals that opportunities are not actually market driven at all, but opportunity driven - and important distinction.

So, to sum up: history shows - through the most successful investors there have ever been - that only an investment framework based on Applied Value Investing will deliver consistent, long-term returns.

Effort is required. Luck doesn't count.

Our approach then is to apply and seek out:

· Residential property (in legally safe countries) with a built-in safety margin.

· A clear investment framework founded on rational analysis and not based on subjective impressions.

· We apply measures of Intrinsic Property Value Principles with the aim of locating Wonderful Assets for the long term.

To optimise our approach investors must be ready to buy fast and buy big - because there are only short windows of opportunity when Market Prices are attractive relative to Intrinsic Property Value in legally secure, high economic growth markets.

And, finally, once again, can I restate: We do not want to convert investors to the Visium way here.

We'd rather expend effort on applying our investment principles to locate wonderful property assets. Instead we are looking to team with investors who examine our Intrinsic Value approach and see a confluence with their own. If that is you, then we want to have you with us.

In the words of Mr Buffett:

"Do business with people you like and who share your objectives."
Warren Buffett

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