16/02/2010 - Recovery or Bubble?
by HO
An uncertain market with a strong long term story
MARKET COMMENT December 2009
Recovery or bubble?
Only 8 months ago, we were presenting a running schedule of target acquisitions showing the discounts that these were selling for relative to their peak of Summer 2007. We started this in December 2008 on the back of prices tumbling visibly in the wake of Lehman’s dramatic collapse. As economists and commentators competed to predict how far prices would fall, our intention was to track prices as they fell and to attempt to spot the point where they leveled out. The following is a representative sample taken from the last schedule in April.
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Address
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House or Flat
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Number of Bedrooms
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Floor
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GFA
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Tenure
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Date placed on market or available to buy
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Estimated Value Summer 2007
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Asking Price
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Revised Price
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Target Price
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Sale price
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Discount achieved on 2007 peak
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Date of Sale
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Kings Quay, SW10
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Flat
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2
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2nd
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976
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100 years
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Dec-08
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1,150,000
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850,000
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800,000
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820,000
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28.69%
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Jan-09
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Onslow Court, SW10
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2 flats
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4
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2nd & 3rd
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2,270
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115 years
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Jan-08
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2,600,000
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2,400,000
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1,950,000
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1,750,000
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1,975,000
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24.00%
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Mar-09
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Cornwall Gardens, SW7
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Flat
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3
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3rd & 4th
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1,545
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75 years
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Dec-08
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1,300,000
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895,000
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775,000
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775,000
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40.38%
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Jan-09
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Neville Street, SW3
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House
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5
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n/a
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3,068
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FH
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Sep-08
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4,500,000
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4,750,000
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3,950,000
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3,200,000
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3,375,000
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25.00%
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Feb-09
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Seymour place, W1
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Flat
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3
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2nd
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814
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107 years
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Jan-09
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850,000
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625,000
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600,000
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625,000
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26.47%
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Feb-09
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In March we were seeing clear signs of prices stabilizing as dollar and euro investors descended on London picking up ‘bargains’ that represented a combined 50-60% discount on 18 months previously. With the pound sinking below 1.4 to the US dollar and the markets predicting that sterling was heading towards parity with the euro, the market was suddenly awash with eager overseas buyers. From our own perspective we saw hard evidence of this and we produced a graph in our March bulletin (see below) showing a dramatic spike in enquiries which completely dwarfed the previous 2 and a half years.
In April we focused on the importance of securing tenants as we saw yields falling as prices recovered. We also warned of buying ill advisedly in a market with little choice and much competition.
In May we were pointing out the strength of sentiment and warning that those who were stubbornly expecting the market to come to them were going to be disappointed. By May we had seen prices very obviously recover with transactions being concluded at around 15% below peak in the preceding month.
By June, we were urging caution whilst recognizing that good property able to show a positive cash flow on sensible gearing represented a sound mid to long term investment.
Through the summer and early Autumn we arranged the sale of a number of our properties (through careful appointment and selection of selling agent) within our client portfolio and achieved prices in excess of their 2007 peak. In particular we achieved a record price on a large flat in South Kensington and another record on a 54 year lease flat in Marylebone (see focus below).
Over the past 2-3 months the acquisitions we have agreed have included two probate sales and three un-modernised properties where lack of development funding was clearly an issue for other buyers. Meanwhile we have been out bid aggressively on numerous others and have observed some irrational bids which reflected the extreme limits in choice and availability.
So we end 2009 in an atmosphere that more reflects the heady days of early 2007, as opposed to staring in to the abyss which many felt during the first quarter. However nervousness and uncertainty abound and no one truly knows what lies around the next corner.
Cash the king loses its crown
The united efforts of Governments around the world to inject liquidity in to the markets and keep interest rates at their extraordinary lows has resulted in the ‘cash is king’ approach being knocked in to touch and gold stealing the crown. With deposit rates being measured in fractions, investors have been looking for their hard earned cash to work harder for them. In an environment offering precious little in terms of yield, it seems that assets that could be bought below their previous peak implied potential capital upside. Or, as is the case with many of the buyers in prime London, short/medium term currency advantages were there to be exploited.
As a result, barely a year on from the world experiencing the worst financial crisis for 70 years, we are now experiencing what could well prove to be another asset bubble. Recent events in Dubai have nearly brought this to a halt, but not quite at the time of writing.
This apparent bubble, as we pointed out in October’s bulletin, is a result of little choice ( a supply crunch) and a lot of cash looking for a quality home.
A future of uncertainty, mini cycles, mini booms and mini busts – bring it on!
We think prices in general have probably ‘recovered’ too much. 6-8 months ago we were looking at Net yields adjusted for cost of borrowing at being better than we had seen since 2001/2002. This was illustrated in a detailed analysis in the June bulletin on a specific property in South Kensington, making a comparison going as far back to 1993. We saw value and opportunity where others saw fear and uncertainty. Since then prices have turned around and yields have fallen as a result. Over the past few months we have seen an opportunity to sell and achieve premiums thanks to levels of supply/choice as tight as we have known for a long time. The remaining value opportunities are typically refurbishment schemes where banks are unwilling to lend on the development funding and where private buyers are put off by the complexity. Probate sales and similar where the seller wants genuine speed from genuine cash or teed up buyers. Properties with tenants in situ where rents are underperforming and capital values are dragged down as a result. Or, the few repossessions that filter through, although these days the rarity of such opportunities lead to some ill advised buyers hearing ‘repossession’ and then paying full market, or more!
It may be that the market continues apace as people continue to seek safety in bricks and mortar, supply remains extremely tight and/or further weakness in sterling attracts more foreign investment. A recent meeting with an old and established family from Dubai only underlines the attractions of prime London real estate in parts of the world exposed to economic or political shocks. However, as we enter the traditionally quiet months of December & January, the year end slow down may just allow the market to take stock and the temptation for some to take advantage of the 2009 recovery may just be too big. The main protagonists of the ‘hold and see it out’ approach have been the banks as they found themselves faced with potentially large numbers of repossessions or debt restructuring. However, just recently there are signs that some banks are seeing a possible exit as values return presenting the opportunity to boost their balance sheets.
We stated several months back that we expected a stuttering recovery with two steps forward and one step back. The general uncertainty, weakness of the economic recovery and twitchy nature of the markets points to this as still being likely. For those who expect a second ‘crash’ we believe this to be unlikely, although we do think the pace of recovery for the broad UK housing market will slow significantly and possibly reverse for a period. We end the year with our rental portfolio 100% let and rents having recovered by around 5% since the beginning of the year and the frustration of not being able to satisfy the enquiries that we are receiving on a daily basis.
There seems to be a growing consensus that prices may slip back in early 2010. If this proves to be the case, we are likely to see buyer appetite fall away and a few more sellers as they become nervous of missing out on 2009’s unexpected rally. The next 6-18 months are likely to be very eventful and we think the smart investor should be poised. Whilst there may be a consensus for a near term price correction, there is also a consensus amongst leading market commentators of a London led recovery leading to very substantial uplifts in value by 2014/2016.
Savills Research latest Prime Central London predictions are;
2010 -1%
2011 7%
2012 11%
As value seekers, we look forward to exploiting weakness in the market and taking advantage as the pendulum swings back in the buyer’s favour.
Herewith example target acquisition opportunities;
Drayton Gardens, SW10 Target Price £2.25m Asking price n/a
Repossession
Part of a portfolio of 6 very high specification new refurbishments that are being sold by a bank in repossession. Although the portfolio is being offered as one lump (guide price circa £11.5m) this is the best unit and we believe could be acquired separately. It is a very large 2 bedroom penthouse extending to 2,268 sq ft. The bank’s loan is £2.437m and our open market value around £2.75m with agents stating £2.9m. Rental value circa £1,800pw (4% gross).
Eaton Place, SW1 Target price £1.95m Asking price n/a
Repossession
A very beautiful garden flat extending to 1,942 sq ft. Part of the same portfolio. This is a large 2 bed apartment with pretty outside areas. The bank’s loan is £2.5m and our open market value around £2.45m with agents stating £2.75m . The expected rental would be £1,400pw (3.75% gross)
Bayswater, W2 Target Price £1.35m Asking price £1.575m
Development
A very interesting opportunity to acquire a sixth floor apartment with direct, south facing views over Hyde Park. The property is currently un-modernised offering 2 beds, 2 reception rooms and one bathroom. At a cost of around £350k it would offer three beds, 2 baths and one double reception room. The building is circa 1950’s and there are current plans to totally reface it and upgrade the common areas, in our view this would give a 10-15% uplift in value on all flats. Projected end value, supported by a bank valuation on another of our projects nearby, would be £2m.
Iverna Gardens, W8 Target price 1.175m Asking price £1.25m
Porter & Parking
A perfect London base. A 1970’s block facing a small garden to the south of Kensington High Street.. This well run building has a porter, underground parking and well proportioned rooms. The 2 bed, 2 bath flat is just over 1,000sq ft.
Flood Street, SW3 Target Price £3.2m Asking price £3.7m
Development
Located in ‘old Chelsea’ near Cheyne Walk, this is a truly rare opportunity to combine two apartments (both circa 1,420 sq ft) built originally as artist’s studios. Plans have been approved to create a 5 bedroom apartment with part double volume ceiling heights. An incoming buyer may opt for less rooms but greater overall volume. Parking is available behind the block. Projected end value £5.5m.
Hyde Park Gardens, W2 Target price £2.2M Asking Price £2.25m
Probate
A large 3 to 4 bedroom apartment (1,800 sq ft) with direct views towards Hyde Park. Off street parking on a first come basis and resident porter. The property requires total refurbishment at around £475,000. Within the past few weeks a similar flat, newly refurbished, received an offer at £1,700 psf placing a value on this better positioned flat of £3m newly refurbished.
Monmouth Road, W2 Target price £4.35 - £4.5M Asking Price £4.95m
Looking for swift exit
A development of 10 apartments just off the very popular Westbourne Grove. Five have been sold off at prices averaging £1,050psf. The remaining five on first, ground & lower floors are all refurbished to a very high standard and the target price equates nearer to £750psf. The properties are fully let on AST’s producing an income of £195,744pa. The target purchase price would show a NET yield at around 3.5% and a conservative 20% discount on open market value with vacant possession.
Queensgate Place, SW7 Target Price £1.4m Asking Price n/a
Buyer in default
A 3rd & 4th floor maisonette, entered on 2nd floor but no lift, in good order. Buyer exchanged privately and unable to complete (introducer’s fee required). Opportunity to acquire contract at £1.4m showing a purchase price equating to £750psf in prime address. Nearby No 3, Queensgate Place has been completely refurbished as 5 high spec units (with lift) with average asking prices of £1,800 psf.
Making the distinction between market sectors.
It is hard not to discuss property prices in broad generalizations. After all, the indices that the markets rely on (Halifax, Nationwide, Land Registry etc.) do just that. We continue to draw the distinction between prime central London and the broad UK housing market. Whilst the two are obviously interdependent, the former is driven increasingly by inflows of foreign investment and London’s status as an International City. Rather than being reliant simply on house price to earnings ratios, availability of mortgage products etc. prime central London’s performance is linked more to the global economy and influenced by sterling’s relative value to other leading currencies.
But even prime central London should not be summed up in a few sentences. There are variations and trends which , if well spotted, can offer investors superior returns. In the past we have got this spot on as we picked up on growing trends. One example of seeing a change in the market was in the late 1990’s when we advised on buying in mansion blocks. Traditionally seen as the choice of old people (usually having sold their 5 story house and moving to one floor accommodation) and ignored by American tenants, we recognized the growing European influence and their desire to find lateral space and accommodation similar to the grand apartments of Paris, Milan or Madrid. This was then taken to the next level as developers turned away from simply maximizing the number of units in their schemes and started creating large lateral space to satisfy the fast growing demand.
A different type of opportunity was presented earlier this year when we highlighted the family house market within the school catchment areas in South London (Battersea, Wandsworth). These areas were initially hit hardest by the city fall out and prices fell by 40%. Unlike more central London, there was reasonable choice and availability in the spring and early summer. In recent years the area had started to attract many Europeans since the introduction of the international schools. By late summer the market was fast recovering and today the prices have nearly recovered completely.
One of the specific areas we would highlight is described below;
FOCUS ON MARYLEBONE
W1 lies at London’s very heart and is dissected in the middle by Oxford Street. To say that the area to the south, Mayfair, overshadows the area to the north is a huge understatement. Mayfair is on par with Knightsbridge and Belgravia as one of London’s pre-eminent addresses. Mayfair of all London’s districts has the Monopoly board kudos. In recent times the growth in boutique banking and the Hedge fund industry has seen Mayfair achieve the highest commercial rents and its limited supply of residential property achieve leading market prices per square foot. The sale of the American Naval Headquarters next to the American Embassy, puts values on par with the top end developments in Knightsbridge which hit over £5,000 psf in 2007.
Just a short stroll from Grosvenor Square, having crossed the manic tide of humanity on Oxford Street, lies an area traditionally known by agents simply as ‘north of Oxford Street’. It’s historical lack of identity avoiding even an estate agents attempt to apply the usual catchy term like Connaught Village in nearby Bayswater or Fitzrovia, the area around Fitzroy Square to the east. Like Mayfair where the freeholds are largely owned by the Grosvenor estate, the area north of Oxford Street is largely owned by two old family estates, the Portman and Howard de Walden Estates. Like Mayfair again, the area is one of mixed commercial, residential and retail with a few clubs, galleries and buildings of historical note and the odd small patch of greenery plus one main square at its heart (Portman in the case of Marylebone and Grosvenor in Mayfair).
About 10 years ago, the Howard de Walden Estate devised a masterful concept for the area of Marylebone which forms the eastern half of ‘north of Oxford Street’. This area was previously known as London’s medical heartland but the de Walden Estate wanted to breath a bit of life in to the area and encourage long term residents. They devised a plan for Marylebone High Street that gave preference to independent retailers and specialist shops. The result was a mix more reminiscent of an Oxfordshire town than yet another street of shops near Oxford Street. The high street offered a specialist butcher, fromagerie, fish monger, independently owned restaurants, a weekend farmers market etc. All of a sudden everyone wanted to shop in ‘Marylebone Village’ (coined by agents!) and then this changed to wanting to live close by.
A similar thing has happened south of the river around Southwark and Shad Thames with Borough Market becoming so firmly established. They used to say an area goes up market when a Waitrose opens up (Marylebone has a Waitrose as one of its few big names!) but it seems that specialist food markets are the big draw. The person behind the Marylebone concept was later poached by the Cadogan Estate and a similar sort of idea has been introduced to the Duke of Yorks area by the Saatchi Gallery off the Kings Road,
The result of course has been sharply rising property prices. There has more recently been a ripple effect which has resulted in prices rising on the neighbouring Portman Estate. However, those in the know realize that there is a distinction and Marylebone has fast established itself as a niche area that offers all that Mayfair offers but with better local facilities. With a more balanced mix of local and foreign owners and the residential feel over shadowing the commercial element, this is an area which is fast adjusting to its historical 30% price discount against its rich neighbor a few hundred yards to the other side of Oxford Street. Whereas the area to the east of Marylebone, Fitzrovia, is seen as another part of London that has huge potential (close proximity to Eurotunnel, Crossrail etc.) the Portman Estates western boundary is the Edgware Road and despite Tony Blair’s desire to live just off, the Edgware Road sucks the value out of property the closer you are to it.
There is one final reason why we pick Marylebone as an excellent area for investment. Just like Mayfair, its mix of commercial and residential means that the supply is very restricted and this makes it extremely challenging to find opportunities. However, as an investment rationale, looking where supply is tight and demand fast growing is as good an approach as any for making money and who ever said making money is easy!
The following are a few example transactions this year in Marylebone with comparisons from Mayfair sales through the year;
Wimpole Street, W1 Purchase price £1.541m End value @ £1,450 psf (after refurbishment)
Refurbishment opportunity
A double aspect first floor flat on the corner Wimpole Street and Weymouth Street, close to Marylebone High Street. The building was redeveloped 10 years ago and they had retained the original Georgian facade but configured this flat in a less than optimal way. Our plan was to reverse the existing layout by moving the living room back to where it would have been creating a kitchen/dining and three bedrooms and 2 bathrooms. The flat is 1,367 sq ft and was on the market for £1.795M.
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