Once upon a time there was a marketplace called UK Property, which was a wonder to behold.
There was so much money around — and not only from the Citizens of the United Kingdom. There were also very wealthy sovereign ‘Kings and Queens’ from all around the world who wanted a safe pot to store their money. The pot was made even more plentiful by other very rich individuals from far-flung realms managing their own ‘Greek tragedies’ and seeking peace of mind, and further fuelled by an abundance of lenders very excited by the Old Lady of Threadneedle Street, who was sweetly promising she would keep her interest rates low until kingdom come.
Because there was such an abundance of money and not enough properties to buy, the wise investors kept on paying more money for properties, which also meant that properties outside of Londinium were becoming far more treasured. And so the garden was rosy… until the pollsters predicted the end of the world was nigh as the Pretender ‘Ed the Red Ogre’ was about to take control. Fortunately, he was vanquished by the Prince ‘Pro-biz Dave’ and all was well again in the United Kingdom… unless, that is, Princess ‘Nicola the Surgeon’ manages to scythe us apart.
So, will our fairytale continue, or is it a case of the emperor’s new clothes? The reality lies somewhere between the two, I suspect.
What we can say with certainty is that our market is cyclical and while elements of each cycle may be recognisable, the concoction of the elements of each new cycle will result in unpredictable consequences. There is, however, no question that we are in a new and topsy-turvy investment environment. And this is unlikely to change very soon as deflationary fears predicate continued QE and the face of banking evolves under the fintech revolution. This all points to the continued availability of cheap money, making property look very attractive relative to other asset classes.
Why invest in government gilts, Nestlé bonds or deposit cash in banks for negative returns when you can have exposure to those very same ‘tenants’ but yielding a 350-600 bps margin that more than makes up for liquidity?
These dynamics will abet further yield compression of commercial stock. Residential prices impact materially on sentiment and will continue to rise as lack of supply combined with historically low interest rates means that, assuming a deposit can be cobbled together, mortgage repayments are a fraction of what the rent might otherwise be.
But what about the flip side? It is easy to see why residential prices are rising, but what about affordability? When interest rates rise, however far off that might be, a 1% or 2% increase in rates could represent a 50%-100% increase in repayments and wage inflation certainly is not going to cover that. On the commercial side, is there sufficient sustainable tenant demand and rental growth to justify the capital growth that we are witnessing?
We are inflating an asset bubble but when will it be in danger of popping? If I knew that I wouldn’t be writing this column, but for my colleagues’ enjoyment when I get it wrong, I guess we have another 18-24 months before some geopolitical or broader banking issue blows up, demanding a reassessment of investors’ perceptions of risk and how they price it.
While there are signs of this, we are also just seeing indicators of real wage growth, which is a key component in deflating any bubble. Regardless, there are always buying opportunities. So be well advised on what to buy, what to sell, and what to hold because if you can get that right the chances are you will live happily ever after.
Daniel Mendoza is a director of Ereira Mendoza & Co