UK Property Price Declines – Rational or Overdone?
A couple of weeks after Brexit, and the world has not ended. Indeed, in the UK the fallout seems relatively tame. Sterling has weakened substantially, which will increase UK inflation relative to global inflation; but it will also help UK growth relative to global growth. That’s not a bad tradeoff, compared to predictions of the end-of-days. Although I am not so sure I like the tradeoff from Europe’s perspective…
There are a number of UK property funds that have been gated – but this appears to be not so much a Reserve Fund moment, and certainly not a Lehman moment, but just a natural reaction when a fund gives broader liquidity terms than the market for the underlying securities offers.
I think the property panic is probably overdone. It is partly triggered by fears that the financial center is going to leave London. This strikes me as absurd, having worked for several of the institutions that have offices in Canary Wharf. I checked my gut reaction with a friend who actually headed up a large banking institution for a time. His answer was “you are right to be very skeptical: English, availability of workforce, taxation, labor laws, contract law and legal framework. There will be some shifting at the margin but that’s it.” Brittania is not about to sink beneath the waves, folks.
Were UK property values overinflated? At least UK home prices don’t appear much more out-of-whack than US home prices do. The chart below (source: Bloomberg) shows the UK national average home price from the Nationwide Building Society (in white) versus the US median existing home sales price.
The picture looks more concerning if, instead of median home sales, you use the Case-Shiller Home Price Index as a comparison (see chart, source: Bloomberg). But while the CS20 is a superior measure of home prices, I’m always a bit wary of comparing two series that are constructed methodologically very differently. Still, this comparison would suggest UK prices have risen more than their US counterparts.
These comparisons are all on residential property, and I am comparing two markets which are likely both a bit overheated. But the scale of decline in the UK property funds seems to me to be too large relative to the overpricing that may exist, and I suspect it is more due (as I noted above) to the structure of the funds holding the property – which would suggest, in turn, that halting redemptions is the right thing to do to protect existing investors who would be disadvantaged if the portfolio was liquidated into a market that is not designed to have daily liquidity. Of course, the right answer is to not offer those liquidity terms in the first place…
One little niggling detail, however, deserves mention. I noted that UK home prices do not appear terribly out-of-whack relative to US home prices. The problem is that US home prices themselves appear out-of-whack by roughly 15-20%. The chart below (source: Bloomberg; Enduring Investments calculations and estimates) shows median home prices as a multiple of median incomes. What is apparent is that for many years these two series moved in lock-step, until the bubble; the popping of the bubble sent everything back to “normal” but we’re back to looking bubbly.
That said, I don’t believe the current drop in listed UK property funds is a rational response to correcting bubble pricing, and it’s probably a good opportunity for cool-headed investors…and, more to the point, cool-headed investors who aren’t expecting to liquidate investments overnight.
Leave a Reply to TWCancel reply
1. “Bubble” is in London property, not UK property. As with NY, lots of extenuating factors (e.g. dirty money and lax regulations on laundering money via property).
2. Property funds that have suspended redemptions seem to be commerical property rather than residential.
Yes, but it’s REALLY hard with those extenuating circumstances to assess fair value. As for commercial, you’re right and I made sure I pointed out I was dealing with home prices because that’s where the data is. But commercial and resi prices don’t tend to diverge too dramatically (at least in the US).
London is always a special case, but I still think the main problem here is having short-term redemption windows on illiquid redemption portfolios!
I think it is too early to tell. Face with much uncertainty over what Brexit actually means, and for most likely many months, volatility will stay high and sentiment fragile.
In such an environment, many investors are on the sidelines. Pulling your capital where it’s not committed makes sense. You’re not missing out and there are some scenarios where you’d rather have capital available.
These funds do remind me of 2007/2008. Products marketed as liquid or short dated where the underlying is illiquid / longer dated. Rings a bell? The magnitude of that issue is far less than back then (as far as I know). But I wouldn’t underestimate the effect to overall sentiment. When fear cripples in, there is trouble ahead.
As far as relocating the city, I think most media are way too black and white. Yes, moving it anywhere is unlikely. But, in some scenarios of Brexit, could it lose a significant proportion of businesses? Absolutely. It’s not gloom and doom. But could very much be gloom.
Last point. Global markets are fragile. When volatility kicks in and stays, any weak point could be hit. And it’s summer… Historically not a period as calm as we all wish it was…
It’s true that it makes sense to pull your capital; just not sure that it ever made sense to LET them pull their capital! Moreover, I continue to think that worried investors should have pulled their capital BEFORE the 50-50 vote (see my column evoking the Kelly Criterion). But it’s rational in the sense that cash balances should have a higher salience now. My suspicion is that people exaggerate that salience, however.
It is certainly possible that in some scenarios of Brexit, the UK is deeply damaged. But it’s also possible that she might be hit by an asteroid. 🙂 The scenarios that cause deep damage to Britain but not to the ROW seem to me to be more likely than being hit by an asteroid, but lots less likely than the possibility that some businesses might move TO Britain, with its weak currency…it has been pointed out, for example, that the UK is something like the #3 export market for Germany. Hard to see how it benefits anyone to punish the UK too harshly, and absent an outright punishment it’s not clear that anything much changes after invoking Article 50. (However, global gloom is a reasonable forecast, for lots of reasons unrelated to Brexit).
Of course, I may be completely wrong! And with your final point I absolutely agree: it’s summer, and moreover European banks are weakly capitalized and US banks are not permitted to commit speculative capital, which has diminished their value as market-makers. There’s no volatility-dampening mechanism in the system right now…it reminds me of the early 2000s when the rates market would get really volatile in November and December because of Lehman and Goldman year-ends. Except it’s potentially every day.
Thanks for the comment!