Sunday Supplement 06/12/2020

by Dec 6, 2020

Sunday is here and that means the supplement!

I’ve promised to talk a bit about why pricing has done what it has done this year in the UK market and it is always useful to learn lessons from past events – but we also always need to remember that past performance is no guarantee of future performance!

The first point to make is the gap between price and value. This exists in everything that we buy. Whether we think about this consciously or unconsciously. In the ideal world we would always buy things below their value to us, and all pricing of things we buy would therefore be BMV! This doesn’t necessarily happen in reality but this is our aim as consumers and economic agents.

Price and value have slightly different implications in property. Ultimately there is one record of price that is robust and well maintained (not perfect, but not bad) for properties in the UK. That is the land registry.

The land registry tells us that prices dropped 15% in 2008-9 for example. This is a factual number, although many who remember it will remember figures of 25-40% being bandied around and indeed some stock halved in price. Price was a bit more manipulatable at the time – for example, many new build flats transacted at 100k but in reality cost the purchasers 85k as they got a gifted deposit from the developer. However, when sold in 2010-11 these flats may well have traded at 50-55k, giving a nominal loss of 45-50%, with the real loss being a fair amount lower (but still significant!!).

So we need to be aware of these anomalies. The transactions are a lot “cleaner” these days with much less “creative” activity around than back then.

So that’s the price. But what’s the value? Or perhaps the better question, what’s the RELEVANT value?

This is where subjectivity creeps in. What a property is worth to one person is different to what it is worth to another.

Some would say it is the value a RICS surveyor places on it. In Scotland, the home report system gives us that number up front. Very rarely does a property sell bang on the home report value and as such that demonstrates for us this gap that I am talking about.

Some would say it is the value that you place on it.

This is where the BMV acronym gets people animated. RICS will, by the book, maintain that something is worth what you pay for it, but they also recognise that there is an open market value, a 180 day value, a 90 day value, a 4 or 6 week value, and a genuine fire sale value (7-14 days). These numbers aren’t the same for obvious reasons and so this also demonstrates a gap.

From a technical perspective, if you operate a variant of the BRR model then you are attempting to arbitrage the situation by buying below value (or at the 4 week or 7 day price), improve or optimise the property and then put in for a revaluation at the full market value. BRR 101!

In volatile years (like 08-09) that gap between price and value, across the market, becomes pronounced. That’s what has happened in 2020.

In an average year, as discussed above, whilst properties rarely trade bang on the value they are not far off and in aggregate, as a market, the price-value gap is limited. In volatile years it becomes pronounced.

Markets are often driven nearly completely by sentiment but this year has offered more opportunities than many for people to make genuine mistakes, because we have not just had a LOT of sentiment and emotion, we’ve also had logistical challenges to markets with lockdowns, slow conveyancing, and mortgage lenders retracting offers after their issue.

Let’s just think about a few of those:

  • Panic and disruption in April leading to an incredibly low number of transactions completing. Was it even legal for people to move house? Did they know? Etc.
  • Pent up demand from years before as uncertainty has reigned since the 2016 referendum.
  • And then – the other end – stamp duty holiday offering a rare opportunity to move without some of the usual frictional costs. Take away frictional costs and you see an uptick in market activity, basic economics.

The end result looks like transactions only down about 6% YOY which is incredible. And there must be a slice of the market who would have participated but have postponed because of Covid. How big we can only guess. But that provides some pent up demand for 2021.

Back to value and price and their part. If you had asked 100 experts in April 2020 the numbers coming back for the property market this year would have been -10 to -15%, I would say. From surveys done at the time, and bulletins from the larger property players.

That would have represented the value gap at the time. That will have led to a small percentage of deals going through at those lower values or near to that, and a lot of transactions falling over or being deferred.

Post SDLT holiday it has gone the other way and RICS have had to be satisfied with “noting” covid rather than using it to downvalue (as a whole), reacting to the market.

I expect there to be events in 2021 which means the price/value gap will rear its head again. Stamp duty post 31st March is an obvious one. Unemployment is a harder one to “see” but it is a recognised drag on prices.

Housing starts are also massively down for obvious logistical reasons and investors hate uncertainty remember. This does impact supply as we miss targets (but in a big way) just like we do every year as a nation!

When these gaps occur there is opportunity. If selling you need to be very strategic and also a bit lucky – but also remember that quality always sells in any market. Never has there been a better time to invest in presenting properties for sale properly.

Up markets are the easiest, but down markets are also relatively easy to deal with. Be well leveraged in a stable way on fixed rates is a great piece of protection. That price/value gap barely matters to you if you are long-term holding and don’t have LTV covenants in your loans. As long as it comes back!

Initial predictions on the back of these supposed falls were a massive rebound in 2021-22. This is now invalid because there is no “mean reversion” expected.

I’ll finish with one thought or possible rational reason for price rises at the lower end of the market.

The risk free rate of return (the base rate) has been torpedoed to a genuine zero. We have seen 10 year bonds sell this year at a negative return. That’s right – you pay the government to look after your money! Why do institutions do this? There are legitimate reasons.

When returns are zeroed then anything with a positive return becomes more valuable. Yield multipliers on good covenants (and that’s a challenge in itself) mean that commercial values go UP! In terms of retail, this isn’t the case because there are very few good covenants out there (although there are some).

Lower end higher yielding properties are like this. We’ve long battled 0.5 and 1% returns in the banks with limp inflation. The next 2 years look like higher inflation at some point and 0.01 in the banks. This forces some people into action because those returns will not preserve wealth or allow savers to live off income – they are forced to live off capital.

This supports property as a comparatively safe haven investment class. So it makes sense at the lower end (all else being equal, which of course it isnt) for prices to rise when interest rates are totally flattened.

So it isn’t all madness! One of the joys of property is how slow the market is to react to events so when you see opportunities you get a decent wedge of time to do something about them. 2021 will favour the strategic, the brave and the smart. Be well researched, don’t be emotional, get the legwork in and you will be fine. Don’t overleverage. Defend mostly but attack at the right times and 2021 will be a good year, regardless of what the market does.

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