A sea change from across the Atlantic?

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North America is leading the way once again, with the exceptional communicator and statesman Barack Obama safely installed in the hot seat for a second term.

Having led (i.e. caused!) the credit crunch, the US is making the most of its relative safe haven advantage and utilising the depth and diversity of its funding markets to great effect. This in turn has provided good real estate investors with more funding options through corporate bond issuances, plus loans from insurance companies as well as banks. DTZ boldly stated last autumn that, as a result, there was no funding gap in the US. In consequence, acquisitive US Private Equity funds such as Blackstone have begun mopping up bargains all over the world. Over the last year, domestic unemployment has decreased from 8.3% in January to 7.7%, homebuilder sentiment has risen to its highest level since 2006, and prices are up by about 17%.

Just as significantly, DTZ also said they expected the UK’s real estate funding gap to be all but eliminated by 2014, with equivalent funding lines to those active in the US recently tested and expected to expand significantly in the months ahead.

In the Eurozone, meanwhile, DTZ expect the funding gap to remain outstanding for some years. Even so, it looks promising that the crisis is taking a course “less bad” than most had expected  -much to the credit of (ex-Goldman Sachs) Mario Draghi, President of the European Central Bank and FT Person of the Year 2012. Draghi’s promise to “do whatever it takes” seems to be working.

As a result, the recovery of Greek Bonds has proven to be the hedge fund play of 2012. And if the Spanish government finally requested a Euro bailout, the country’s banks only required half the expected £100bn. The great exception of course is France, where policy makers seem to be doing their utmost to dismantle the economy (to the benefit of London). Economic disaster looks increasingly likely as wealth creators jump ship before they are pushed or even have their ships confiscated (as with Arcelor Mittal)!

Returning to the outlook for the UK, Mike Carney (notably also ex-Goldman Sachs) has been recruited as the new Governor of the Bank of England. He is widely considered to be one of the top two central bankers in the world, which is quite a coup for George Osbourne. Carney is generally expected to promote higher growth and employment, with interest rates staying lower for longer at the price of higher inflation.

This should be good news for investors like Inspired who concentrate on “real assets”, as values and incomes increase while debt as a proportion of value diminishes.

It is likely to encourage greater risk taking by investors who need to find higher returns in order to protect their capital, which will be at greater risk of erosion from inflation – currently standing at 2.7% and remaining stubbornly above the 2% target. Again, this represents good news for opportunistic investors like us: competition for assets may make it harder to buy cheaply, but there should still be plenty to go around as the US funds that bought loans in 2012 take action and make their margin by offloading in 2013. Additionally, our existing assets are all located in Inner London and should benefit from an increase in value, while capital should become easier and cheaper to raise.

I firmly believe that more risk taking (within reason) is a good thing generally: fear has a corrosive rippling effect through morale and into trust, investment and employment and has in itself become the greatest threat to our future wellbeing and prosperity. A more confident approach, as we’re beginning to see in the US, may just offer the perfect antidote.


Smiles all around

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Star JP Morgan real estate analyst Harm Meijer and his team recently published their 2013 forecasts – and they made for very encouraging reading.

The key message underlined the strong capital flows into markets and the belief that we are entering bubble territory for prime real estate in core Western European countries, which will prompt investors to move up the risk curve and invest in secondary assets.
Experienced management teams will be able to raise capital cheaply. To illustrate the point, almost 90% of listed property management teams (as surveyed by JP Morgan) expect capital raisings in the sector over the coming months.

The report also specifically highlighted London in stating:

“The ‘London is booming theme’ will carry on next year and we expect John Burns, CEO of Derwent London, to say at our conference in January again: ‘I can’t say it is bad, when it is good’.”

Shaftesbury too recently affirmed that London is more vibrant than ever.

“And we agree with that. The interest rate for London itself is too low. Valuations will rise further, but we believe there will be more talk about property values, after those have further surprised on the upside, and the coming residential boom in 2013.”

That sounds good to me and we share the sentiment.


Inspired is delighted to have acquired 19 sites during 2012. These will ultimately produce some 84 units of mostly residential accommodation in Inner London (typically Zone 2) locations and will be worth a total in excess of £20m on completion, with margins on cost typically exceeding 50% and in some cases even 100%+.

Such impressive returns are the result of a bold contrarian approach in a nervous market, not to mention an awful lot of very hard work. We couldn’t have achieved it all without the help of the people we have had the privilege of working with over the past year including friends, family, investors, lenders, professional advisers, and our Inspired team.

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Our objective has always been to establish an efficient business in which we and all our stakeholders would benefit. 2012 was the year we could truly say we succeeded in that aim.

I have absolutely no doubt that we will do even better this year and look forward to working both harder and smarter to achieve the best possible results. After all, it’s not really work when you’re having so much fun, is it?!

Notes from the Ernst and Young EMEIA Real Estate Workshop

Ernst & Young EMEIA Real Estate Workshop

Here are my notes from the excellent E&Y Workshop I attended recently.

Bid-ask spreads narrowing
Transaction levels rising

Sir John Gieve (former Deputy Governor of the BOE)
The uncertainty is still there because:
Economic forecasting models are broken
Prediction: big swings in market sentiment & lots of volatility in the markets Currently fiscal (spending) and macro-prudential (regulation) brakes on while the monetary (interest rates, QE) accelerator is firmly on Expectation that private sector investment, consumer spending and emerging market growth will pull the UK towards around 2% GDP growth in 2011 MPC likely to be cautious about raising rates early in 2011 but if growth continues throughout the year then rates could rise faster than the market currently expects (to somewhere between 3-7%) Emerging market economies in particular the Chinese likely to lead to a big inflationary boom that spreads to the West through commodity prices

Adrian Cooper (CEO, Oxford Economics & ITEM club advisor)
World GDP growth is outstripping already relatively bullish forecasts North and South Europe dramatic divergence in growth and prospects German competitiveness has improved significantly over last 10 years whereas southern European states have become significantly les competitive as labour costs have risen Fiscal tightening and divergence in investment will also hold back the Southern economies for a prolonged period c50% chance of Greek debt restructuring and/or smaller chance of some form of Eurozone breakup Other notable risks include oil and commodity inflation and recognition of Spanish debt/losses as a result of their boom time lending to construction In the UK massive switch in govt spending worth around -1% on annual GDP growth Household de-leveraging to hold back growth further Rising exports will help though past failings in exports to emerging economies (Italy exporting more to the BRICS than the UK for example) Modest growth forecast in office-based employment and consumer spending leading to limited demand growth in offices and retail property High single-digit total returns expected for prime commercial property

Macro-Economic Panel
Huge demand from the Middle East for construction and infrastructure but there are major risks around political risks as a result of underinvestment in food, healthcare, education, employment and social stability.
If we can see civil unrest in the UK then we can expect to see unrest in other states as austerity measures start to bite.
US deficit is not expected to be a major threat in the next couple of years but it will be in the longer term – the UK had the same problem when it ran the reserve currency and that held us back for 50 years after the second world war Currency disparities and interventions make life difficult for global Investors seeking to hedge out risks Pension funds slowly increasing allocations to real estate but notably focussing on core assets and focussing increasingly on specific cities rather than whole countries Negative real interest rates could lead to a bubble in some asset values.  Highly leveraged investors even in core assets are at risk from interest rate rises designed to combat high inflation Euro stress tests back in July showed 84 out of 91 banks were well capitalised including the 2 largest Irish banks which are now bailed out.  This will prove a drag on the economic recovery and it will take quite a long time to relieve c50% of maturing real estate debt is underwater and although resulting opportunities are few and far between they are worth looking for

Drivers of Real Estate Panel
Property looks more interesting than bonds but less attractive than equities (Harm Meijer, JPM) Lots of inflows to direct investment funds moving out of bonds (Harm Meijer) JPM are positive on property, more prime but starting to find opportunities in secondary Institutions are currently underweight in property and increasing their allocations.  Increased inflation driving this demand as they look to protect themselves.  Harm Meijer is astonished that they are coming so late to the party Trust issues will endure for years ahead while funds re-align their interests with LP’s and increased co-investments are demanded UK retail funds raised a lot of money in Q1 2010 and 2007 opportunity funds are all sitting on a lot of cash but is there a bubble in prime and super-prime and do return expectations need to come down.
“If you look at what is happening to real estate, it is exactly what happened in 2007 and 2008 when cap rates were plunging and LTV’s were going up without cash flows”. (Starwood Capital Chairman & CEO – Barry Sternlicht) Caveated with in certain prime sectors (Doug Kirkman, Blackstone) It’s probably the best time in living memory to setup a bank because margins are very high and lenders can pick their borrowers and properties.
Existing lenders cannot afford to take the losses on existing loans so they are very limited in their capacity to lend.  Particularly in the UK where there is still no securitisations market in contrast to the US which has begun to close some and is expected to increase this flow.
Insurance companies may increasingly likely to enter the market (Solvency II will encourage them to do so) but it will take them time to build their teams and they are unlikely to buy up existing debt portfolios.
According to Knight Frank 2010 occupier take-up in Financial Services in the UK was actually higher than during the boom years however this is substantially offset due to impending lease expiries and competition from Internet based businesses etc so net absorption and rental growth is likely to be quite limited and generally restricted to prime.
London and Germany are relatively booming whereas regional locations are really struggling.
Supply of product is going to be slow while the clearing prices continue to sit below the holding values and supply of debt is highly restricted and it is likely to take some years before big non-performing loan books really come to market due to political debates around bank break ups etc.
Sustainability – opportunistic investors are less interested in this than price etc however pension funds are pressuring listed owners and occupiers are increasingly expected to demand higher standards.
Increased transaction activity is expected though only by around 10-20% and from a relatively small base.
Banks will have to extend and pretend until deals break and have to be dealt with or they have generated sufficient profits for their capital base to enable them to take losses on existing holdings.

Bank stays hand on new money and holds rate

Good news that interest rates have been held again as expected; not great news that they’re not expanding the Quantitative Easing program although they’re likely to do so after the next inflation report.  IHMO they should be increasing QE and at the same time reducing the tier 1 capital requirements thereby encouraging banks to increase their actual lending rather than just hoarding the cash – this is what China is doing quite effectively – encourage banks to hoard cash in the good times and to lend it to in the difficult times.

Gary Duncan, Economics Editor

“The Bank of England pegged interest rates today for a fourth month in a row and stayed its hand over any other changes in its recession-fighting strategy as it paused for breath in its battle to combat the slump.

The Bank held interest rates again at their existing 315-year low of 0.5 per cent as it weighs the impact of its expanded £125 billion drive to jump-start the economy with massive injections of newly-created money.

The decision by the Bank’s Monetary Policy Committee (MPC) to prolong last month’s “wait and see” stance surprised the City.

Many economists had predicted that the MPC would further extend its quantitative easing (QE) scheme to pump extra money into the economy through huge purchases of government and corporate bonds.

The Bank has already completed purchases of more than £100 billion in bonds under QE, and analysts had expected the MPC to increase spending to the £150 billion maximum authorised by Alistair Darling. Some had predicted that the Bank would seek the Chancellor’s authority for a still higher limit.

The Bank said that it would review the scale of QE at the MPC’s next meeting in August.

Instead, the Bank today fuelled uncertainty over its next move by keeping its policy on hold, and deferring any extension in QE until it completes its next set of quarterly forecasts next month.

The MPC’s verdict will unsettle markets, since it is bound to spark speculation that the Bank may now call an imminent halt to the quantitative easing strategy as signs accumulate that an economic recovery is starting to emerge.

But pressure on the Bank to expand QE still further is likely to persist following grim news last month that the economy suffered an even steeper first quarter slump than was thought, plunging by 2.4 per cent, rather than the 1.9 per cent that was previously estimated.

Despite hopes that conditions have since greatly improved, with a slew of indicators pointing to recovery taking hold, optimism over prospects was dealt a blow this week as manufacturing suffered an unexpected further decline.

Factory output fell by 0.5 per cent in May to a level not seen since 1992. The influential National Institute of Economic and Social Research estimated that this pointed to a further 0.4 per cent drop in GDP in the second quarter. If confirmed in official data due on July 24, that it would dash City hopes that the recession might already have ended last month.

The further expansion of the QE programme will fuel controversy over the policy, however, with critics warning that its results remain disappointing.

Some economists argue that much of the extra cash created under the scheme is being hoarded by banks that remain reluctant to boost lending to businesses and consumers, while another large part of the money is flowing abroad as overseas investors dump holdings of gilts.” (Gary Duncan, The Times) http://business.timesonline.co.uk/tol/business/economics/article6667803.ece

Have house prices finally found their level?

Great article on recent UK house price rises and why falls have bottomed out earlier than expected.

David Smith: Home Economics

How do we interpret the latest house price numbers? The Nationwide says prices rose 0.9% last month, after a 1.3% increase in May. They have now gone up in three of the past four months, and the three-month-on-three-month change is positive for the first time since December 2007.

Caveats apply: Bank of England figures showed mortgage approvals rising but only modestly, and still well below normal levels. Mortgage rationing could put a lid on any further recovery in activity, and the fear remains of a W-shaped graph — where prices rise only to fall back again.

But what if the evidence from the Nationwide and the others means the fall in prices is over? What would that tell us?

Something rather interesting. Markets do not normally adjust in a smooth way — instead they overshoot, in both directions. When house prices have fallen in the past, they have not usually just come down to fair value: they dropped until they became cheap. That is why, if they have stopped falling now, it would mark a break with past housing cycles — possibly because the Bank of England has supported the market by cutting interest rates so aggressively this time.

Everybody agreed houses were overvalued in summer 2007. The question was whether that overvaluation would be worked off slowly — stagnant prices against a backdrop of rising incomes — or suddenly. Thanks to the credit crunch, and the squeeze on mortgage availability, we saw the latter.

Opinions differed on the extent of the overvaluation, but the International Monetary Fund’s estimate that prices were 30% above what was justified by fundamentals was often quoted. Factoring in inflation, we have seen the 23% fall in real terms needed to bring them into line with fundamentals. Other measures, including prices relative to their long-run “real” trend, as measured by the Nationwide, also show they are back in line.

It would be wise to wait to see what happens to mortgage availability over the autumn and winter before concluding that prices have stopped falling. Some say an overshoot on the way down is required to lure cautious buyers back into the market. Others are sure the fall is over. We shall see.

– There are further signs of recovery in the country-house market. The agent Knight Frank says the average price of prime country properties in the home counties rose by 0.8% in the second quarter of this year, but it is not just houses near London that have benefited: prices have also risen in the parts of the Cotswolds popular with second-home owners. Overall, prices fell back by 0.9% — but this was considerably less than the 4.7% drop in the first quarter. Prices of houses costing £5m-plus rose by 2.2%.

– Fernhill, in Mountain Ash, north of Cardiff, is the cheapest street in England and Wales, with the average house value just £24,640, according to a survey by Mouseprice.com, the property website. It is followed by Ann Street, in east Middlesbrough (£26,910) and Alpha Street, in Manchester (£28,890). The northwest of England accounts for half of the 20 most affordable streets.” (David Smith, The Sunday Times).  http://property.timesonline.co.uk/tol/life_and_style/property/buying_and_selling/article6632733.ece

How the ECB’s fig leaf has completely withered away

Another great article by Anatole Kaletsky confirming the superiority of the UK & US fiscal approaches (over the ECB) to resolving the financial crisis.  The UK and US will emerge much stronger than the broader EU and interest rates are likely to remain low for longer than people expect (which is good for residential property in particular):

“Now that the global recession appears to have passed its low point, panicmongers in the media and financial markets are shifting their attention from deflation to inflation — and especially to the debasement of the dollar by the money-printing operations of the US Federal Reserve. Whether printing money necessarily always leads to inflation is a long-running theoretical debate which the economics profession shows no sign of resolving, there is a factual question related to this argument that is much more important and straightforward, yet completely misunderstood. Leaving aside the question of whether it is a good or a bad idea to print money, which of the world’s leading central banks is printing money faster: the Fed or the European Central Bank?

Last Wednesday, the European Central Bank injected €442 billion (£377 billion) of new cash into the euro money markets. This was the biggest long-term lending operation in the history of central banking and was equivalent to half the Fed’s entire monetary expansion in the past 18 months. Yet most people still believe that the Fed (along with the Bank of England) is engaged in a “reckless” experiment with inflationary quantitative easing (QE), while the ECB is steadfastly honouring the deflationist traditions of the Bundesbank’s “steady hand”.

The ECB Council debated for months about QE, the modern equivalent of “printing money”, since it involves the central bank creating money out of thin air by signing computer-generated promissory notes and then distributing these around the commercial banking system by using them to buy up government bonds. In the end, the ECB decided to print only €80 billion to buy on private sector bank bonds, in contrast to the $1 trillion (£606 billion) of bond purchases undertaken by the Fed. And even this trifling monetary expansion was ferociously attacked by Angela Merkel for threatening Europe’s inflation outlook and jeopardising the credit of the ECB.

However, if we look at the facts, the transatlantic difference is less clear. In fact, the ECB is printing money even faster than the Fed is.

It is also supporting fiscal policy more explicitly through debt monetisation and taking much bigger risks with its credibility and solvency. The first point is illustrated in the chart. Since mid-2007, central banks have expanded their total liabilities (the broadest definition of what it means to print money in the modern world) by $1.2 trillion in the US and by $1.5 trilllion in euroland. Given that GDP is 12 per cent bigger in the US than in the eurozone, this means that the ECB’s printing presses have actually been running 50 per cent faster than the Fed’s. Someone should point this out to Mrs Merkel: since the ECB presses were presumably made in Germany, it would give her something else to boast about.

Meanwhile, we can move on to a second surprising comparison between the European and US central banks: their willingness to monetise government debts.

Having established that the scale of the money-printing operation has actually been bigger in Europe than in America, the next step is to compare the methods used by the Fed and the ECB to achieve these expansions. On this point, consensus opinion is even clearer: the ECB is almost universally seen as more “prudent” in the way it has expanded its balance sheet. The Fed has been buying government and agency bonds outright, thereby exposing itself to the risk of capital losses from rising interest rates, which in turn could potentially constrain its future monetary decisions. Even worse, the Fed’s willingness to buy Treasury bonds, at a time when the US Government’s deficits are exploding, means that it has taken the first step down the primrose path of debt monetisation that leads ultimately to Zimbabwe and Weimar. The ECB, by contrast, has not weakened its balance sheet with long-maturity bonds and dubious corporate assets and, most importantly, it has refused to buy government bonds or engage in debt monetisation.

This is the conventional wisdom, but again consider the facts. It is certainly true that the ECB has expanded its balance sheet almost entirely by lending money to the euro-area banks, while the Fed’s new lending has mostly been to the US Government and agencies. But does this really mean that the Fed has taken greater risks than the ECB or done more to facilitate profligate public borrowing? The answer to the question is a clear “no”. The ECB’s loans to eurozone banks at the latest count stood at $1.5 trillion — before accounting for last week’s €442 billion bonanza. Are these loans really as safe, or even safer, than the Fed’s $1.7 trillion of US Treasury and agency bonds? According to ECB apologists, its loans to the banks are completely safe because they are secured by collateral that can be sold if the borrowers default. But this reassuring claim disregards the massive reduction in the quality of collateral that the ECB has been accepting since the start of the credit crunch.

Unlike the Fed and the Bank of England, which only accept AAA public bonds as collateral for their lending operations, the ECB now lends against low-rated mortgage bonds, commercial loan books and other dubious assets that the markets would treat as “toxic” were it not for the ECB’s willingness to turn them into instant cash. The ECB has been praised for the boldness with which it has set aside the traditional rules of central banking in the crisis — and this is perfectly justifiable, but the ECB’s apologists cannot have it both ways. Those who praise the ECB for its “imaginative” response to the crisis must also acknowledge that it has accepted much greater credit risks than the Fed. Which brings us to the question of financing public debts.

The Fed has “monetised” roughly $1 trillion of US Government debt since 2007, if we combine its Treasury and agency bond buying. Meanwhile, the ECB has lent $1.5 trillion to the euro-area banks. But what have the euroland banks done with this new money? They have lent most of it straight to their governments. Indeed, the governments in Ireland, Greece, Portugal, Spain and Austria would long-since have gone bust had it not been for the willingness of the commercial banks in these struggling economies to buy unlimited quantities of government bonds with money borrowed from the ECB. And these bond purchases have, in turn, been used as collateral for more ECB borrowings, which could be used to buy more government bonds.

In effect, therefore, the ECB has been lending money by the shed-load to governments, with commercial banks acting merely as a fig leaf for what would otherwise be seen as a blatant monetisation of the most insolvent European countries’ public debt. In normal circumstances, this fig leaf might at least have theoretically protected the virginal purity of the ECB by interposing the commercial banks’ own balance sheets between the government borrowers and the ECB.

In normal circumstances, if the Greek Government defaulted, damaging the collateral deposited by Greek banks at the ECB, the losses would fall on the Greek banks, rather than the ECB, since commercial banks remain the beneficial owners of the collateral they deposit. But in today’s conditions, this Maginot Line between the credit problems of European governments and the ECB’s balance sheet is a joke, since the Greek, Irish and Spanish banks queuing up for ECB funding are near-insolvent and would certainly be insolvent were it not for the limitless supply of money they are getting, in exchange for dubious collateral, from the ECB itself. In short, the commercial bank intermediaries interposed between the ECB printing presses and European governments’ borrowings should not even be described as a fig leaf — more like the climactic G-string in the world’s most expensive strip show.” (Anatole Kaletsky, The Times).  http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article6597813.ece