Watch share prices, brace for a bang.
“If something is true, no amount of wishful thinking will change it. – Richard Dawkins
Real estate currently beats any but the riskiest investment classes – doesn’t it? Provided interest rates remain below rental yields, property will remain a safe bet – won’t it? Wishful thinking. This ‘positive yield gap’ rationale holds as much water as reasoning that the equity markets are safe as long as dividend yields lie above interest rates. Between 2007 and 2009, capital values fell 45% and the FTSE 100 by the same amount. The truism that property income outweighs capital risk lies crushed under the debt that brought the house down.
Seeking signals of the next crash? Keep an eye on the FTSE 100. Fine, over 7000 at the time of writing. Act as soon as it begins to drop. The index fell from 6,500 to 5,600 in the year up to the Lehman Brothers collapse in September 2008. Ignore forecasts. “This is a correction, not a crash,” said the late Dennis Turner, then HSBC’s chief economist, in February 2008. Even after the fall of Bear Sterns the following month, the mood remained benign – until Lehman crashed six months later. Not one British forecaster foresaw the depth of the 2008 crash. Stick with watching the FTSE 100 barometer.
No one says ‘hey, the boom starts today’ either. The index soared from 3,500 in March 2009 to 5,400 by that December. Stock bulls quietly returned, their hoofbeats drowned out by the general wailing and gnashing of bankers’ teeth. Traumatised property bears continued to hide in the woods until at least 2011. Watching the moves of those you respect can pay dividends. Patrick Vaughan and the late Raymond Mould paid £74m for One Fleet Place in 2009 and sold the City offices for £112m in 2013. A rare example of bid courage.
Today UK commercial property feels like a faulty four-cylinder engine. The office piston has barely faltered. The retail cylinder is deeply pitted and has lost power. The industrial cylinder has compensated, and total power output is about the same. The fourth cylinder (what you might call ‘the rest’ – medical, student, leisure and so on) chugs along. An example: in the three years to November 2019, British Land’s retail portfolio has fallen by 30% to £4.8bn, a £2bn drop. Segro has seen the value of its wholly owned sheds rise by £4bn to £10bn.
What will of course trigger a crash is a drop in demand for space. In September a persuasive 72-page report called Bubble or Nothing was published by the Jerome Levy Forecasting Center of America, showing what might happen, the proposition being that the size of company assets and liabilities is way too much above income. Little firms with supposedly big assets but real debts are the danger. If their asset values fall, they’ll find income won’t generate enough profit to pay the interest on their debts.
Can anything be done? Not a damn thing. The Levy forecast has been gazing into the corporate crystal ball since 1949. The report is incredibly detailed. “The present cycle is almost certain to end badly,” warns boss David Levy. “Big balance sheets will produce serious financial instability during the next recession.” What does he know? Well, Levy made 500% returns for his investors during the 2007-09 crash, after setting up a fund to invest his and other people’s money where his mouth was. Respect.
If Levy is too recherché, read the signals from the UK’s two biggest REITs. The phrasing of their utterings is agonised over by lawyers, PR staff and investor relations teams, which has the same effect as putting a mute on a trumpet: you strain to pick up the undertones. At their interims in November, Landsec boss Rob Noel talked of “unsettled conditions” and remaining “alert to market risks”. Chris Grigg of British Land said he felt “our focus will remain on thoughtfully progressing our strategy to reduce exposure”.
During the summer of 2006, growing caution was evident in my off-the-record chats with chief executives. I expressed their feelings in a jokey leader in Estates Gazette, imagining a chat between a wary CEO and his financial PR adviser, which ended with the boss saying: “For ten years this business has done nothing but grow. I’ve given the City my blood and all it ever wants is more. Stuff ’em. All the chaps at the dining club think we’ve seen the best of the market. So, it must be true. Mustn’t it?” Wishful thinking that was fulfilled.
When writing a book on the topic in 2012, I asked Landsec’s then boss, Francis Salway, why the company had not overtly warned the market. “We did,” he said, pointing me towards a company statement in November 2006 which talked of “moving to equilibrium conditions” that were likely to “herald the end of yield compression”. A pretty muted warning. Another recession is coming; no one knows when. So why do the investors keep coming?
David Levy comes up with a pretty convincing arguement: “Why are people willing to accept so much risk, even after the painful and highly visible market debacles of recent business? Why do they cycle back into such areas as savings and loans, commercial real estate, corporate equities, mortgage-backed securities, and housing? The main reason is simple: People see no other way to obtain financial returns that are anywhere near their goals and, in the case of many institutional investors, anywhere near their explicit targets.” All is explained.
