The year ahead may still look good for business, but the industry is concerned that George W Bush could preside over a faltering US economy. Overpage, we sound out property heads on the prospects for 2001, while on pp34-35, Anatole Kaletsky argues for a revaluation of the quoted sector
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Prospects for 2001 |
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” Savills’ Aubrey Adams (left) is one of the agents seeing good growth in business income |
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” Offices to be top sector |
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” US-led recession could hit the UK and the property market |
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” Recruitment to be a headache |
Kaletsky on the quoted property sector
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” Property shares suffer only by comparison with equities |
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” A new cycle may be starting, putting balanced investment portfolios back in fashion |
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” The dot.com bubble has burst and the Old Economy is back |
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Could we be Bushwhacked? Agents, developers and investors are starting the new year in a bullish mood, predicting inflation-busting growth for their businesses. Only the spectre of a USrecession, sparked by the fall in hi-tech stocks and the election, is large enough to disturb the UKproperty chiefs. But they hope that the strength of the UKeconomy and blossoming European markets will shield their companies from the worst effects of any USdownturn. The majority of respondents expect their businesses to have a good year and predict that their turnover will increase by substantially more than the rate of inflation. While the UK’s economic growth is predicted to hit 3% at best, most expect to raise their incomesby over 10% this year – although three respondents more cautiously predict 7.5-10% growth and two investors expect lower returns (see chart below). Staff increases required To cope with the extra work generated by expansion, most anticipate increasing their staff numbers by at least 5%, while some expect to take on more than 10%. However, achieving these increases may not be simple. Robert Farnes of CB Hillier Parker is concerned about the shortage of high-calibre staff, and says the difficulty of attracting quality staff is the greatest challenge facing the property service sector. Global firms see mainland Europe as offering the year’s greatest potential growth opportunities. As the potential to earn agency fees in the main UK markets is hampered by a shortage of property, agents are looking abroad for income growth. Investors are also confident that Europe offers high-yielding opportunities. Other respondents predict that outsourcing will show the greatest growth potential this year. Most see offices as the sector that will perform best. Support for industrial, leisure and retail parks was limited, and nobody tipped town-centre retail. Both Aubrey Adams of Savills plc and John Martin of Knight Frank foresee residential property continuing to perform well this year, while GVA Grimley’s Michael Corbett tips both industrial and residential. Against the generally upbeat tone, several respondents raised the spectre of economic uncertainty caused at home by the impending general election and worldwide by a recession in the US. Voicing widely expressed fears, Adams believes that a US hard landing represents the greatest threat to the success of his company. “Growth in Europe will be higher in the US this year, so many firms are happy that Europe can take up the slack. But people in the Far East are very worried about the US situation,” he says. Government interference and stamp duty William Hill of Schroders is one of several respondents who see government interference as a potential threat. He also lists the switch to equities as a challenge to the future of property investment. Nigel Hugill, managing director of Chelsfield, is worried about the future of the investment market following the rise in stamp duty. “It is a real possibility, in the face of the general lack of institutional enthusiasm and no perceived direction in the investment markets, that high transaction costs arising from increased stamp duty will be reflected in increased illiquidity and low transaction volumes.” He believes that the poor performance of mid-range retailers has not only adversely affected investor sentiment towards retail property but towards the market as a whole. Other fund managers are also concerned about the poor performance of property relative to other investments. For agents, there are several areas of concern that represent a challenge to growth prospects this year. The lack of office stock in some key markets threatens to affect agency fees, while the patchy performance of multiple retailers could hold down retail rents and transactions. Doubts over the sustainability of demand from the telecoms sector are also cited as a possible threat to business. Problems with planning A few respondents mentioned the government’s planning policies as cause for concern. The “politicisation” of planning is considered a threat, while planning minister Nick Raynsford’s actions on retail rent reviews are seen by some as an indication of the government’s readiness to adopt causes without considering the long-term consequences. The future of the quoted property sector receives some comment, with several respondents anticipating that the “privatisation” of quoted companies will continue this year. Another continuing trend is likely to be further restructuring of large companies following mergers and acquisitions. This in turn could generate more business for outsourcing specialists. Whatever the problems expected in particular sectors, most agents are aware of the challenge of winning business in a highly competitive marketplace against a background of slowing economic growth.See also Focus, Financial preview, pp47-57, and Management, Predictions for 2001, p68-69 |
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Time to get real Economic commentator Anatole Kaletsky argues that now, after the dot.com craze, investors should be reconsidering property shares In the past few years, the property sector has been something of a Cinderella at the London stock market’s glittering investment ball. A parade of fashionable industries – banks, utilities, phone companies and internet stocks – have enraptured British investors with their gorgeous business forecasts and their sparkling investment performance. The unloved property shares, meanwhile, have been left behind to collect dust. Quoted property companies have, on average, suffered a decline of more than 60% in relation to the FT All-Share index since 1989, even though most property shares have enjoyed a revival this year and underlying asset values have risen steadily for almost a decade. This massive “derating” has needled financial analysts into questioning the fundamental justification of property investment in a way that would have been laughed to scorn a decade ago. Misery Does property deserve a place at all in institutional investment portfolios? Should the quoted property sector simply be put out of its misery and wound up? Economic analysis suggests that the recent, still hesitant, revival of the quoted property sector may in fact mark the start of a fundamentally driven uptrend that could stretch many years or even decades ahead. To see why, it is worth exploring some of the economic reasons for the underperformance of property shares in the 1990s. Why have property shares done significantly less well than underlying asset values since 1998? Why do most property shares now sell at large discounts to their net asset values? Most of the standard explanations seem unpersuasive. There is no evidence, for example, that the management and development skills of property company executives have suddenly deteriorated – still less that these skills have acquired a negative value or been overtaken by the abilities of investment institutions to manage property portfolios themselves. Equally unconvincing is the popular City argument that property companies must be poor investments because of the discounts to net asset value at which they trade. But this is a circular argument: property shares trade at a discount because investors shun them, and investors shun property shares because they trade at a discount. Normal fluctuations In fact, the much-debated fluctuations of discounts (or premium) merely reflect the normal fluctuation of all equity prices relative to their companies’ underlying asset values and earnings prospects. The big difference between property shares and oil, pharmaceutical or telecom shares lies not in the presence of discounts to asset values but in the simple fact that property companies regularly update and quote their net asset values, while industrial and commercial companies do not. As a result, the ever-shifting divergences between market and book values are much more obvious to shareholders and transparent to analysts in the property world. Occam’s Razor suggests a much simpler reason why property shares sometimes trade at a discount to net asset values – and this simple explanation happens to make economic sense. Property shares trade at a discount if and when investors believe (rightly or wrongly) that other stock market sectors will offer much better returns than real estate investment. And property shares will again trade at a premium if and when real estate investment comes back into vogue. This brings us to the heart of the matter. Why is property still so unloved that massive discounts remain the order of the day? What economic developments might bring property back into fashion? Did the recovery which started in April possibly mark a sustainable break in the long downward trend? The key point to note is that a property, like an equity share but unlike a bond, is a “real” asset whose value is derived directly from real economic activity. Housing, retailing, manufacturing and office employment all use property inputs and these activities all generate revenue streams which ultimately determine property values and rents. A property company represents an ownership stake in UK plc in exactly the same way as a diversified portfolio of shares. In the very long term, both property prices and broad equity indexes should rise roughly in line with the growth of Britain’s GDP. In the years since 1989, however, this has not happened. Property shares and underlying asset values have risen more slowly than equity prices and have not kept up with GDP growth. Three major factors have worked against property since the 1989 boom – and all suggest that a cyclical explanation of property’s underperformance is more plausible than a permanent change in the long-term relationship between property, equities and economic growth. ” The decline in inflation is the first factor. Property, because of its foundations in the real economy, is an excellent hedge against inflation but, since the 1980s, inflation hedging has become less important. Property prices have therefore lost the hedging premium they once enjoyed. However, low inflation does not in itself make property a bad investment. What hurts is the process of adjustment from a high inflation to a low inflation environment, since this entails the loss of hedging premium as well as a period of high real interest rates. Once the period of disinflation is over, the real value of property again becomes a function of real economic growth. Inflation does not need to re-accelerate for property prices to resume their advance. In fact, some of the greatest property booms occurred in periods of very low inflation. Property boom What boosts property values is the prospect of strong economic growth. If this perception is combined with low real interest rates and a rapidly rising money supply (as they were in both Japan and Britain in the late 1980s) a raging property boom often results. In the absence of such conditions, property prices tend to grow fairly steadily in line with GDP and national income. ” A second reason for property’s underperformance in relation to broad stock market indexes has been even more obvious. Shares have risen so quickly in the past decade that most property investments simply could not keep up. Although underlying values have advanced strongly in most property markets since the early 1990s, real estate has been seen by many investors as a disappointing asset because gains (even in central London) have failed to match spectacular stock market returns. However, the perception that property is at best a dull investment in relation to equities is valid only if we look at the 1990s in isolation. From the mid-1960s to the early 1970s, property gained strongly in real terms, while equities went nowhere. In the next 15 years, from 1974 to 1989, property and equities moved about equally. Since 1989, property has advanced only slowly, while equity prices have made up for the ground they lost in the 1960s and early 1970s. Viewed from this long-term perspective, property’s recent underperformance can partly be explained as a catching-up process by shares. New cycle The question is whether this long cycle of relative valuations is now more or less completed. If it is, a new cycle may be starting. Equities and properties may again roughly match each other in the long term, but the sub-cycles in property and equity should continue to move separately for long periods, helping to stabilise returns in balanced portfolios which own both asset classes. ” The question of portfolio balance leads to the third reason why investors have recently shunned property and property shares: the fashion for technology stocks. The bubble in technology stocks encouraged a “new paradigm” mode of thinking, according to which all the economy’s growth potential would supposedly be concentrated in New Economy industries, while traditional businesses (including property) were assumed to be permanently sidelined in a moribund Old Economy of cut-throat price competition and negligible growth. In the New Economy, investors value knowledge, “mind share” and other intangibles, shunning material assets such as property. Indeed, in the dot.com frenzy which climaxed in April, the phrase “bricks and mortar”, so long a slogan of reassurance to property investors, became a symbol of everything that was economically obsolete. Now that this bubble has burst, investors are asking themselves whether the distinction between the new paradigm and the Old Economy really makes sense. The massacre of internet and technology stocks has revealed that many New Economy companies are not technology businesses at all. They are simply retail, marketing and service businesses which moved a little faster than some competitors to exploit the internet and other new technologies. These technologies are now universally available and, as their use becomes increasingly widespread, they will offer no special competitive advantage – and certainly no monopoly power. Investors are also starting to notice that technological advances have created new demand for Old Economy resources: for paper, energy and transport and also for retail and office space. E-commerce, for example, is encouraging “bricks and mortar” retailers to redefine shopping as an enjoyable experience, rather than an unavoidable chore. This is increasing demand for quality retail property in prime locations. Networking requirements are boosting the value of modern office buildings, while the difficulty of recruiting skilled employees is pressuring employers to offer better-located office space. In short, it is becoming clear that the Old and New Economies are really one and the same. As the artificial distinction between Old and New disappears, investors will realise that the view of property as an outmoded sector cannot be economically correct. In the long run, property is automatically put to the most profitable uses. Property therefore adapts to become an input in the economy’s most advanced industries. What ultimately determines property values is the rate of economic growth, not the particular industries that generate growth. If a nation’s or a region’s economy expands and thrives, then the property sector will thrive with it. Equities and property will always go through divergent cycles, but in the long run they will gain value at about the same rate – a rate that will always reflect the economy’s long-term expansion. Investment managers who believe otherwise should sell their houses in Knightsbridge and invest the proceeds in internet stocks. |
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Property shares’ performance (1989-2000) |
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Source: Thomson Financial Datastream |
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Even though most property shares revived this year, the quoted property sector’s stock market value has fallen by over 60% relative to the general equities market over the past 12 years |
Predictions for 2001
Estates Gazette asked 30 leading figures in the property industry for their predictions for the year ahead. Their responses reveal a high level of optimism about the business prospects for 2001, tempered by concerns about the US economy and the looming general election here
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How much will your income grow? |
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What percentage of extra staff will you take on? |
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What’s the greatest threat to business? |
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Which will be the best-performing sectors? |
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Who will dominate the headlines? |
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Anatole Kaletsky is principal commentator of the Times, managing director of Kaletsky economic Consulting and a consulatant to The British Land PLC, which commissioned and published this independent article on quoted property companies. |
