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235: UK property investor's update

11-08-2008 team

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Gloom Is All Around Us

This time it's not “Love is All Around Us” – it's “Gloom Is All Around Us – let the feeling grow”. Maybe it's time to buy!

Yes, more gloomy news – panic and financial meltdown. Where is it all leading? We're not surprised the stock markets have tumbled – we wrote about this in June 2007 – the end of the six year bull run (refer to Special Report 139). And also the threat of rising oil prices to a recession .


UK Recession: The UK has now entered a period of negative growth that started Q3 2008. GDP announced for Q3 2008 was -0.5% and it's expected to continue negative growth in Q4, thereby putting the UK into a technical recession. Most analysts believe the UK will experience at least three quarters of negative growth. Some believe the recession could last 2-3 years or even more. It's hard to predict at this stage. One thing is almost certain, inflation will plummet from its current level of 4.7%. It is likely to go negative in 2009 or close to it. Because the Bank of England has a 2% CPI inflation target, it will likely be forced to drop rate dramatically from its current level of 4.5% to under 2.5% by mid 2009 to follow inflation down.

Massive Debit Costs: It's also worth noting the US interest rates are now 0.5% - a massive 4% lower than the UK - despite similar GDP and inflation figures. Normally, the UK has approximately a 1% higher interest rate than the USA - hence this implies UK rates could drop quickly to 1.5% or thereabout. Difficult to believe - but if oil prices remain low, we expect this to happen.

In summary, what we are experiencing is the deflation of an asset bubble - all assets. It's not just house prices that will deflate, it will (and has been) stocks and shares, oil, wheat, copper, metals, the price of antique cars and artwork etc. This is likely to be followed by services charges like a hair cut, and food prices, travel costs etc.

For too long the Western World has been borrowing money to fuel spending and this has led to asset prices escalating. Wages have also risen. Whether most people deserve such high wages is a contentious point – one could argue we've all been paid too much for too long and the governments have then taken advantage of this by increasing the tax burden, have spent it on inefficient public sector jobs and projects and wasted a great amount of value in the process. The North Sea oil wealth and petrol taxes have not been used to improve infra-structure and business efficiency – they have been spent on education, hospitals and public sector jobs. The benefits in value creation of this massive spending spree are debatable. And has UK PLC been able to afford this increased spending during the good times?  And can we keep things moving forward in the bad times - by borrowing our way out of recessions?

Productivity: One area of concern is UK productivity – apart from financial services which has performed well up until mid 2008, manufacturing and public sector productivity have had meagre productivity improvements compared with the US and most other European countries. There are more public sector jobs in Newcastle as a proportion of the working population than Hungary before the end of communist Soviet Union in 1987.

So – regrettably – we're in for a rough ride. The big question is whether jacking down interested rates to 2% and massive injections of borrowed capital by the UK government will stimulate the economy and lead to positive growth after a short while and thence stabilize of house prices. We rather hope it will, but we fear it will not. It could even create deteriorating productivity and further pressure on Sterling. Certainly investment in industry has been meagre over many years of 3+% GDP growth, so it's hard to envisage industrial production improving in productivity as investment is slashed and private enterprise budgets are reduced.

Unemployment: Clearly unemployment will rise – it could even double from current levels. As borrowing costs rocket down, and employed tenants become harder to find, we predict rents will also drop. Rental yields on newly purchased property will probably rise, but house prices will continue dropping. We hope prices will start to stabilize by mid 2009, but the downside is they will continue sliding after this.

The worst case scenario is that deflation starts to set in. At this point, borrowing costs almost nothing in interest rates, but the value of the assets may decrease by 2-5% a year as happened in Japan in the 1990s.

Credit Squeeze: A particular concern is whether banks will have any money to lend to anyone. If borrowing remains very difficult, house prices will continue to decline as first time buyers disappear completely. Buy-to-let investors would be shy of entering the market in anticipation of future price drops and bargains to be had further down the line - leading to further price declines.

The good news is that the overall mortgage gearing on properties was 38% early 2008. This means assets were valued at almost three times borrowing on the overall UK housing stock. So negative equity if it does hit should not affect the vast majority of property owners.

Oil Prices Down: The other positive news is oil prices crashed from $147/bbl in mid 2008 to $60/bbl 28 October - then recovered to ca. $68/bbl. They will rise again in future, but this could be a few years away after the slowdown in the global economy knocked the stuffing out of demand – commonly referred to as “demand destruction”. Demand in the western economies has plummeted by 1 million barrels in the last six months, partly because of high oil prices and partly because of the slowing global economies. It's now likely demand in 2009 will also drop, just as new oil production comes on-stream. Please note however we still maintain that the world is on a bumpy plateau of peak oil production – production (or supply) cannot rise much further. So as oil investment drops in the next year, this will sow the seeds of the next oil price skyrocketing when the global economy finally starts coming out of recession – whether this is in six months, 2 years or 5 years it's difficult to predict at this time. It's more likely to be after 6 months than 5 years.

High Oil Causes Recession As Expected: Also note, we believe the massive increase in oil prices from $70/bbl in June 2007 to $147/bbl in April 2008 added to the sub-prime crisis August 2007 was the key trigger for the current recession in the USA and UK. Whenever oil prices skyrocket, the world goes into recession. This happened in 1971, 1981 and 1991 – it's happening now in 2008. If you can imagine the US oil bill rising to $1 Trillion at $125/bbl – some 6% of country's overall GDP, it's no surprise the country is now heading for recession. Who can afford these bills or oil taxes?  Ditto South Korea that uses vast quantities of imported oil per capita. The good news for the UK is that it does not import much oil, and only imports 35% of its gas needs – so it's quite well protected from skyrocketing oil prices. But it does seem that above trend GDP of 3+% for a period of 10 years was to a large extent an illusion based on massive borrowing, massive public spending and an economy heavily weighted to financial services in London and partly fuelled by oil exports and oil taxes that have since dried up.

Consolidation: We believe there will be a correction, consolidation of industry/companies – a shake out of large proportions. Ultimately in a few years time, these companies and private enterprise may well be far stronger and more sustainable. Expect the mergers to begin, but don't expect large prices to be paid – it will be mergers, takeovers and consolidation based on crisis and necessity to survive rather than speculative asset price increases and opportunism. The competition commissions will likely go very quiet as political and public pressure to prevent unemployment and companies going under will allow mergers to take place in many business sectors that would not have been allowed a few years ago. Airline companies, finance/banking, energy and manufacturing are all examples of industries that are likely to consolidate in the next few years.

If interest rates drop and borrowing starts to become far easier, it could kick-start the housing market, albeit this relies on unemployment remaining relatively low – something that could change quickly as the private sector starts laying off employees.

Warren Buffet Buys: Warren Buffet has started purchasing US stocks – he's an expert – but maybe even Warren Buffet is being too optimistic and stocks will continue to slide. The FT100 most likely bottomed out at 3650 around 28 Oct 2008. Remember it was 6600 in March. That's more than halved in value in six months - and about 40% down in its level ten years ago. This demonstrates how poorly the UK stock market has performed over many years - particularly compared with the ca. 250% increase in house prices. In the last week, the FT has risen back to 4400 but this could be temporary – whatever happens, the market is very turbulent. Only the experts make money. The average person stands litle chance. But we're not experts at stocks and shares – we tend to avoid them for obvious reasons. A halving in value in six months is pretty dramatic – some argue this could also happen to property, but we doubt it (we expect peak to trough declines of about 22%-30% in the UK, then rises after this).

As you can see, we're rather downbeat and we don't advise buying property at present – simple reason is we expect prices to be lower next year. So the trick is to watch the asset bubble deflating then step in when you think it's reached a bottom. Beware since many troughs occurred in Japan in the 1990s – false dawns. It could be only a short sharp recession then back to normal growth, or it could be a long protracted recession or depression that last many years. We'll have a better idea early 2009 what scenario looks most likely. We're hoping for the former. And concerned it could be the latter.

Trillions Disappear: We've modelled what we think is most likely to happen to interest rates and inflation in the next year. As people pulled their money out of the stock market, an estimated $12 Trillion globally in the last four months, some of this money will likely end up in property – considered by most as a safe haven – despite the scare stories. West London - despite the financial meltdown - is probably one of the safest places to invest in property at present. London's global centre of the wealthy is not going to go away. Kensington, Mayfair - you won't find much hardship in these places!  Remember at the end of 2001 – the stock market crashed, New York thought it might suffer a recession and interest rates in the US dropped to 1% - this was the precursor to a house price boom - and New York was one of the main beneficiaries. So don't be surprised if UK rates drop dramatically to say 2% - then borrowing becomes so cheap, house prices start moving higher again and London and southern England rapidly recover with the north following a year or so later. But be wary, if this happens for another cycle, it may be setting itself up for another collapse a few years later! Also be wary that the baby-boomers start retiring around now, and this will reach a maximum around 2013-2017 - so be very careful from now on. The good news is the UK population will continue to grow and building levels are at an all time low - sowing the seeds for another housing shortage in a few years time.

Overseas Property: For overseas property, be particularly careful at present. The first problems are just starting in the emerging markets and as China and India's GDP growth drops and stock markets take a pummeling, real estate markets will suffer globally. It's difficult to see a country that will not now be affected.

•  Developed western economies USA, UK, Europe) – reeling from the financial meltdown

•  Emerging economies (India, China) – big manufacturing and services slowdown and real estate bubbles that may burst

•  Oil exporting nations (Middle East) – as oil prices have crashed from $147/bbl to $65/bbl finances will become tighter and real estate prices that have boomed may go into reverse

•  Holiday destinations (Greece, France, Spain) – low cost airline routes will be cut, less people will be able to afford second homes in the sun, and prices are likely to plummet in may holiday areas, particularly those on UK low-cost airline routes that close – watch out!

Despite all the gloom about UK property in London, we believe it's one of the safest places to invest despite property prices that are currently falling. If you purchase property close to high paid jobs, you'll be safer than most. But don't expect holiday homes in average areas well away from high paid jobs to see any property price rises in the next few years – no-one will be able to afford them in the current climate.

Recovery with drop in interest rates: But – watch out for a quick recovery in house prices when the interest rates drop – if previous history is anything to go by, this is likely to start feeding through second half of 2009 (refer to the chart below from Nationwide Building Society).

In summary, our feeling is that one should "hold off" from big investments until mid 2009, then build-hold until 2012 - then be very careful after this (consider selective divestments) - since a prolong slump could kick-in after 2012.   

Governments Help Private Enterprise

One of the positive things coming out of the recent government interventions has been the acknowledgement by stepping in to help of how important private enterprise and the banks actually are. Definitely a synergistic relationship. Thinking this through, the government derives a large proportion of its taxes from companies' profits and employees' income taxes, so it's in the country's best interests as a whole to make sure companies don't go to the wall and unemployment does not sky-rocket. Lost incomes taxes and increased benefits payments are just two direct outcomes of companies folding.

Years ago, a socialist oriented government would be likely to sit back and watch as companies that over-extended themselves through bad practices (such as leveraged lending) went under – now, most of these banks are being saved despite the complaints of greedy CEOs and the like.

High Tax Employees versus Low Tax Business Owners

The economic landscape has changed much since the last recession in 1991 – and even further since 1981 and 1971. Globalization now means companies can up sticks and move wherever they wish – with remote internet/IT operations in tax efficient havens. So the governments cannot any longer tax the heck out of companies – because these companies will move along with their employees to other countries. This has created intense competitive pressures on inter-country tax rates – driving them down. However, for the treasuries to balance their books, they have instead resorted to increasing income taxes, VAT, fuel duties and other indirect taxes like property stamp duty and oil royalities in oil producing countries.

So in summary, the average middle class high earning employee now gets hit the hardest – no wonder the governments are keen to keep these big previously wealthy companies afloat. No more talk of windfall taxes on massive company profits – otherwise the companies take their high tax paying employees overseas!

The message we would like to give to all our newsletter readers is to re-iterate the fact that being an employee may seem like a good safe option, but one is taxed at 40%, then pays 17.5% VAT on good/services, 10% national insurance, 80% tax on petrol and massive taxes on moving home. So you'll be lucky to see 20% of what you originally earned!

Property Investors Low Tax: Compare this against a private property investor with the new 18% capital gain tax rules that came into force last April. Instead of 40% tax, you'll get 18% but with the ability to offset all expenses against this tax bill. Then you can take advantage of no VAT on certain types of renovations (flats above shops or empty property conversions as examples). You can avoid stamp duty by purchasing low priced flats. You can even move abroad and work remotely on your project – and potentially pay almost no tax. Your petrol charges will also be tax deductible. Overall, instead of total 80% tax rate, you'll probably have 15-30%. It sucks being an employee in today's tax climate, but not many people realize what has happened in the last ten years. At any time you can lose your job – you cannot control your direction. If you have a small business, okay, it's a responsibility but at least you should be able to control it – and see which direction you are heading.

That's not to say all those employees should leave their jobs in the current climate. One big benefit of being an employee is that banks are far more willing to lend money to employees who have a regular verifiable income – on a permanent employment contract (not a consultant).

The lowest risk approach is therefore likely to be building a business whilst one is still employed by a company or public sector – then go it alone when you are sure you have the resources for your business to succeed. Your business will have grown, you'll know about the business – it's risks and upside, then be better prepared to succeed without getting into financial trouble.

Love is All

What drives people to want to progress, make money, invest and improve their lives? Why do we all strive to improve our lot in lives? Love

This is the biggest single driver. It can also be the most damaging. If you can harness it – you will succeed in making money beyond your wildest dreams. If you ignore it, or misuse it, you will end up with nothing.

Strong words. We will need to justify this statement – here goes.

Question yourself: First of all ask yourself the question – “why am I keen on property investing”. You might take a not very in-depth analysis of this and answer – “because I want lots of money for myself”. But this will invariably not be the case. The reason for this is, you want money not just for yourself, but for the loved ones around you. Money on your own will not help you. It will not make you happier – you will be lonely, you will lack purpose, you will lack encouragement, you will lack respect from others – respect from your loved ones.

The more accurate answer will probably be – “because I want to make lots of money so I can share it with others around me – I will gain respect, sometimes adulation, security, freedom – this is what I want for my loved ones, the family, friends and associates I have in this world”. You'll be making money to gain control and keep your loved ones happy. If you have no loved ones (an example is a single immigrant with no family), having money will also make it a lot easier to find a loved one. People love money. You'll find it easier finding a partner or keeping a partner. They also want financial security and freedom – just like you.

Men: If you are a man, women like winners – they want to be with a winner – they don't like losers or anyone with a losing mentality. If you are positive, make lots of money and provide financial security for your loved ones – they will stick around. Likely if you are a loser or have a losing mentality (they almost always go together), always struggle financially and having a negative outlook on life, your partner will be off. Okay, it's a generalization but think of these partnerships that have broken up – it's often because of negative squabbling, financial worry and lack of security and financial freedom.

Yes – there are the occasional so called “gold diggers” around – but they are few and far between – and often they may enter the relationship hoping for the best, find they split and then they are wrongly accused of being a “gold digger”. Successful relationships are based on trust, communication, sharing of ideas, dreams and goals and a true sense of doing things together.

Women: If you are a woman, and your man or partner is always discouraging you from property investment, entrepreneurial behaviours or showing initiative, you'll have to try and coach them, bring them around to your ideas and views in a diplomatic way. You need to try and be inclusive and open. But if it still doesn't work, and you are determined to succeed in your own business enterprise, then you'll have some tough decisions to make. Men normally like to feel as though they are the “bread-winner”, it's a male thing. If you exclude them, you'll create endless friction. If it's a partnership, it's more likely to work. Sharing and doing it together – as long as you trust each other and can share the same values.

Friends: If your friends do not share your values, then you might have to find other friends. You can keep your old ones of course, but just make sure you don't talk property investment – they won't understand, they may get envious, jealous, self righteous or in the worst circumstances – hostile. You'll be wasting your emotional energy and thinking powers on them. These friends can stay friends – just don't talk money and property all the time – you'll switch them off and they won't like you for it.

Careful: But, be careful with your friends and family. Because if you want to be truly very wealthy, you will have to be very determined, often or at least sometimes going it alone, and be prepared to upset loved ones around you in the process. It's always a balance – you need to keep your partner on your side. Carry them along. If you want to be truly wealthy, you'll have to sacrifice time, energy and passion to get wealthy – your partner needs to have bought into this. If you have a partner that has similar values – you are away. If your partner does not have these values and you find it a struggle – you're in for a tough ride. If you haven't yet got a partner, make sure you find one with similar values and dreams to yourself – one that values making money highly if this is what you want – and is prepared to back you with your investment plans.

Negative Influences: If all the loved ones around you are risk averse, Doubting Thomases, and put fear into you every time you try and make an investment decision – it won't work. If they criticize all your ideas – you'll be in for a very hard time. You might have to unshackle yourself from these associations. Your family, partner and immediate friends are your strongest influences. If you find them all negative about investment – you'll have to consider breaking loose – moving away – you'll have to decide which way to go. Stay with them and be under the investment cloud for the rest of your life, or break free so you can go about your business. Tough decisions – tough even to think about it. Would you be happier? Would you feel more or less secure in the short, medium or long term?

Employees – don't expect them to understand: If you are an employee, don't expect your work colleagues to understand anything about property investment or making serious money – this is why they are employed – they consider this low risk, high security – even though we all know it's actually high risk, low security (anyone who has seen pension performance and the performance of the stock market recently can attest to this) – if you are an employee, you can lose your job any time of any day of the week – and you have no control over this. And this is probably why you are property investing – to improve your financial security for your loves ones. Don't expect 80% of the population to understand this though – they don't teach financial literacy at school – we get 10,000 visitors a day to our website and only 5% of the UK population are buy-to-let investors. Don't imagine you are surrounded by like minded people – you are definitely in the minority so watch out!

It all goes back to Love as an umbrella for the following that you desire:

All these things come with wealth and successful investing – and you almost certainly want these because you want to be loved by your:

This we believe is the single biggest driver behind the motivation to invest to make serious wealth. So you have choices to make:

Encouraging loved ones: If you are fortunate to have loved ones that are supportive – you'll find a huge reservoir of emotional support for all your entrepreneurial efforts . You will be motivated by them, encouraged, be a fearless objective investor with positive thoughts and dreams. You will become very wealthy if you can make the correct investment decisions and properly manage your portfolio.

Discouraging loved ones: If you are unfortunate to have loved ones that are not supportive – are fearful of your exploits and cast doubt and fear into your minds – you'll find this is the biggest single impediment to your financial success. You might get lucky and be able to go it alone quietly without upsetting them too much and come out of it with their respect. But you might find at every move you are discouraged and it never happens. You cannot get the approved time and financial and emotional support to enact your plans.

What's holding you back: So, the single biggest thing holding people back from making serious money is normally their loved ones. But the single biggest driver is also their loved ones. You just need to make sure your loved ones understand your values and let you get on with it.

Excuses: And don't make excuses about your partner and family being the reason why you have no wealth – that's a cheap way out – face up to it and do something about it. Don't blame anyone else but yourself. They have reasons for not being supportive, if you cannot change them and you cannot do it without them – then you'll either have to put up, shut up – or get the hell out!

Conclusion: We thought it appropriate to surface what we consider to be some hidden truths. We hope it has made you more aware of the influences around you, and how you can leverage your loved ones to create the desire in your life to become a successful and wealth property investor. And if you are being held back, at least you will understand, but don't blame them please – blame yourself! We hope this report has helped.

Concluding Remarks: We hope you are enjoying your property investing so far in 2008 in these particularly challenging times. We also hope you have found these further insights and advice helpful. If you have any comments, feedback or suggestions, please email us on .

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