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201: UK and US property market and economic update

07-01-2008 team


UK Market Update


More doom and gloom. Its no surprise with oil prices at $142/bbl and inflation has reared its ugly head again. Indeed the negative impact of oil prices on inflation could have been far worse so far, but the affects are well and truly now feeding through. In the UK CPI inflation is now 3.1% and looks likely to rise to over 4% in the next year. So this in theory would add at least 1% to interest rates, and push mortgage costs up about 20%. If oil prices dont rise further then its likely inflation will drop back from 4% to its target range 2 to 3% within a year - but we believe oil prices will continue to rise and cause inflation to stay stubbornly high and put pressure on the Bank of England to raise interest rates. They cannot do this indefinitely because this could cause a fully-fledged recession, but they are well and truly between a rock and a hard place on this issue. We believe its all down to the oil price as weve been warning for the last 18 months.


Meanwhile the effects of the credit crunch appear to be working their way through, and some interest rate offers have recently been reduced a good sign of good credit availability to the banks. Berkleys the builders will now start buying large tracts of UK land, stopped paying out dividends and therefore seem to have called the bottom of the property market theyve called the bottom and top successfully before. Wed like to re-iterate our view that the property market has not reached the bottom yet, and is unlikely to do so any time soon. It may now take years to properly recover because of high oil prices. This is why we have been advising for 18 months to invest in cities and areas that are positively impacted by high oil prices. You can read the range of Special Reports at the end of this Newsletter.


One element missing so far that could cause a fully fledged house price crash in the UK is dramatically rising unemployment employment has stayed stable for the last year. As long as the jobs market holds up which is not for certain of course then house prices should not drop more than say 5-10% per annum for the next year or so with the possibility of stabilizing prices at any time if the oil price drops.


Landlord Rental Update


The rental market generally remains firm as first time buyers struggle to obtain mortgages because of the credit crunch, and are avoiding taking the plunge because house prices are likely to drop further. This has been a boon for buy-to-let investors as there are plenty of tenants for reasonable quality accommodation in central convenient locations. The employment market remains strong and the wave of immigrants needing accommodation shows no sign of reversing. We believe unemployment may rise slightly, but not significantly despite the UK slowdown. As long as your properties are in reasonable decorative order, well presented and in handy locations at competitive prices, you should avoid long void periods in the current market. Rents have generally been rising in the last year or so, particularly in London. Yes, mortgage costs have risen a lot as well, but although many buy-to-let properties dont make positive cashflow, most buy-to-let investors are sitting on sizeable equity so are not suffering undue distress as yet. Some reports of distress seem to come from media coverage of people who entered the market very late and also bought into new build developments for instance in northern cities. But this is not the average buy-to-let investor most investors purchase older flats and houses and are less exposed to a flood of new build properties hitting the market at the same time.


Continued UK Housing Shortage


As house prices rose in 2007, the government predicted that the UK needed an additional 300,000 properties per year, yet only a net 180,000 were being built. Now building levels have dropped considerably, probably to something like 120,000 a year - mostly flats. But these government targets should not really change since they are based on population growth, immigration, aging population, and predicted smaller family units. So we expect a further shortage of property now and in years to come as building levels drop when they should be rising. Any older house in the south of England that can be purchased at low price in a good location close to higher paid jobs should be a good long term investment. So we advise looking for selective bargains in London and southern and SE England within 60 miles of London hopefully requiring some easy renovation upgrade. As oil prices rise, huge profits will be generated from London based oil/gas and mining companies London is also energy efficient compared with most areas with its electric trains, commuting and lack of manufacturing. So GDP should be maintained at reasonable levels as long as banks do not go under (unlikely since the key reason they would go under is stress caused by high oil prices, and Middle East investment funds would then step in and buy them up).


In summary, the current conditions are enough to discourage building just when there should be a big building spree for the medium to long term. This lack of building should help support prices into 2010. Yes, transaction levels have halved, and people are staying put, but there is not much sign yet of severe distress, unemployment or a crash. Its hardly surprising so few people want to move because of massive stamp duty increases and transaction costs a key reason why so many people are choosing to extend or upgrade existing homes. So for the buy-to-let investor, one can see opportunities abound in southern England and London particularly in the run up to the Olympics in 2012. (Stratford, Hackney, Bow, Canning Town spring to mind, with Gravesend further out another good bet with the new Ebbsfleet station).


US Market and Future Economic Outlook


The dollar has dropped as we all know by about 25% against most currencies in the last 8 months. This has probably fueled about 25% of the oil price rises. Its also helped re-balance USAs massive trade deficit. Exports have been very strong since the dollar dropped hardly surprising. Inflation has been remarkably well contained despite higher energy prices and the weak dollar. Productivity improvements and general efficient public and private sectors have helped the US weather the economic downturn and it now looks likely that despite the sub-prime crisis, credit crunch, house price declines and general low consume and business confidence levels, the economy will escape any form of recession. Indeed, GDP growth is likely to be well over 1% in the next year or so. Even with oil prices up to $170/bbl, we believe the US economy is robust enough to not drift into a recession. We think the worst will be over by end 2008 and a recovery will start in 2009. For US real estate investors, end 2008 is probably a good time to purchase bargains particularly in areas hit hardest by the sub-prime crisis and re-possessions such as Florida, Phoenix in Arizona, and parts of California. These are the areas that in future years will encounter large population increases, GDP growth and retiring baby-boomers settling in the sun. Texas is another winner with the oil prices booming. Wyoming and NE Colorado (coal) are other areas that will benefit from high energy prices. Bakersfield in California is another a rather depressing small industrial city, but oil production activity will continue to boom so rentals and oil worker homes will be in short supply.


For non US investors, there is a dollar currency risk to investing in the USA which needs to be properly considered. If you believe the US dollar will continue its decline, it might be worth investing in your home country. Its also a function of local interest rates, local inflation, where you are financing, how much equity you put in yourself (and currency) and which currency you are financing in. Were no experts at currency risk not many people are hence your real estate investment strategy needs to add this risk into your decision making. They say if you dont understand it its best to avoid it! Overall, if you are a non US American investor and believe the dollar will strengthen it should increase your appetite for US investments. If you believe the dollar will continue dropping over many years, its probably best to avoid the exposure unless you intend to settle in the USA one day.


For global investors, our steer is, dont under-estimate the US economy. People have been writing the USA off for years, but its got the following going for it:


         Highly motivated, organized and educated workforce

         Innovation and high technology

         Available financing for business

         Small public sector, large private sector

         Low taxes

         Increasing workforce and population

         Low cost building

         Coal, oil, gas, nuclear, water, forestry, agriculture, minerals

         Oil shale deposits, and tight gas deposits for when oil price rise further

         Much land, varied climate, good security and political stability


There are not many countries that have so much going for them yes, the US uses too much oil and gas, but they do produce half of what they need. They have the largest coal reserves in the world these will not run out. So when the US finally begins to wean itself off its addiction to oil, it should be well placed to trade with China, Brazil and India in the global economic expansion.


Most countries have public sectors inefficiencies dragging down their economies the continued US productivity improvements in manufacturing and services is impressive and its difficult for many European countries to compete, particularly now the dollar has declined in value. 


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