Learning from the past?
As the old saying goes, if you don’t learn from the past you are doomed to repeat it.Because the type of investment property that flows through auctions remains relatively constant, it is illuminating to look back over past boom-bust cycles, what messages came out of the auction sales during those periods and how those compare with what we are seeing today.There is an interesting comparison to be drawn between this cycle and the property cycle spanning the end of the 1980s to the mid-1990s. Whilst the causes of this recession may be different from the 1988-1992 boom-to-bust, the way in which investors are reacting seems to be similar.The previous cycle saw its boom year in 1988 but negative economic factors began to creep in at the end of that year. However a “momentum effect” had built up over the previous three years and pushed activity on into 1989.The slashing of the very high interest rates in late 1992 created a demand for the high income return that well-secured property investments provided. Investments let to triple A covenants on 25- year leases, albeit by then over-rented, could be bought for 11%+ .Led by these special circumstances, the recovery lasted just 14 months with the second dip coming in 1994. Sentiment was heavily against property as an investment medium because of the perceived risks of increasing tenant failure, voids and over-rentedness. Banks were not prepared to lend on an asset class with which they had burnt their fingers so recently.This didn’t change until 1996 when the debt tap was turned on albeit only as a trickle. We would have to wait for another 5-6 years for the tap to be fully open and the loans to come gushing out.Fast forward to 2008 and the “momentum effect” was again in evidence. Deep down, most seasoned investors had called time on the market at least 12 months’ earlier and there was an interesting downward blip in activity just before the summer of 2007 when the market paused as in disbelief at the continual rise in prices. This didn’t last long and activity resumed in the autumn of that year. Analogous to 1989, Investors, IFAs and fund managers – or more probably their clients who thought they knew better – took the view that the outperformance of property would continue. Seeing how well they had done in the past persuaded them to continue investing regardless of what the fundamentals were saying. This was reinforced by some banks continuing to lend freely.We now know that this all came to an end in 2008 with a 40% plummet in values and a 60% drop in transactions. Peak to trough was quicker this time around than in the early 1990s but what then happened in 2009 was reminiscent of 1993.The momentum built up over the five years to 2006 took hold again after the spring of 2009 but now demand was not from the debt-driven buyers but instead from the cash-rich buyers They believed they could see a light at the end of the tunnel and prices for certain assets made up a significant amount of the ground lost in 2008.However the weak fundamentals of property outside Central London became more apparent and by summer of last year what many thought was the light at the end of the tunnel was actually the “demand train” heading in the opposite direction.So what can we learn from the previous cycle to help guide us into the future?Well, we are firmly in the second phase of a cycle which has similarities with the 1994-1996 period. Prices for prime assets have held up well since 2008 and on a rolling average basis have hardly changed over the last 15 months.After the early 1990s crash there was a lack of confidence and a lack of demand. Today, there does not appear to be a lack of demand and there is now also a wider, more accomplished skill base for working property assets.Prices for the more secondary assets will need to reflect that debt is expensive; that there is a risk of voids; and there may be a need to spend capital simply to maintain the value of the investment. A private property company with good asset management skills and an intimate knowledge of the local market in this environment should do well if they buy selectively.However there is a big question mark over whether valuations will match the price expectations of sellers and buyers in the next few years. With transaction levels down, there is a paucity of evidence especially at the secondary end of the market. This lack of evidence is not a question of falling sale rates for properties when they are offered and then not sold; it is purely a lack of supply. Owners are simply not bringing this type of asset to market.So with a lack of supply, investors – and their debt providers as well – have to ask themselves when do they expect this market to recover sufficiently to recoup historic purchase prices/loans? The evidence from the last cycle is that it could be some time.The question for the property investment community today is: have you learnt from the past and are you really facing up to the future? If so, perhaps you’ve already been adhering to that other old axiom: “Sell in May and go away”.