Written by Stephen Yorke - D&G Asset Management
Prime residential property has long been acknowledged as a major asset class of the global rich. The post war period has seen Prime Central London residential property (PCL) emerge as a magnet for successive waves of new wealth from different regions of the world.
In the 1970s Middle Easterners were the first to invest, and as economies around the world have liberalised, further capital has been redeployed from previously closed economies into London.
Careful analysis of the available data has shown that it has been an excellent investment class producing strong and consistent real long-term returns (see chart on p.5). On a risk adjusted basis it sits very well against equities and gilts. It is precisely because of its track record that PCL is constantly featured in the press. We are the investment advisor to a fund (the Prime London Capital Fund) invested in Prime Central London residential property for the last seven years. We have just set out our route map for the next ten years.
Prime Central London residential property is a macro trade
There has been an underlying theme to much of the research that we have published, that PCL is a 'macro' trade and that the future for PCL asset prices is tightly linked to what the future holds for the global economy, financial system and growth of high net worth individuals.
In essence the direction and longevity of global monetary policy continues to be the single most important consideration when trying to assess the future direction of asset prices, and especially prime real estate asset prices.
The outlook for global monetary policy
Our current view is that asset allocation decisions since 2009 should have been based on the answer to the question, what is more likely, inflation or deflation?
We have consistently argued the latter is the greater risk and, more importantly, we think that the authorities consider it the greater risk. In fact we think that deflation still haunts central banks and that accordingly, policy will be very accommodative/abnormal for, in the words of the ex-CEO of Pimco, 'light years to come'.
Our reasoning:
- The eurozone is starting to be hit by deflation which will lead to accommodating monetary policy. Further economic and political turmoil will unravel, with the possibility of increasing questions about the sustainability of the whole Euro project.
- The problems of Greece will resurface and further bail outs will be required. Dramatic and immediate wealth taxes as a precondition may result, as in Cyprus last year, and Italy in 1992.
- Japan's recent economic numbers leave the Bank of Japan little option but to stick with easy monetary policies in an attempt to keep the Yen low – a weaker Yen will impact the wider Asian region, especially China.
- Deleveraging in China may push many high net worth individuals to diversify their wealth. London with its strong education system has already been a big attraction for Chinese investors; but hitherto it has been 'insiders' who have been able to get around existing capital controls. If their domestic economy continues to slow, to encourage further devaluation of the renminbi, the government might further relax capital controls, opening up a savings pool of $4.5 trillion (the US savings pool is $2.25 trillion) to look at overseas assets.
- In the US mixed consumer confidence figures, combined with a desire to stop the US$ rising too far, will mean that quantative easing remains in place.
The UK and its London City state
One of the key themes that we have hammered away at since 2006/7 is that the 'right' Bank of England UK interest rate will almost always be the 'wrong' (i.e. too low and thus inflationary) interest rate for inner London.
The scale of this 'London-loose' monetary policy is getting greater each year as the London economy thrives and the rest of the UK suffers from the deflationary/low growth environment, of other developed economies.
Finally, and importantly, the demographic projections for London are strong – the population is forecast to grow from today's level of 8.3m to 9.6m by 2030, commensurate with a growing economic hub that is one of a few truly global cities.
Possible headwinds – the threat of a mansion tax
There has been a lot of talk in the press about a mansion tax. The Liberal Democrats proposed it as a wealth tax on properties valued over £2m, and a year ago the Labour party said that they would also endorse it. Inevitably the question arises as to what effect, if any, will a mansion tax have?
The mansion tax is not uncontroversial, even within the Labour party. As the Conservatives may win an outright majority at the next general election in mid-2015, the question is best answered by assessing the practicality of collecting such a tax. Our strong impression is that Labour is considering the advantages of using an existing tax (council tax) rather than introducing a new tax (which would have huge implementation issues). Moving the burden of taxation from ownership to occupation would also pacify policymakers, fearful that the link between foreign wealth investing in London real estate and the creation of new homes may be threatened.
However, while the uncertainty surrounding the possibility of a mansion tax on owners of property valued over £2m exists, we think that value opportunities will arise in the £2m - £4m market over the next 12 months prior to the general election in May 2015.
Ten year outlook
We firmly believe that global demand will remain strong for AAA UK, and especially PCL. Rents in PCL in the £1m – £4m range will continue to rise in line with UK RPI but underperform capital rises.
PCL capital values will double over the next 10 years and gross yields may very well fall below 1%.
We have taken great care to ensure the accuracy of this
newsletter. However, the newsletter is written in general terms and
you are strongly recommended to seek specific advice before taking
any action based on the information it contains. No responsibility
can be taken for any loss arising from action taken or refrained
from on the basis of this publication.
© Smith & Williamson Holdings Limited 2014.
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