How did so many people come to own two houses?

Since the late 1990s it has become quite normal to own a second home and today there is a massive industry selling holiday homes in wide range of exotic locations around the world. According to the Office for National Statistics, around 2 million Britons now own more than one home, many of which are in the UK but there is also a growing number abroad, with sales being driven by overseas property features in the media and the expansion of budget airline routes.

If you cast your mind back you can probably remember when it become the norm for the majority of people to own their own first home rather than to rent. It wasn’t that long ago and it was a normal progression that enabled people to borrow money more easily and to make the jump from renting to owning. Even though financing became more widespread, people still had to save up for a good deposit and for everything that went in the house. Today, no-one saves money anymore and everything is bought on the never-never (as it used to be known). During the last decade the world has changed as far as money and wealth are concerned in the UK.

In the long run it makes sense to own a property rather than to pay money in rent each month because a portion of each mortgage payment usually goes towards paying down the debt and therefore the capital in the property accumulates. Getting on the housing ladder has become a rite of passage today, not just an aspiration.

During the last decade things have changed enormously. Whereas 10 years ago it was only relatively wealthy people that owned a second home, it has now become a realistic possibility for millions of ordinary people, as illustrated by the explosion in adverts for holiday homes as far as away as Thailand and Canada. Bearing in mind that the average real income (i.e. accounting for inflation) has hardly risen at all during the last decade, how is it that so many people now have two houses without having any significantly higher disposable income?

If you ask the average person in the street what the currency is in Bulgaria or how to say Hello in Romanian, they won’t have a clue. If you ask them whether or not Bulgaria is considered a good place to own property as an investment, I bet many Brits will be able to express a view. There are so many developers promoting holiday homes in eastern Europe that British people now consider it desirable to own a luxury apartment or villa in what is still considered to be a third world country. The advertising does a very good job of selling a lifestyle that is often far removed from the wider reality in these countries but part of the appeal is that property in many eastern European countries is very cheap compared to the UK. However, in addition to the image buyers have of themselves sipping champagne on their terrace as the sun sets over the countryside, I would argue that the main appeal is the potential for capital growth.

It is amazing how many people compare eastern European prices with UK prices and remark how cheap property is there. There seems to be an underlying assumption that the low prices are simply lagging behind those in the UK and that they will one day catch up. This view tends to ignore the fact that there is no shortage of property in many countries, plus the rush for rapid economic development also means that these countries are unlikely to put the same obstacles in the way of new property developments as the UK or France might.

The whole experience of owning a property abroad is different from the bottleneck system that is the UK housing industry. Supply of new build property has increased dramatically in most holiday hotspots and many people who have bought apartments in new developments find it very difficult to sell when there are 200 new apartments being built just down the road. New apartments tend to attract a premium price initially but after a year or two they are no longer new and can’t compete. In a rising market this isn’t such a problem but in a market where prices are falling it can be disastrous for highly leveraged buyers. If more people are forced to sell their second properties because of rising mortgage rates, worries about exchange rates or simply more urgent demands on their income at home, there is likely to be a flood of properties into the market at around the same time.

In addition, due to the long lead time between giving the green light for a property development and the final completion of the project, there is unlikely to be a slowdown in new supply for some time. This has been well illustrated in the US where there is 9 months of new housing supply waiting to be sold.

Whereas owning a second home has been easy in recent years due to cheap and available finance, things have now changed and we are likely to see a reversal of the trend to own. This is due to several factors:

- Mortgage rates are rising and people are paying more each month for their property.

- Other everyday expenses such as fuel bills and buying food has increased dramatically in price, which means there is less disposable income available for luxuries.

- Paying for two lots of council tax, two lots of maintenance expenses and two lots of mortgage refinancing fees is all going to be a drain on resources if budgets are tightening.

- Cheap flight prices have increased in recent years as fuel prices have soared.

- Many loans in eastern European countries are taken out in low-yielding foreign currencies such as the Yen and Swiss Franc. These currencies have strengthened considerably recently which increases the size of the outstanding debt.


Whilst the pressures of owning a second home have increased there is further bad news for those wishing to sell:

- Supply of new developments has not yet peaked in most countries (with the possible exception of the US) and supply is probably outstripping demand now.

- Mortgage applications in the UK are now running nearly 40% lower than a year ago which means that the number of potential buyers has dropped off a cliff.

- The media has latched onto the negative sentiment in the property market in many countries and this is a blow to confidence. Inexperienced investors who would previously have jumped on the bandwagon will now hesitate.

- Many people who initially found it relatively easy to buy property abroad are finding out how difficult it is to sell when everything isn’t laid on for you. In many countries the local population can’t afford the prices asked for new developments and that only leaves the overseas market in which to sell.

Owning a second home has gone from being a luxury only the rich could afford, to being quite commonplace, and is soon likely to be viewed as a step too far for many families. If the UK experiences a serious economic downturn as many people are predicting, that is going to mean higher unemployment, less job security and less chance of getting a pay rise. Most people could soon find themselves financially much worse off and many of those people who own a second home are going to feel like they have a huge millstone around their neck.

The explosion in easy credit in recent years has created a strange state of affairs that has allowed people to feel as though they are wealthier because their purchasing power has increased, as they have been able to borrow more and more money. The equity in their property has made them feel wealthier, even though they have to borrow against it in order to spend it. The availability of cheap credit, alongside a society that is obsessed with celebrity worship and all the material trappings that goes with a successful celebrity lifestyle, has enabled many people to escape the chains of their static incomes and their dull lives and they have been able to buy into a whole new lifestyle if they want to.

The boom in second homes has been a symbol of British society’s detachment from reality and this illusion is very likely to end in tears, and very soon. Whilst the UK’s love for holiday investment properties is not likely to become our very own sub-prime disaster, there is no doubt that a large number of people are going to find that an expensive illiquid investment can be something of a nightmare in a falling market and I expect to see a lot of bad luck stories emanating from this sector for many years to come. Bargain hunters should keep their powder dry for now but watch out for some fantastic deals in the next few years.

Sell, sell, sell!!! Oh no, you can't.....

After several years of very enticing double-digit returns and massive inflows of private investor money, the UK commercial property sector is now seeing huge numbers of investors attempt to take their money out. I say ‘attempt’ because many popular funds have imposed long notice periods for withdrawals in order to stem the flow and many people are finding that commercial property unit trusts are not the liquid investment they were claimed to be or were sold as.

One of the main selling points of unit trusts is their liquidity. Property is traditionally a highly illiquid asset class. It takes time to buy and sell a physical property, much longer than it takes to buy or sell a share for example. Therefore, property unit trust managers are usually obliged to keep a certain amount of available cash in their fund to satisfy redemptions when they were requested. However, funds don’t want to hold too much cash because this can dilute overall returns. The problem in the last few months has been the sheer volume of investors wanting to redeem at the same time as there hasn’t been enough cash in most funds.

New Star Asset Management had one of the most successful retail property funds, advertised on billboards across the country last year and valued at £2.2bn. However, after large markdowns in its net asset value, it recently announced that around £500m has been withdrawn from its flagship fund. That is quite a chunk of money to find in a short period of time. Many funds have been forced to sell properties into a weak market to raise cash. When a sale is forced, and valuations are falling, the extra property coming into the market just pushes down prices across the board. Now the big employers in the City of London are starting to reduce headcount and the demand for office space is dwindling.

There are still plenty of new construction projects under way, due to the long interval between getting the green light for the project and the final completion, which means that the supply of offices and shops is increasing at a time when demand is falling. The explosion in new ‘landmark’ construction projects such as the Shard in London will seem like a familiar sign to anyone who watched the Canary Wharf saga unfold at the end of the last property boom and to more seasoned investors it is surprising that we have seen the property boom continue for so long. There has been a huge amount of new construction in recent years as small, old buildings have been torn down to make way for higher and more modern properties. And when you regularly see fully functioning businesses bought and closed down so that their buildings can be turned into apartments or offices, you realise that the business of property, itself often a necessity of business, has become the tail that is wagging the dog.

Property cycles come and go but this one was the mother of all property cycles, both in the UK and in many other countries. It is normal for cycles to end, to recede and then rise again, often even stronger than in the previous cycle, but this time the rush into property was almost frenzied and the exodus out of it was even more rapid. More than £20bn has been invested by small investors in the sector since 2002. Property has long been considered a relatively stable asset class, certainly more so than the stock market, but there has been nothing stable about the collapse in commercial property prices and in the share prices of the companies that invest in commercial property. Many funds have seen valuations fall by more than 15% in just a few months and listed property companies have seen their share prices fall 40% or more.

However, even though this cycle may have ended more severely than past cycles, it is the behaviour of the unit trust managers running the commercial property funds that have presented the industry with their next challenge: how to convince investors to put money into funds that they might not be able to access in falling markets? Many investors have made paper gains in recent years in commercial property funds but a lot of them probably won’t get the opportunity to realise those gains because they can’t withdraw their money for up to 12months. Imagine if all investors across all markets, upon discovering that asset values were falling, were told that they were not able to remove their money. The financial system would collapse.

The very name ‘unit trust’ implies that investors entrust their hard earned savings with the fund managers and expect them to invest it accordingly. But now any semblance of trust between investment managers and investors has been destroyed because it is only when the unit trust statement comes through the door and the investor tries to remove their funds that they realise who has control over their money. If banks suddenly imposed a 12month notice period on formerly-accessible bank accounts then there would be widespread rioting in the high street but investment companies seem able to get away with it.

Maybe in a few months time, when more small investors have received their fund statements and after commercial property values have fallen even further, will we see more protests in the media. It’s possible that we will see investors queuing outside the offices of Jupiter Asset Management or Fidelity Funds, angrily demanding their money to be returned. Or will it become the norm for investment companies to be able to increase the notice periods on funds as they deem appropriate? Will we see the same thing happen to other asset classes? Even though stocks are more liquid, it could be argued that a significant increase in withdrawal demands would increase the level of selling in the stock market, pushing prices down further. In this scenario, should the investment management industry be able to attempt to prop up the market by refusing to sell stocks and refusing to give clients their money back until markets are more calm?

Maybe these extended lock-in periods are simply a sign of the times we are living in today. It appears that many of the largest banks and hedge funds have not been pricing assets to market as they prefer to wait until markets return to ‘normal’. To someone working outside the complicated world of hedge funds it sounds more like they don’t want to be forced to price assets at these levels and are waiting for better prices before they go public with their losses. This kind of attitude might explain why so many of the losses that have been announced have been huge and rather out of the blue. Investors lost a lot of faith in corporate executives after the Enron debacle but it looks like some people at the top of large corporations saw it as a good example of how to cover up problems. It seems that investments are becoming less transparent and some investment managers and chief executives are becoming a law unto themselves.

If unit trust managers start imposing longer notice periods on normal investment funds then investors would have to reconsider whether those funds are as safe as previously thought if there is a question mark over how long it will take to get our money back.

In the longer run, maybe a couple of years from now, we could find that investors distrust of investment management companies has grown significantly. If commercial property values keep falling then there is going to be greater demand for withdrawals and a greater need for fund managers to stop those withdrawals. This could easily be another financial markets scandal that the FSA will have to deal with by drawing up new legislation to regulate the industry and it could be a serious blow to confidence in the industry in general. If the economic slowdown develops into a major global recession on the scale of the 1930s depression, which is a longshot but a possibility, then there is going to be huge scramble to sell assets and the most illiquid ones are going to cause the biggest panics. I suspect we’ll hear more about this issue in the not-too-distant future.

Strong Dollar policy: Is the Fed wearing the emperors new clothes?

The Dollar is still widely seen as the world’s reserve currency, namely the most secure, most liquid currency in the world today. However, anyone living in a country who’s currency isn’t pegged to the Dollar, ie most countries, will have lost a lot of money over the last few years if they have been holding the Greenback. Since the start of 2002 the US Dollar has lost 43% against the Pound, 40% against the Euro, 31% against the Swiss Franc and 37% against the Canadian Dollar. It’s even depreciated against the Yen. For many investors, holding the reserve currency must seem like a license to lose money.

After slashing interest rates to 1% after the dotcom crash, another classic example of financial market mismanagement, the Fed has since raised rates until this year when it started cutting again. Even during this period of monetary tightening, the Dollar struggled to retain its value. The US Federal Reserve has maintained that it has a ‘strong Dollar policy’, which in terms of credibility ranks alongside those other famous US beliefs such as the existence of weapons of mass destruction in Iraq (remember those?) and that Elvis is alive. At the very least someone should inform the Fed that their policy doesn’t seem to be working….. and that it would be difficult for someone as famous as Elvis to hide away for this long without being discovered.

In reality there are plenty of arguments to explain why the Dollar is so weak and why it is no longer needed as the worlds reserve currency. Firstly, the US is the world’s largest debtor country, having formerly been the world’s largest creditor only a few years ago. It can be described as ‘living beyond its means’ and if it were a company it would probably be declared insolvent. In fact, the plummeting value of the Dollar means that the US is, in practise, holding a liquidation sale of its assets such as US treasuries, property and well known businesses, all of which can be bought at knockdown prices by the overseas investor.

Secondly, the Euro provides a handy alternative and is certainly liquid, tradable and relatively strong. Iran already sells its oil in the Euro denomination and other countries are at least considering making the switch. At the last OPEC meeting one of the microphones was left on after the press conference had finished and several ministers were unwittingly heard discussing the subject. Oil producers have been protected from the weak Dollar by rapidly rising oil prices but they probably can’t help thinking how much richer they would be if the US and other countries were forced to pay for its oil in Euros.

Thirdly, if the Federal Reserve continues to print more Dollars each time the economy sags then the Dollar is simply going to be devalued even further. It goes against the laws of nature that something so abundant and easy to create, by simply printing more, should be used as a store of value. In the world of commodities it is the least abundant metals and energy products that are the most highly valued. Gold is doing a great job in its role as the anti-Dollar, with the price having nearly tripled in the last 5 years, because it is a store of value and because supply is limited. If we could master the art of alchemy and simply make gold whenever we wanted then a large part of its value would be lost. This is what has happened to the Dollar. I’m sure that the Federal Reserve Chairman was only trying to be colourful when he said they would drop Dollar bills from helicopters if the economy needed reflating but that comment is on a par with Gerald Ratner saying that his jewellery company’s products were cheap because they were crap, a remark that caused sales to dry up and the company to go bust.

With the US possibly heading for a recession, after years of excess leverage that is now unwinding, the attraction of US assets is waning even further. The question now is “why would you want to invest in US Dollars at all?” There is no good reason; there are alternative currencies that are liquid, there are plenty of attractive foreign assets if you are in the mood for buying up a company and the US is no longer particularly welcoming to foreign ownership anyway, especially if you come from the Middle East.

The US is still considered the premier location for entrepreneurial activity and is the spiritual home of capitalism, materialism and the equity culture but in recent years it has become more of a leader in off balance sheet financial engineering, collateralised debt obligations and sub-prime lending. The spirit that once drove the American Dream is looking a little tarnished and is facing some strong competition from other quarters such as Vietnam (rather ironically), China and India. If the fundamental reasons for investing in the States are becoming less clear then the demand for more Dollars is going to get a little thin. Even the Chinese have realised that it might have been prudent to spread their foreign currency reserves around a bit, having lost billions of Dollars whilst they watched the local currency value of their assets fall. Still, they are probably happy in the knowledge that they could dump their foreign reserves tomorrow and bring the US economy to its knees if they wanted. They probably won’t do that, but they could, and it puts the Americans in a position of weakness.

So, at what point will the Federal Reserve admit it has a problem, and seek help? As Alcoholics Anonymous say, admitting you have a problem is the first step. But many alcoholics can’t give up because they like drinking. And the Fed likes the fact that US exports are a lot cheaper if the currency is weaker, and therefore people start to buy more from them. But ultimately a weak currency is inflationary, as prices of imports rise and interest rates need to rise to attract capital inflows. America can’t afford to raise rates now, at the end of history’s largest credit boom, so it remains to be seen what solution they come up with. But if the Arab states or any other countries that are pegged to the Dollar decide to break those pegs, they will have to do something, or the Dollar will spiral out of control. At that point, make sure you are holding gold.