Last week I met the Iveagh fund manager who touched on the shape of the recovery and it got me thinking about it in more detail. He says we are probably experiencing a v-shaped recovery and that he doesn’t see a double dip coming for economies or markets (although he has only become confident about this during the past 3 months). It made me think about what people would actually be seeing and feeling even if a double dip scenario was ‘in progress.’
The double dip scenario looks like a large W.
We have been down the first part of the w and are now climbing up the second part, so it could still be a V-shaped recovery. However, in order for markets to start this climb up the central part of the W there has to be something driving it. Therefore, one would need to see positive economic indicators and positive stock market sentiment to drive the rise, which is exactly where we are today.
If we were seeing predominantly negative indicators for the economy and stock market then it is unlikely that we would be climbing out of the trough and we would be experiencing something that more closely resembles an ‘L’.
In short, the optimism that we are seeing now, that is built on the belief that the worst is behind us and we are on a sustainable up-trend, is an essential part of a W-shaped recovery which means it is too early to discount the possibility of one occurring.
For the next stage of the W to pan out there would need to be something on the horizon that could derail an economic recovery and knock stock market sentiment. With interest rates at close to zero and government debt levels at record levels a combination of rising rates, higher taxation and government spending cuts is a foregone conclusion and could be the catalyst.
For the V-shape recovery to pan out we need to see growing consumer spending in the West, falling unemployment and stronger corporate investment. This will need to occur against the headwinds mentioned above.
I can see why an optimistic investor could argue that we are enjoying a V-shaped recovery but I also think that it is still too early to say that we are out of the woods as the current economic environment is as much a prerequisite for a W-shaped recovery as it is for a V-shaped recovery.
Wednesday, April 21, 2010
Monday, March 22, 2010
Is the commercial property sector facing a long-term decline in demand for shops and offices?
The government has announced it is going to put as many services as possible online in the next few years. Ministers and their advisers are currently drawing up plans to move the delivery of services relating to passports, job centres, benefit offices and town halls onto the internet. Tens of thousands of public sector jobs could be ‘streamlined’ as a result. This highlights a growing trend in society and suggests that we might already have enough shops and offices for our future needs. Modern life is evolving because technology is forcing rapid changes to the way we work and the way we live and this announcement to cut jobs in public services by automating processes and putting services online is only the tip of the iceberg. The internet is to 21st century industrialisation what the production line was to 20th century manufacturing.
Ever since dotcom euphoria started to take hold and online business began to look like it would change the world people have been claiming that the end of bricks and mortar business is in sight. We got slightly ahead of ourselves by a decade or two but things are changing rapidly now, driven by the need to cut costs, better technology, widespread wireless communication and a need to adapt to a new generation of adults that are completely at home in the virtual world of instant messaging, social networking, text messages and online commerce. These changes, at the very least, raise the question: how many more shops and offices do we really need?
According to a recent report commissioned by the British Council of Shopping Centres, one in five shopping centres in the UK are at risk of defaulting on loans, which suggests that demand for new retail space is weak whilst supply is still growing. There has been a huge amount of new retail space built during the consumer boom and this has continued to some extent during the past two years as lead time from planning to completion is quite long and shopping centres such as Newcastle’s new £170m mall that was opened in February this year will have been conceived before the UK went into recession. By mid-2008, just as the downturn hit home, the rate of retail space development was at its highest for 40 years. Some developments have been postponed since then and some projects have been cancelled altogether due to a lack of financing but there is also a drop in demand from retailers who are experiencing a downturn in consumer spending. It is possible that the nationwide volume of retail space when combined with the potentially long-term effects of the financial crisis could mean that we have sufficient supply for decades to come.
The huge expansion in personal loans, leasing, equity release, credit cards and mortgages in the years leading up to the start of the financial crisis has created what could turn out to be unnaturally high levels of consumer spending, especially in the UK. We are now seeing an increase in the savings rate as households attempt to unwind their high debt levels and this will have a negative impact on retail spending overall whilst it continues. This level of spending might fluctuate in the short term but for the next few years it could actually decline in real terms as consumers come to grips with weak pay increases, persistently high unemployment, reduced government spending, higher interest rates, higher inflation and higher taxes. A decline in spending power hits retailers directly and they may be forced to continue cutting costs and streamlining their operations. Past experience suggests that they will close underperforming stores and focus on improving sales from better-performing locations whilst trying to boost online sales as much as possible. The net effect could well be less need for new shops.
Technology is also having a significant impact on consumer shopping habits. According to Retail Decisions, a card payment business, online sales in the UK increased by 21% between 2008 and 2009 and up to 33 million people made a purchase online. There is a growing tendency for shoppers to spend their time in shops at weekends and then to make their purchases online during the week, with Monday traditionally being the busiest day for online sales. The role of shops is changing and they are often used by consumers simply as a means to physically view items before searching online for them at a better price. The rise of smart phones, such as the iPhone, and netbooks is also making this easier as shoppers are now able to obtain an online price comparison of an item whilst standing in a store looking at it. Portable widespread access to the internet is making it easier and quicker to shop around without moving and online retailers often have a price advantage because they don’t pay high rents for prime retail sites. The extrapolation of this trend, as 24hr online access and the prevalence of browser-enabled portable devices make accessing the internet much easier, suggests that online competition will continue to intensify for bricks and mortar-only businesses.
Demand for office space is another sector under threat on a long-term basis. Outside of London rents are expected to fall during 2010 due to oversupply and the public sector cutting back on workspace requirements. The need to be physically close to other people is diminishing rapidly as communication via the phone and the internet is improving and becoming more widespread. The ability to speak to people and to see them via a webcam is becoming more mobile, less expensive and of much higher quality. The idea of a face-to-face meeting between 2 people in separate cities is now entirely possible and the use of video-conferencing is expanding as it saves time and money whilst still enabling participants to read expressions and body language. Only the physical handshake is missing from the meeting.
The concept of working at a distance has been around for some time but there are certain catalysts that might cause a significant step-up in the evolution of the process. The financial crisis could be one such catalyst, especially if we see the economy drop back into recession, another could be a change in government policy such as tax breaks for those who are prepared to change their habits, but change will probably come more gradually. Advances in technology are making remote working easier and cheaper as mentioned and as companies have sought to cut costs during the recession they have reduced spending on business travel (high and rising fuel prices haven’t helped) and have looked at ways to reduce fixed overhead costs such as office space. The financial crisis has made ‘streamlining’ a priority for businesses that only needed to focus on managing expansion during the boom years and a drawn out period of weak growth could see this continuing for longer than usual.
One particular theme that is rapidly gaining prominence is the misery of commuting and congestion for workers travelling to and from their workplace on a daily basis. The sheer numbers of people moving around the country, especially at rush hours, makes the idea of working from home increasingly more appealing. The roads are already clogged up so imagine what they will be like in 10 or 20 years time if society continues on its current course. The threat of transport strikes as unions fight with employers and the government about pay rises only highlights how pointless so much commuting really is. Home working saves wasted time (some people spend 3 hours a day or more going to and from work), whereas commuting costs money, can be stressful and adds greatly to pollution. Whilst there will always be a need for certain jobs to be located in one single office, I believe it is unlikely that we will need a growing number of centralised workplaces over the longer-term when the alternative is becoming more feasible and more attractive.
I’m not suggesting that the construction industry will disappear, there will always be a need for new buildings, even as technology brings changes to requirements. For example, the adoption of the desktop computer helped automate offices but businesses also required new building designs to accommodate all the cabling under floors and through ceilings. In turn it is likely that changes in technology and their effects on our lives will create new ‘machines’ for living and working (as Le Corbusier described them). Online businesses require warehouses to store goods and an expansion in distance working could see more residential development being adapted to suit the requirement for work space in the home, but the net overall effect is that the migration of services into the online world could change the physical landscape of the country and this would have massive repercussions for the commercial property sector as it stands today.
Ever since dotcom euphoria started to take hold and online business began to look like it would change the world people have been claiming that the end of bricks and mortar business is in sight. We got slightly ahead of ourselves by a decade or two but things are changing rapidly now, driven by the need to cut costs, better technology, widespread wireless communication and a need to adapt to a new generation of adults that are completely at home in the virtual world of instant messaging, social networking, text messages and online commerce. These changes, at the very least, raise the question: how many more shops and offices do we really need?
According to a recent report commissioned by the British Council of Shopping Centres, one in five shopping centres in the UK are at risk of defaulting on loans, which suggests that demand for new retail space is weak whilst supply is still growing. There has been a huge amount of new retail space built during the consumer boom and this has continued to some extent during the past two years as lead time from planning to completion is quite long and shopping centres such as Newcastle’s new £170m mall that was opened in February this year will have been conceived before the UK went into recession. By mid-2008, just as the downturn hit home, the rate of retail space development was at its highest for 40 years. Some developments have been postponed since then and some projects have been cancelled altogether due to a lack of financing but there is also a drop in demand from retailers who are experiencing a downturn in consumer spending. It is possible that the nationwide volume of retail space when combined with the potentially long-term effects of the financial crisis could mean that we have sufficient supply for decades to come.
The huge expansion in personal loans, leasing, equity release, credit cards and mortgages in the years leading up to the start of the financial crisis has created what could turn out to be unnaturally high levels of consumer spending, especially in the UK. We are now seeing an increase in the savings rate as households attempt to unwind their high debt levels and this will have a negative impact on retail spending overall whilst it continues. This level of spending might fluctuate in the short term but for the next few years it could actually decline in real terms as consumers come to grips with weak pay increases, persistently high unemployment, reduced government spending, higher interest rates, higher inflation and higher taxes. A decline in spending power hits retailers directly and they may be forced to continue cutting costs and streamlining their operations. Past experience suggests that they will close underperforming stores and focus on improving sales from better-performing locations whilst trying to boost online sales as much as possible. The net effect could well be less need for new shops.
Technology is also having a significant impact on consumer shopping habits. According to Retail Decisions, a card payment business, online sales in the UK increased by 21% between 2008 and 2009 and up to 33 million people made a purchase online. There is a growing tendency for shoppers to spend their time in shops at weekends and then to make their purchases online during the week, with Monday traditionally being the busiest day for online sales. The role of shops is changing and they are often used by consumers simply as a means to physically view items before searching online for them at a better price. The rise of smart phones, such as the iPhone, and netbooks is also making this easier as shoppers are now able to obtain an online price comparison of an item whilst standing in a store looking at it. Portable widespread access to the internet is making it easier and quicker to shop around without moving and online retailers often have a price advantage because they don’t pay high rents for prime retail sites. The extrapolation of this trend, as 24hr online access and the prevalence of browser-enabled portable devices make accessing the internet much easier, suggests that online competition will continue to intensify for bricks and mortar-only businesses.
Demand for office space is another sector under threat on a long-term basis. Outside of London rents are expected to fall during 2010 due to oversupply and the public sector cutting back on workspace requirements. The need to be physically close to other people is diminishing rapidly as communication via the phone and the internet is improving and becoming more widespread. The ability to speak to people and to see them via a webcam is becoming more mobile, less expensive and of much higher quality. The idea of a face-to-face meeting between 2 people in separate cities is now entirely possible and the use of video-conferencing is expanding as it saves time and money whilst still enabling participants to read expressions and body language. Only the physical handshake is missing from the meeting.
The concept of working at a distance has been around for some time but there are certain catalysts that might cause a significant step-up in the evolution of the process. The financial crisis could be one such catalyst, especially if we see the economy drop back into recession, another could be a change in government policy such as tax breaks for those who are prepared to change their habits, but change will probably come more gradually. Advances in technology are making remote working easier and cheaper as mentioned and as companies have sought to cut costs during the recession they have reduced spending on business travel (high and rising fuel prices haven’t helped) and have looked at ways to reduce fixed overhead costs such as office space. The financial crisis has made ‘streamlining’ a priority for businesses that only needed to focus on managing expansion during the boom years and a drawn out period of weak growth could see this continuing for longer than usual.
One particular theme that is rapidly gaining prominence is the misery of commuting and congestion for workers travelling to and from their workplace on a daily basis. The sheer numbers of people moving around the country, especially at rush hours, makes the idea of working from home increasingly more appealing. The roads are already clogged up so imagine what they will be like in 10 or 20 years time if society continues on its current course. The threat of transport strikes as unions fight with employers and the government about pay rises only highlights how pointless so much commuting really is. Home working saves wasted time (some people spend 3 hours a day or more going to and from work), whereas commuting costs money, can be stressful and adds greatly to pollution. Whilst there will always be a need for certain jobs to be located in one single office, I believe it is unlikely that we will need a growing number of centralised workplaces over the longer-term when the alternative is becoming more feasible and more attractive.
I’m not suggesting that the construction industry will disappear, there will always be a need for new buildings, even as technology brings changes to requirements. For example, the adoption of the desktop computer helped automate offices but businesses also required new building designs to accommodate all the cabling under floors and through ceilings. In turn it is likely that changes in technology and their effects on our lives will create new ‘machines’ for living and working (as Le Corbusier described them). Online businesses require warehouses to store goods and an expansion in distance working could see more residential development being adapted to suit the requirement for work space in the home, but the net overall effect is that the migration of services into the online world could change the physical landscape of the country and this would have massive repercussions for the commercial property sector as it stands today.
Wednesday, March 3, 2010
The Nightmare Scenario for Britain’s Property Market.
The nations favourite conversational subject for many years has been that of house prices and the state of the property market. In spite of a significant downturn in the market since the credit crunch began, we have recently seen evidence of a revival in prices and renewed enthusiasm for the sector as we hear reports of auction houses crowded with property developers looking for a bargain. Buy-to-let investors seemed to have scraped though the crisis and property-related programmes show no signs of disappearing from our tv screens. It was a downturn but not the major crash so many people expected. But what if this was just a taste of what is still to come?
It looks like the huge drop in base rates to 0.5% has staved off a lot of potential pain for the nation’s homeowners but things could be very different if interest rates were forced to rise substantially. By current standards the 1970s and 1980s were characterised by persistently high Bank of England base rates, until they started to come down in the early 90s. These lower rates then laid the foundations for the rise in house prices that started in the mid-1990s and continued their seemingly-unstoppable ascension until the peak in 2007. However, the Bank of England has no more room for manoeuvre, base rates only have one possible course from here: up.
Under the current arrangement between the government and the Bank of England it is the Bank that is responsible for inflation targeting and it is inflation that is the most likely reason for interest rates to go higher. Whilst the Governor of the Bank of England was recently forced to write a letter of explanation to the Chancellor, as inflation reached 3.5% year-on-year in January, the Bank still expects inflation to fall back below this level later in 2010. However, there are growing signs that inflation may yet become a force to be reckoned with.
The Pound has dropped nearly 5% against the Euro in just over two weeks. Europe is the UK’s largest trading partner and the falling Pound means that imports from the Eurozone have suddenly become significantly more expensive. Sterling has also recently weakened against most other currencies, many of which have their own problems to face, which indicates the low esteem in which it is held today. The UK’s dire financial situation and the threat of a hung parliament have led investors to reassess our ability to pay down debt and this is weighing on the Pound, to the extent where some commentators are talking of the Pound/Euro exchange rate falling below parity and with the possibility that the Pound will keep on falling beyond that level.
Whilst UK exports would undoubtedly benefit from a weak Pound the reality is that life in the UK today relies heavily on imports and a severe drop in the Pound pushes up prices for everyone. If the government decides that Sterling has weakened too much, to the point where it seriously undermines the fiscal credibility of the currency, then the government may be forced to defend it, as it did in 1992 when Sterling was forced out of the ERM. Even though the currency is now free-floating and events would not exactly mirror those of Black Wednesday, the question remains: what action would the UK government take if a beaten down Pound meant that import prices were forced up sharply? This could soon feed through into inflation figures and everyone knows that strong inflation is very hard to tame once it becomes imbedded.
If UK interest rates were forced up suddenly to relatively high levels, in order to stifle inflation and to make the Pound more attractive, the effect on the UK property market could be devastating. House prices are still about 40% above their peak in the 1980s housing boom, even adjusted for inflation, and much of that rise has been fuelled by an expansion in mortgage lending. Household debt levels are still high, there are still plenty of examples of high levels of corporate debt (especially in the commercial property sector) and now government debt levels are also very high. In the event that the interest rate on a large proportion of this borrowing was raised significantly then we can expect to see extremely severe stress in all sectors exposed to high debt levels and in particular the property market.
If the Pound continues to weaken substantially from here then it won’t be long before something needs to be done to support it. If rate rises aren’t forthcoming then Sterling could remain weak for some time and that means import prices will stay high. Either way, it’s not good news for the UK economy. Relatively few distressed assets have come onto the market during this recession because the banks have largely been able to service debt at historically low interest rates and they have therefore been able to avoid putting them up for sale but this could all change if interest rates are forced up. Rising yields on Greek sovereign debt have already highlighted how worries about debt servicing can push up interest rates on borrowing and the threat of a downgrade to the UK’s triple-A credit rating have been a reminder of concerns about the UK’s own fiscal situation.
Some hard choices will have to be made about how to deal with the UK’s debt burden at some point but it wouldn’t surprise anyone if it turned out that the political will to deal with the problem was lacking. Unless the economic situation improves without the requirement for ongoing government fiscal stimulus then investors will choose to avoid Sterling or they will demand a premium for holding it, both of which suggest that interest rates will need to rise. If this rise is badly managed by the Bank of England then the bond market will probably force a change. If interest rates shoot up then investors that managed to preserve their capital during the downturn, and who are not heavily leveraged today, could find that the investment opportunities of a lifetime might finally start to appear.
It looks like the huge drop in base rates to 0.5% has staved off a lot of potential pain for the nation’s homeowners but things could be very different if interest rates were forced to rise substantially. By current standards the 1970s and 1980s were characterised by persistently high Bank of England base rates, until they started to come down in the early 90s. These lower rates then laid the foundations for the rise in house prices that started in the mid-1990s and continued their seemingly-unstoppable ascension until the peak in 2007. However, the Bank of England has no more room for manoeuvre, base rates only have one possible course from here: up.
Under the current arrangement between the government and the Bank of England it is the Bank that is responsible for inflation targeting and it is inflation that is the most likely reason for interest rates to go higher. Whilst the Governor of the Bank of England was recently forced to write a letter of explanation to the Chancellor, as inflation reached 3.5% year-on-year in January, the Bank still expects inflation to fall back below this level later in 2010. However, there are growing signs that inflation may yet become a force to be reckoned with.
The Pound has dropped nearly 5% against the Euro in just over two weeks. Europe is the UK’s largest trading partner and the falling Pound means that imports from the Eurozone have suddenly become significantly more expensive. Sterling has also recently weakened against most other currencies, many of which have their own problems to face, which indicates the low esteem in which it is held today. The UK’s dire financial situation and the threat of a hung parliament have led investors to reassess our ability to pay down debt and this is weighing on the Pound, to the extent where some commentators are talking of the Pound/Euro exchange rate falling below parity and with the possibility that the Pound will keep on falling beyond that level.
Whilst UK exports would undoubtedly benefit from a weak Pound the reality is that life in the UK today relies heavily on imports and a severe drop in the Pound pushes up prices for everyone. If the government decides that Sterling has weakened too much, to the point where it seriously undermines the fiscal credibility of the currency, then the government may be forced to defend it, as it did in 1992 when Sterling was forced out of the ERM. Even though the currency is now free-floating and events would not exactly mirror those of Black Wednesday, the question remains: what action would the UK government take if a beaten down Pound meant that import prices were forced up sharply? This could soon feed through into inflation figures and everyone knows that strong inflation is very hard to tame once it becomes imbedded.
If UK interest rates were forced up suddenly to relatively high levels, in order to stifle inflation and to make the Pound more attractive, the effect on the UK property market could be devastating. House prices are still about 40% above their peak in the 1980s housing boom, even adjusted for inflation, and much of that rise has been fuelled by an expansion in mortgage lending. Household debt levels are still high, there are still plenty of examples of high levels of corporate debt (especially in the commercial property sector) and now government debt levels are also very high. In the event that the interest rate on a large proportion of this borrowing was raised significantly then we can expect to see extremely severe stress in all sectors exposed to high debt levels and in particular the property market.
If the Pound continues to weaken substantially from here then it won’t be long before something needs to be done to support it. If rate rises aren’t forthcoming then Sterling could remain weak for some time and that means import prices will stay high. Either way, it’s not good news for the UK economy. Relatively few distressed assets have come onto the market during this recession because the banks have largely been able to service debt at historically low interest rates and they have therefore been able to avoid putting them up for sale but this could all change if interest rates are forced up. Rising yields on Greek sovereign debt have already highlighted how worries about debt servicing can push up interest rates on borrowing and the threat of a downgrade to the UK’s triple-A credit rating have been a reminder of concerns about the UK’s own fiscal situation.
Some hard choices will have to be made about how to deal with the UK’s debt burden at some point but it wouldn’t surprise anyone if it turned out that the political will to deal with the problem was lacking. Unless the economic situation improves without the requirement for ongoing government fiscal stimulus then investors will choose to avoid Sterling or they will demand a premium for holding it, both of which suggest that interest rates will need to rise. If this rise is badly managed by the Bank of England then the bond market will probably force a change. If interest rates shoot up then investors that managed to preserve their capital during the downturn, and who are not heavily leveraged today, could find that the investment opportunities of a lifetime might finally start to appear.
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