Thursday 16th April, 2009
REFRACTED BOUNCE, OBVIOUS - ONCE YOU'RE AWARE OF IT!

There is an old adage that asks "if you take a man and put his feet in the freezer and his head in the oven, is he, on average, comfortable?" You see, the problem with averages is that while they may suit politicians, statisticians and strategists, they don’t necessarily help when determining specific short term tactical decisions.

According to the Halifax price index (and the Nationwide Index is broadly similar) the UK property market has seen a drop in average values of around 17.5% in the last 12 months. But this is only half the picture. Our own research shows some values (certain new build city centre apartments for example) have fallen by as much as 65% in extreme cases, whereas the desirable 4 bed detached on the development within striking distance of the motorway and in the catchment area of a couple of great schools has fallen less than 10% over the same period.

You may feel that this is stating the bleedin' obvious and, to an extent, I agree. However, what is much less obvious is the significance of the way these different property types will recover from the substantial correction in values over the last 2 years.

Although there are many differences between this downturn and the last comparable event in the late eighties, there are also an awful lot of similarities. I have spent many hours going through our archives here at the Agency to look in detail at how values moved both going into the downturn of 20 years ago and, crucially, coming out of it.

Broadly, I was able to separate all of the new build developments we were involved in at that time into 3 categories, which, for easy description I have called primary, secondary and tertiary. Anybody with more than a few years experience in the residential property sector will know precisely what I mean.

The primary sites are those which always sell, regardless of market conditions. In good times sales rates will be deliberately slowed to take advantage of rising prices and to extract best value from every plot. The sort of site you know as soon as you see it and the one that everybody tries to buy and which, ultimately, drives the inflationary process.

The secondary site is the bread and butter product most loved by the volume developers, often built on Greenfield sites and much less in evidence since the advent of PPG3 and the move to regenerate our towns and cities. A good mix of houses and apartments, not too many three storey designs, with good access to established centres of employment and commerce.

Finally our tertiary site is the classic example of the one we just ‘had to buy to achieve our volume for the year’ , it often involves high rise apartments or is sited in a particularly dodgy area of town, or maybe even miles from anywhere which, in better times might just make it appealing to second home buyers.

By looking at the change in advertised prices over the last 12 months for these different types of development we have been able to arrive at the figures I suggested earlier, 5-7% reduction for primary, around 20% for secondary and an average of 48% for tertiary. They are broadly similar to 1989/90. (Don't forget, these figures are based on actual advertised prices. If you look at the Halifax Price Index for the 89 to 91 period you will be shocked by how shallow the dip in prices actuallywas - on average!)

Then I took a look at how these different grades of development emerged from the downturn back then and what became very obvious very quickly was that their ‘bounce’ from the bottom of the market was refracted in inverse proportion. The more steeply a value declined going in, the shallower its emergence coming out (see the accompanying chart). What all three grades of development shared was the timing of their lowest value.

The chart assumes the market's low point will be March 2009. The figures up to March are actual and the figures from April onwards are estimated on the basis the market emerges in a similar fashion to the early 90's.

What causes this fluctuation in value change is that most difficult of human qualities to control, sentiment. When the prevailing sentiment among property buyers is that we are at or close to the bottom of any downturn, the likelihood is, we have already passed it. Just note how, right now, any good news from the RICS, the Halifax or the Nationwide, or even the Government, is treated with deep scepticism by the media and influential voices everywhere. Nobody wants to be the fool that suggested the lone swallow, blown off course, and arriving weeks ahead of his mates, meant that summer was well and truly here. Even Bellway, the UK’s fourth largest developer, warned that their better performance since December didn’t necessarily reflect an upturn and may just be a ‘Spring Bounce’! As a result, by the time our nervous journalists are prepared to agree things might be getting better, the bottom of the market probably passed a month or so before.

Once the stories start appearing in the press, prospective purchasers see the opportunity to take advantage of the change in sentiment and seek the opportunity to cherry pick the best plots on the best sites or the most desirable second hand properties before they leap up in value.

As a consequence, those sought after properties appreciate dramatically while the secondary and tertiary stuff is less earnestly pursued and its values are reflected accordingly. All of the evidence we have taken from asking prices for new homes on sale between 1988 and 1991 endorse this theory.

It is worth making the point however that this variance appears to eventually even out, as availability aligns across all three grades. Although this may take two or three years.

So why is this theory important?

For the property investor and the land buyer in particular, provided they can accurately identify prime sites, it makes calling the bottom of the market much less critical. Let us suggest for example that a land buyer believed that we were close to the bottom already and took advantage to cherry pick a prime site currently on the market. Let us further suggest that he was hopelessly wrong in his assessment of current conditions and we are in fact still a year away from any sort of a recovery; provided our land buyer was right about it being a prime site, the value would probably fall no more than 5%-7% in that time and, if history can be believed, that deficit would be recovered in as little as three months once the upturn was underway.

Opinions vary about the current state of the UK property market. Personally, I am convinced that the decline is slowing rapidly and we will see the classic ‘average’ indices rising next year. Indeed, I can state as a fact that some of those prime sites to which I allude have already increased their prices in the last two months. I know of ten new build developments among the 800 or so which our group has an involvement in where prices were increased in April.

Green shoots or spring bounce? Who can say? But one thing is for certain, as a consequence of ‘Refracted Bounce’, the risk of investing is dramatically reduced if you restrict yourself or your business to genuine prime properties and developments.

You can be certain that those who are able are already picking the cherries as I type.