385: UK Property Update - The Commodities Bull, Inflation Bear and London opportunities
07-09-2011
PropertyInvesting.net team www.google.co.uk 
Re-Balancing: This is a rebalancing process after 13 years of Labour government ending May 2010. Labour pumped billions into public sector government jobs and projects in outlying provincial areas. Employment levels rose, salaries rose and house prices rose. Taxes on the wealthy were used to help fund this spending binge, along with increases in national borrowing and debt. We are now paying the price as we all know for these excesses. It will be a long drawn out process of re-adjustment. If the UK citizens revolted, then the economy could end up looking like Greece - in a downward spiral. This is not likely but at least we now know what it looks like if it goes pear shaped.
North Sea Tax Hike Mistakes: Labour benefitted from high North Sea oil revenues, increasing oil prices, high oil and gas production peaking in 1999 and a massive expansion of the financial services sector in the City of London. Years of tax increases led to a decline in oil and gas investment therefore accelerating production declines – leading to the UK imports 10% of its oil needs and 50% of its gas needs in 2011. 
Petro-dollars have dried up. One reason why Sterling has dropped – remember it used to be a “Petro-Currency” in the 1990s.
Tax Revenues Drop: This lack of oil tax revenue has made it far more difficult to balance the books. As Labour left office, the deficit was over 10% of GDP, massive by any standards. As businesses have closed, and public sector job cuts have eaten into tax revenues, it’s been very difficult to reduce the deficit. If the Tories were frank about the current situation, they would probably admit it will take years to re-adjust the economy. It took the Tories at least ten years last time to get the country back into shape after mismanagement in the 1970s, with a recovery from 1977 to 1987. This time will probably be no different – from 2010 to 2020. Another 8½ years left.
Energy Prices Rise: Up until about 2018 we will see inflation increasing as energy prices rise. Inflation is frankly out of control. The Bank of England has been sitting on its hands crossing its fingers hoping that inflation will drop. But it won’t. It will stay high and get higher. They will eventually be forced to ratchet up interest rates dramatically – this will the precipitant the next severe stock market correction.
Bank of England Inaction: Most people expect rates to start rising slowly sometime mid 2012. It’s difficult to say for sure, because one thing seems quite clear, the economy is not growing. We have good old fashioned stagflation and it’s probably the only way out of the mess. To have inflation running at 6%, wage rises at 3% and overall drops in real disposable incomes of 3% for a period of maybe 5 years looks appropriate. This is one reason why we would not expect to see any significant house price rises in areas far from London for quite some time. Don’t expect the government to advertise this though, it’s not a very pleasant message.
Mortgage Debt Reduction: The good news is the debt on mortgages will be inflated away quite rapidly. House prices will probably increase but not keep pace with inflation. This happened in the 1970s and early 1980s. It’s part of a cycle that we believe will be repeated. We also think the Bank of England discusses this in their closed chamber – a smart bunch of people - and have deemed it best to stop printing money, keep rates very low and keep their fingers crossed but realistically expect inflation of 5% or more for some time, particularly if oil and gas prices keep rising as expected. They have been wrong on inflation for years now (or just not telling us the real story). They don’t seem to be able to get the message (or are not telling us the message) – that inflation is here to stay. It’s quite possible they know and are just not telling us, because they want wage rises to remain low to re-balance the economy – and avoid emotion and at worst civil disorder.
Inflation Reduces Debt: Enclosed are two example scenarios that illustrate why so many investors choose to invest in property as a hedge against inflation. The example are for a property of value £160,000 with borrowing of £125,000. In example A, with 5% annual inflation, the real terms 2011 debt after ten years is only £74,842 - assuming interest only mortgage payments. In example B, this debt reduces with 7% inflation to a mere £60,498 after ten years (less than 50%). So as long as a property investor can afford the interest rate payments - and the rent is high enough - the debt reduces quickly. Even if the house prices trail inflation by 1% or 2%, the proportional equity (gearing) rises significantly. In example B, the equity rises from £35,000 to £161,536 - and when adjusted for inflation, from £35,000 to £96,717.
A. Annual -2% real term house price decline (2% less than 5% inflation) and 5% real term rental price increase
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Price
160000
164800
169744
174836
180081
185484
191048
196780
202683
208764
215027
Borrowing (nominal)
125000
125000
125000
125000
125000
125000
125000
125000
125000
125000
125000
Borrowing (real terms 2011)
125000
118750
112813
107172
101813
96723
91886
87292
82928
78781
74842
Equity
35000
39800
44744
49836
55081
60484
66048
71780
77683
83764
90027
Borrowing Inflation Adjusted
125000
118750
112813
107172
101813
96723
91886
87292
82928
78781
74842
Rental
7200
7560
7938
8335
8752
9189
9649
10131
10638
11170
11728
Yield on Borrowing
5.76%
6.05%
6.35%
6.67%
7.00%
7.35%
7.72%
8.10%
8.51%
8.94%
9.38%
Inflation house prices
3.0%
Inflation
5.0%
Inflation rental
5.0%
Deflated back to today
53902
56739
59725
62869
66178
69661
73327
77187
81249
85525
90027
B. Annual -1% real term house price decline (1% less than 6% inflation) and 4% real term rental price increase
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Price
160000
169600
179776
190563
201996
214116
226963
240581
255016
270317
286536
Borrowing (nominal)
125000
125000
125000
125000
125000
125000
125000
125000
125000
125000
125000
Borrowing (real terms 2011)
125000
116250
108113
100545
93507
86961
80874
75213
69948
65051
60498
Equity
35000
44600
54776
65563
76996
89116
101963
115581
130016
145317
161536
Borrowing Inflation Adjusted
125000
118750
112813
107172
101813
96723
91886
87292
82928
78781
74842
Rental
7200
7488
7788
8099
8423
8760
9110
9475
9854
10248
10658
Yield on Borrowing
5.76%
5.99%
6.23%
6.48%
6.74%
7.01%
7.29%
7.58%
7.88%
8.20%
8.53%
Inflation house prices
6.0%
Inflation
7.0%
Inflation rental
4.0%
Deflated back to today
96717
101808
107166
112806
118744
124993
131572
138497
145786
153459
161536
Gas Prices and Inflation: It’s of course galling to see British Gas announcing gas price rises of 18% a 
few weeks after the Chancellor imposed a punitive extra 18% tax on gas producers in the North Sea. Gas production is now dropping at record levels – 15% per annum (up from 5% a few years ago) and gas imports have sky-rocketted recently. Much of this gas comes from Qatar, the other side of the world – and gas prices have risen sharply. So much for energy security and energy independence – the UK Chancellor has just shot us in the foot. The quicker they reverse this tax hike the better – and we might start to see less oil and gas production declines and increase revenues – our oil and gas import bills have doubled in the last few years and revenues dropped. And we all know that when inflation rises next month, the Bank of England and Government will blame it on energy prices!
Trends: In summary, we are about:
* 60% of the way through a cyclic 17.5 year stock market bear run
* 60% of the way through a cyclic 17.5 year commodities market bull run
* At the start of an inflationary period of 7.5 years
* Which ends when the FTSE100 stock market is lower than today in numerical terms, but about 40% lower in inflation adjusted terms, ending a 17.5 year bear market when the FTSE100 has dropped to a staggering 25% of it’s original real inflation adjusted value of end 1999.
Depressing Low By Mid 2017: At this most depressed point, house prices will be depressed and stock markets will be depressed though commodities prices will be very high and be blowing-off. At this point we would expect commodities prices to drop sharply followed by the start of a 17.5 year stock market and house price bull market, and 17.5 year commodities bear market.
London Property Safe Haven: What we are saying is, property will still be a good in
vestment in London and other select areas in the UK, but average property will not keep up with inflation. Prime property – over £1 million properties in London – will probably rise at just above inflation over this same period as richer people shift money from stock markets into the safe haven of prime property in this select international destination.
Low End Going Nowhere: Don’t expect the same in low priced sub-urban areas of SE London for instance (e.g. Sidcup). This will be an entirely different market. Same for Dagenham, Thamesmead and other areas with high unemployment rates and poor transport communications.
Manchester: In the north Manchester probably has the most potential during these challenging times – because business is expanding, the city has an excellent airport, the are two big football clubs and the BBC has moved north to Salford- the city is also a regional hub which overtook Liverpool in the 1970s and never looked back. 5 million people live in the area within a 1 hour drive.
Aberdeen: This city is another hotspot because of the high oil prices – the city is also a hub for international energy firms and engineering services. It has been hampered by the North Sea Oil tax hike which will cut production, but it was already growing strongly from international overseas engineering projects.
Commodities: One common theme of course is that both London and Aberdeen are positively impacted by high commodities prices. As global oil supplies tighten into 2012 and oil prices rise further, massive profits will be made by commodities brokers, oil firms and international people in the Middle East, Africa and Russia - much of this money will find its way into London prime real estate as a safe haven for the super rich. Let’s face it, if you had made a billion in Africa in oil investments, would you buy African real estate? Probably not. This money finds its home in Chelsea, Kensington, Notting Hill and Mayfair real estate – African, Middle East investor etc.
Tightening of supplies cause oil prices to rise - proprietory in-house model -:
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Mining Centre: London is also home to many new mining and oil/gas firms, and investment banks make serious money from fees and investing in these start-ups - this money is also circulating London and finds its way into prime property. Go to an expensive restaurant in South Kensington – you won’t find many indigenous UK citizens. It’s international wealthy people that enjoy the culture, history, freedom, liberty and services that London has to offer. This won’t change any time soon. It dates back to when Britain had an Empire – and it still fosters these relationships in some shape or form.
Peak Oil Production UK - decline accelerates as taxes rise and investment declines:
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Peak Oil: Finally our latest modelling of Peak Oil re-affirms that demand will outstrip supply moving forwards unless there is a global recession. As this supply-demand tightening increases - exacerbated and accelerated by the Libyan civil war and global tax rises – oil and gas prices will continue to rise – a continuation of the 17.5 year bull run we mentioned earlier. The only way to close this gap will be if price rises cause demand destruction thence people use less oil – mainly through driving less or switching to more economical methods of transport.
Opportunities: This will continue to lead to big opportunities in:
-
Oil, gas, LNG
-
Wood
-
Shale Gas
-
Gold
-
Silver
-
Oil Sands
-
Oil Shale
-
Copper
International: Key investment opportunities will be in Africa, India, China, Brazil, Canada, Russia and Australia – the key resources countries (along with Shale Gas in the USA). However, we would be very careful investing in anything exposed to the USA at the moment. The USA has still not sorted out the debt ceiling rise above $14.3 Trillion, and is running a deficit of $1.15 Trillion which is close to 10% of GDP. On 30 June 2011 the Fed stopped printing money. We think bond and interest rates will need to sky-rocket to help auction off more US debt. It all looks like a mess and an accident waiting to happen. The only US investments we would consider are shale gas, oil shale, coal and oil services at present. We really see no upside and a huge downside in most stocks and real estate (except Texas and North Dakota) – the US stock market is due for a 25% correction downwards sometime in the next year.
Saudi Oil Production Export Decline Consumption Increase Peak Oil - Saudi is the global "swing oil producer" but has "run out of steam". Our modelling indicates that even though it is able to marginally increase production, it's overall exports will still decline because of its increased oil consumption based on accurate modelling. Export will decline. One key reason why supplies will tighten into 2012 onwards.
International Commodities: We remain convinced that commodities in overseas destinations are the best investment – along with London prime real estate – or as close as one can get to these areas - for UK property investors.
Property hotspots for London are likely to be:
1 Chelsea, Kensington, Mayfair, Notting Hill, Soho, Bloomsbury (prime)
2 Hoxton, Battersea, Clapham, Wandsworth, Islington (close to prime)
3 Highgate, Hampstead, Wimbledon, Surbiton, Richmond, Chiswick (traditional rich)
4 Stratford, Limehouse, Kings Cross, Bow, Hackney, Hoxton, Shoreditch, Bethnal Green (rising stars)
Young Vibrant Business: The demographics of London are 
also far more healthy than other parts of the country. It has the youngest and most rapidly growing population. And not enough homes are being built. 800,000 extra people are expected in the next ten years, but building rates are only 25,000 homes a year maximum. No wander rents are going up, and property prices should rise broadly with inflation as long as there is not an economic meltdown. Even if they don’t the debt will be reduced significantly for all those people with large mortgages. 5% compounded over ten years is a 60% reduction in the real terms value of the debt – no wander people like property when there is a bit of inflation around.
Central London Best: Not much different to what we have been advising for the last five years though more focussed now on Central London opportunities in the upper end of the market, as cash rich international buyers pile into the market off the back of high commodities prices, high inflation and the prolonged stock bear market.
Final Thought of the Day for Investors: If you read mainstream ne
ws, watch hours of mainstream popular TV - then don’t expect to become rich or make money. You will learn very little. You will get poor advice. You will hear stories of crime, scandal, war and terror – all negative news. Meanwhile there will be a select group of ultra-rich investors spending their time learning about investments, gaining financial acumen and actioning investment opportunities. These same people will probably end up giving much of this money away to charities in their latter years. They will have fun making money. They will have fun giving it away. Meanwhile the masses will be watching news about the news (e.g. BBC on News of The World). There’s nothing more galling than hours of news on the news when people are starving in East Africa. Egos feeding egos. Part of the large media family. News? Better off actioning investments.
Insights: We hope this all makes sense to you and you can also see its part of a trend – that this is not likely to change much in the next five years. Commodities, London prime real estate and inflation all the way! We also hope this Special Report has delivered some interesting insights to you. All for free as normal. If you have any comments, please contact us on enquiries@propertyinvesting.net If not, that’s great of course and we hope this helps your investing strategies.