A contrarian bet on London housing

House prices in London fell in September year-on-year for the first time in eight years, according to Nationwide. The drop was only 0.6%, but prices for higher-end central London properties have fallen more than in the outer boroughs. This is due to a number of factors, including higher taxes, uncertainty about Brexit, the increasing supply of newly built flats, and plain old cost – prices have run well ahead of earnings. But for contrarians, the current gloom provides a great opportunity.

The share price of Capital & Counties (Capco, LSE: CAPC), the property company redeveloping the Earl’s Court site, peaked in mid-2015. Since then it has fallen by 45% to 262p, giving the company a market value of £2.17bn. At that price, the shares trade on a 33% discount to net asset value per share, despite the fact that two-thirds of the portfolio is doing rather well.

In fact, £2.4bn-worth of Capco’s property assets (comprising 73 properties and 463 lettable units, from shops to residential blocks) are in Covent Garden, where valuations are still rising. In the six months to mid-June, the valuation of Capco’s Covent Garden holdings rose by 1.5%, while “estimated rental value” (ERV – the potential income if all properties were re-let at current open-market value) rose 3% to £99m. Capco targets an ERV of £125m by the end of 2020, based on improvements to the estate and rising rents, which in many cases are still below those of comparable quality areas in central London.

With Covent Garden accounting for nearly all of Capco’s market value (barring £620m of debt), there’s little in the price for the 70-acre Earl’s Court site, which will hold a minimum of 10,000 new houses. The Earl’s Court “Masterplan” development envisages 8.9 million sq ft of residential property and two million of commercial.

(This excludes the 7.5-acre Lillie Square site to the south, which is the first to be developed and will provide 608 flats for sale, plus 200 affordable homes. Half the units have been pre-sold and 78 completed, with Capco owning 50% of the development.) Work at the Earl’s Court site is currently “preparing the land for future development”, which includes the challenge of sinking foundations for buildings that will span several tube and railway lines.

Even more conservative is the zero value placed on the area (comprising a third of the Masterplan) that was bought from Hammersmith and Fulham council for a fixed price of £105m, of which £60m has been paid. Capco is committed to replace the 760 homes in the West Kensington and Gibbs Green council estates, allowing the building of significantly more flats in the area for private sale.

Also excluded is the likely inclusion of Transport for London’s (TfL) Lillie Bridge depot, though TfL will presumably extract tougher terms than Hammersmith. With prices in Lillie Square currently around £1,400 per sq ft and building costs of £69,000 per flat, it is not hard to see the whole development generating many times its current valuation of £1.1bn, especially as prices rise, rather than the modest fraction of it that the current share price implies.

London prices should start to pick up in 2019, says KPMG, which makes 2018 a good year to buy. Those with a less-than-apocalyptic view of post-Brexit London should buy Capco shares now, following finance director Situl Jobanputra. He bought 37,500 shares in July at 296p.

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