Over Easter, two close friends upped sticks and moved out of London. Nothing so unusual about that, you might think: people in their mid-30s with young children often leave the capital in search of cleaner air, bigger gardens and better schools. Except that in this case, neither family much wanted to leave. Their plan was to move locally. Their mistake was to sell up and rent while they looked for somewhere bigger, either because they expected the market to move in their favour, or because they were bamboozled by estate agents into accepting an offer on their old home.
Of course, the market didn’t move in their favour. It moved against them – so much so that one couple wouldn’t even have been able to buy back the house they had sold just a year earlier. I know several other people in a similar situation. They will now be hoping the latest rise in inflation and talk of higher rates will bring about the correction that allows them back into the market. I’ve no idea whether their wishes will be granted. As Keynes noted, “markets can stay irrational longer than you can stay solvent”. Instead, the lesson I draw from my friends’ dismal experiences is one of the oldest lessons in the book: the importance of diversification. I’ve written before about the need to maintain a weighting in property and not trying to time the market. But the same principle also works in reverse.
No sensible investor should put all their capital into property and not have a weighting in other assets. If the market does crash, those of us who smugly borrowed to the hilt to buy over-priced houses while neglecting to keep up pension contributions may no longer be feeling quite so clever.
City talk moves to property
Property has not just been a hot topic at suburban dinner parties this week. It’s also been the number-one talking point in the City. If residential prices have gone through the roof over the last year, commercial property hasn’t been far behind. Some prime London office buildings, for example, are being sold on yields of just 4.5% – that’s less than the cost of borrowing. Other types of property, such as shopping centres, have also gone through the roof. Now Michael Prew, the Lehman Brothers analyst who correctly called the rally in property stocks in 2003, has called time on the sector, saying that it is hard to see where the rally can go from here.
I suspect he’s right. But if property stocks are fully valued, there are still other ways to play the property boom. Look at the private-equity bid for Sainsbury’s. There was a firm trading at little over 400p a share until CVC turned up with an offer of 582p. How could it justify such a huge premium? Because the market wasn’t properly valuing its property, which some analysts now reckon is worth up to £10bn – not far off what the whole firm was thought to be worth before the bid. Now Robert Tchenguiz, the property tycoon, is demanding Sainsbury’s spin off its property into a listed real estate investment trust, which he says will force the market to fully value both parts of the business. This follows a similar campaign Tchenguiz has been fighting at pub group Mitchells & Butlers, where he is also a big investor.
Tchenguiz has plenty of opponents. They argue that his claims to be able to create huge value from splitting these firms up depends on being able to put massive amounts of debt on the property and persuade the market to pay full prices for retailers saddled with giant rent bills. In the case of Sainsbury’s, critics argue the margins are too thin for this. Besides, this value creation is illusory, they say, since it depends on pure financial engineering. There are better ways to allow investors to share in soaring property values, such as borrowing against them to fund share buybacks. The snag is that none of these other methods seems to deliver the goods. No matter what ruse retail and leisure firms come up with, none can boast the share-price performance of the property sector.
That’s because investors look at these businesses and instead of seeing juicy property that offers a secure, stable income, they see only the uncertainty of a supermarket group or pub operator, whose earnings are dependent on the quality of the management. Worse, property ownership may actually protect weak managers. Would Sainsbury’s have squandered billions on IT in the 1990s if it had to pay rent?
Tchenguiz is on the side of the future here. Many of the UK’s fastest-growing retailers are leasehold operators, including Zara, H&M and Intercontinental Hotels. In the US, almost all retailers and leisure groups are leasehold, while the property is owned by specialist investment trusts of the sort Tchenguiz is proposing for Sainsbury’s and M&B. This switch will not happen overnight. Sainsbury’s and M&B may hold out for a while yet, but others are likely to come under pressure, including hotel group Whitbread. The first specialist hotel investment trust is expected to float later this year. That suggests that for those looking to play the next stage of the property boom, the best pickings may be found among the retail and leisure sectors.
Simon Nixon is executive editor of Breakingviews.com