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  1. Property
February 2, 2009

Bernie Madoff Syndrome

By Spear's

Jeremy McGivern wonders why property investors never stopped to consider that what comes up must go down

Bernie Madoff’s Ponzi scheme and the British property market may seem like different worlds, but the reasons for the losses suffered by the sophisticated investors in Madoff’s fund are identical to those made by many purchasers of property in recent years.

The false premise in both cases was that you were guaranteed to make alpha returns. Madoff’s fund produced good and absurdly metronomic results. Property, as we know, only ever goes up… The extraordinary thing is that in both cases most people knew that neither claim was true: there had been numerous warnings about Madoff’s fund and anyone who was financially sentient in the early 1990s knew that property was not a sure-fire winner.

Unfortunately, fear and greed, the friends in the bar who urge you to have another drink even though they know you are driving, exerted their malign influence. Their sales pitch – ‘it’s different this time’. Consequently, few were willing to question the prevailing logic: Bernie had his suitably vague investing system, while the UK property market was safe because there was no more land on which to build.

Demand would always far exceed supply apparently. But if demand was so strong why weren’t rents keeping pace with the rise in prices? If there is not enough property, that must mean there are not enough homes for people to live in – irrespective of whether you are renting or buying. Fact: there are 762,635 empty homes in England according to the latest data from the Department of Local Communities and Local Government.

As with Madoff, most property buyers did not really understand the market in which they were investing. Just because one has lived in a house does not mean one understands property any more than using petrol qualifies you to invest in oil shares. Unfortunately with prices sky-rocketing more and more exotic ways to invest in property were propagated.

One phenomenon was property clubs. Some of these were legitimate, but some were simply a scam. The basic premise was that by being in a club (for which you had to pay membership and then commission on each transaction) you would get discounts buying off-plan because of the club’s bulk purchase.

Unfortunately, a discount is not a bargain if the property is hideously overvalued in the first place. For example, a flat bought in Sherborne  Street, Birmingham, on 23/09/04 for £178,000 was resold at auction on 26/11/08 for £78,000. Imagine being the investors who decided to buy multiple units.

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Then there was Guestinvest. The premise was that, instead of a pied a terre, you could buy a hotel room and earn income from the room when you weren’t using it. The group went into administration in October last year.

Dubai and overseas property, another much-touted theme, was a classic case of investors buying into a dream rather than looking at the figures. Many investors bought on the back of the celebrities who were highlighted as having bought there – following celebrity endorsements has never been a shrewd decision.

Too many homogeneous apartments were built and the market is over 40 per cent down in some areas. Nakheel, the developer, has scaled back dredging at the Palm Deira and even the Trump International Hotel & Tower is on hold.

Of course all of these ideas were great when the market was soaring. But, as investors in Madoff’s fund are discovering, these investments were not as solid as they may have seemed.

Even the super-prime end of the market has belied the myth that it was invincible. For example, the buyer who defaulted on his purchase of a £36-million penthouse in Knightsbridge, forfeiting his 10 per cent deposit. Or the house in Mayfair which is in the hands of the administrators – asking price: £17 million.

Just as investors feared they would never be allowed to have access to Madoff’s fund, the fear for many property buyers was that if they didn’t purchase then they would never be able to afford or find a suitable home – this was just as true for buyers in the ‘super-prime’ market as for the average man on the street.

Meanwhile investors didn’t worry about the yield on their properties as the capital gains adequately compensated for the shortfall in rents. Consequently, they were buying liabilities rather than assets.

But why buy when it is so considerably cheaper to rent? This may sound odd advice coming from somebody who is retained by clients to buy property, but it is true. If somebody is willing to effectively subsidise you to live in their property let them.

You will also not have to worry about maintenance costs, service charges, stamp duty or tumbling prices. We have recently found an apartment in Holland Park for clients while they are waiting to buy – Asking price for sale £2.5 million, rent negotiated £1,200 per week = 2.5-per-cent yield.

So what should one do now? The question the majority are asking is ‘when will the market hit the bottom?’ This misses the point. Trying to time the market is a case of luck rather than judgement, despite the numerous experts giving their forecasts.

Instead, the question you need to ask yourself is ‘how can I ensure that I am in the right place at the right time to take advantage of good opportunities when they arise?’ There will be some exceptional bargains, though waiting for the market to come to you will end in failure.

The chance to buy astutely arises when someone is forced to sell. This will often happen well before the market is at the ‘bottom’. It is a question of patience and having a system in place so that you are the first to hear about these opportunities. Then you can assess each on its own merit and profit accordingly, whether you are acquiring a home, building a portfolio or simply buying a flat to give to your children in the future.

Jeremy McGivern is the Founder and Managing Director of Mercury Homesearch

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