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  1. Property
February 17, 2009

Hi-Ho, Hi-Ho! It’s Off the Cliff We Go!

By Spear's

Jeremy McGivern on the flawed logic and mindless herd instinct that led so many property investors over the edge and into the abyss

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 data from the Department of Communities and Local Government. As with Madoff, most property buyers did not understand the market in which they were investing, and more and more exotic ways to invest in property were propagated.

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

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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, in September 2004 for £178,000 was resold at auction last November for £78,000. Imagine being the investors who decided to buy multiple units.

Dubai and overseas property, another much-touted theme, was a classic case of investors buying into a dream rather than looking at the figures. Too many homogeneous apartments were built and the market is more than 40 per cent down in some areas.

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

Just as investors feared they would never be allowed 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 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 retained by clients to buy property, but it is true. If somebody is willing effectively to 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 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 experts giving their forecasts.

Instead, the question to ask 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 having a system in place so that you are the first to hear about opportunities.

Then you can assess each on its own merit and profit, whether you are acquiring a home, building a portfolio or simply buying a flat to give to your children in the future.

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