Wednesday, October 03, 2007

Hedge Funds and the UK Property Crash

One of the quirky things about the UK economy of recent years has been the inexorable rise in the property market. In 1998 I lived in a 2 bedroom riverside apartment in a converted Victorian hotel. The views were fantastic and for a young man with a plan it was the perfect location. The walls were paper thin and the whole building needed some work, but all in all it was a great bachelor pad. So I decided to buy it.

The lady who owned it wanted £180,000. I explained to her that there was zero chance it was worth anywhere near that and offered £160,000, she declined. That very same flat is on the market today for £450,000, the building still needs work doing and the walls are still paper thin..

This is not even in London, where the story is even more crazy. What a lot of people have forgot, however, was the early nineties property crash when you could not give property away. The rumour is that hedge funds think that this state is on its way once again..

According to the Sunday Telegraph, Hedge funds are aggressively short-selling shares in U.K. home builders, developers and landlord companies in anticipation of a drop in Britain’s housing market. Big bets have been placed on shares of Persimmon Plc, the U.K.’s biggest home builder and Grainger Plc, the nation’s biggest quoted investor in residential property. Data Explorers research shows that 13% of Grainger’s shares have been sold short, nearly four times the average short for companies on the London stock market. Short-selling of Persimmon’s stock has grown from 2.5% to 8%.

“Investors have significantly increased their short positions on property stocks across Europe,” William Duff Gordon of Data Explorers is quoted as saying. “Residential property stocks are now some of the most heavily shorted shares in the market. This reflects an increasingly gloomy outlook for the residential property market among some investors.” According to property investors who spotted the short-selling, the hedge funds seem to be taking positions on the basis of sentiment about the wider residential property market rather than the individual companies.

The chart certainly doesn't look good, but if there was an unravelling of the UK housing market, what would be the factors?

Firstly, Northern Rock were one of the biggest lenders in the UK to people of low credit. They will lend up to six times earnings and have a product that gives a 125% mortgage..still, believe it or not.

I can only imagine that whomever takes the company over will be reviewing those particular situations very carefully and if you take products such a these out of the market it starts to look bad for first time buyers. If first time buyers are squeezed out of the market there will, obviously, be trouble.

Also the market in the UK has been fuelled by 'buy to let' mortgages where people were buying everything that came onto the market to rent out. I would imagine that a lot of people will be looking at these properties and wanting to consolidate their portfolios. According to Bank of America's Matthew Sharratt, buy-to-let property prices relative to rents have surged to an unsustainable 60% above their long-term average.

With UK property being so expensive and therefore purchasers having to extend themselves to the limit in order to afford property, then any interest rate hike could be a killer for these property speculators and it looks as if we are in a period of interest hikes.

The bottom line is that property prices have been outstripping earnings for many years and a correction is well overdue, with the credit crunch starting to bite, interest rates moving up and sentiment changing to one of caution by buyers then a price fall is inevitable. We have already seen a slowdown and in some parts of the country even a fall in prices.

There are, of course, mitigating factors such as higher immigration and high demand etc but the question is; will these factors be enough to avert a crash or just enough to give the 'correction' a soft landing?

This BBC report is good additional information:

Or for a more amusing take... those of you in the UK will recognise the ever positive people on a certain housing program.

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