The Boom in Top End London Properties is About to End
Posted on 27 July 2007 by
Stock markets around the western world look very different at the end of this week compared to just one week ago. What always catches the imagination of the media in these situations is the equity market - after all reporting that an index has fallen several hundred points in one day makes for good headlines.
However, when equity markets move in a big way bond markets usually do the same, but in the opposite direction. This week was no exception but it was the bond markets which led the way, with equities reacting, not the other way round.
The root cause is the rapidly escalating problems which began to seriously surface early this year in the US sub prime mortgage market, as the combination of sharply higher interest rates, falling property prices and irresponsible / predatory lending combined with devastating effect for both borrowers and the capital markets. The extent of the collapse in confidence of investors in sub prime mortgage bonds can perhaps best be demonstrated by looking at the US ABX index, which is linked to 20 U.S. sub prime mortgage bonds rated BBB. This index has plunged a staggering 57% in the last 6 months!
Consequently large chunks of the bonds imaginatively created by the investment banks to finance these sub prime mortgages, which make up about 25% of the US market, are now worthless and many investors have now become so nervous of CDOs (Collateralised Debt Obligations), CLOs (Collateralised Loan Obligations) and other mortgage backed bonds that the market has almost dried up for new funding of anything other than top quality securities.
Given time it will settle down and find a level but the cost of financing US sub prime mortgages will be sharply higher and this will make it even more difficult and expensive for existing US borrowers who are already struggling to remortgage onto a better deal.
The UK sub prime mortgage market is very different to the US market and also represents a much smaller percentage of the total, only about 9%. Furthermore UK lenders’ criteria are generally much sounder than in the US and so I don’t expect problems here on anything like the US scale. However, it would be worrying if the Bank of England pushes Bank Rate up much further as that would help to push property prices lower, leaving fewer options for those borrowers, both prime and sub prime, who can’t afford the higher mortgage payments.
As well as causing some hedge funds to go bust, or at least suspend withdrawals, contagion from the problems in the mortgage backed securities market has inflicted a crippling blow on Leveraged Buy Out activity. Some banks have been unable to sell on bonds they have issued to finance big Leveraged Buy Outs, including a total of £10bn for the takeovers of Alliance Boots and Chrysler. They have thus effectively been forced to sit on these bonds and when they do eventually manage to sell them the losses are likely to wipe out most, and maybe all or more, of the juicy fees they charged for arranging the deals.
The top end of the London property market has been fuelled for the last couple of years by the large bonuses earned by hedge fund managers, investment bankers and others involved in the mergers and acquisitions boom. With the financing crucial to putting these deals together now becoming at best much dearer, and at worst not available at almost any price, the party is rapidly grinding to a halt.
As a result I expect buyers of expensive London properties to become much thinner on the ground as many of the traditional buyers of these properties react to the unwelcome thought that their bonuses for this year will be much lower. London has been the strongest performing region of the English property market recently. That is about to change and I think it probable that after the big gains of the last 2 years top end London properties will fall in value by around 10% over the next 18 months.
Categories: Property market, Bank of England, Mortgages, Personal finance, House and home, Interest rates
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