Property, Credit crunch and Investment – Part I

This short analysis is prepared to assist a private sector house builder facing the credit crunch. In the next posts we provide strategies and insights in evaluating the development scheme and improving its performances…

Location Analysis

The site has the advantage of strategic location nearby the City of London. We found only a small number of local shopping facilities, suggesting the need for small scale retail units. Residential streets north of the property contain a mix of older homes and new infill development. Employment centers are accessible by car and public transport.

Market Area Definition

Interviews with estate agents identify the primary market area (PMA) with the following places: Gloucester City, Audubon, Brookway and Oaklyn.

Housing Characteristics

Homeowners occupy 70% of all housing units in the PMA, vacancy rates are between 3% and 5%.

Demographic Characteristics

The suburb has a total resident population of 1.000.000.

Inflation and Interest Rates

The Monetary Policy Committee has nominal target of 2% (medium term) for the CPI. The average loan for the construction market trade at 5%, but conditions may vary.

Employment/Unemployment

The unemployment rate in the suburb rose to 2.9% in 2009 (4,5% national average), a 1.2% increase is partially offset by an increase in goods producing sectors.

New Construction Activity

In most of the jurisdictions within the PMA, there are no new developments of similar units while the commercial sector is experiencing some growth.

Housing Supply

We find an average price of £ 120.000 for 800 homes sold in the PMA with characteristics similar to the ones developed; we note a decrease in the last 6 months in all but two of the zip codes within the PMA mainly due to the tight conditions of the mortgage market.

Housing Demand

We note an increase in the number of households, the need to replace obsolete units, shifts in tenure by renters in PMA becoming homeowners and changes in household income and in the prices of the units available. Affordable housing units will serve households with income ranging from £ 15.000 to £ 35.000, we estimate a capture rate of 2% of age and income qualified households. Market rate units, for which we estimate a capture rate of 5%, are targeted to the income band from £ 35.000 to £ 65.000.

Buyer Profiles and Home Features

It is expected to serve first time buyers with a small percentage of senior households. While not provided in the units object of development, we note that surveys report the availability of additional storage area and energy saving features as characteristics that could command +8% on average prices.

UK Property Market

The property market, especially the residential sector, had inflated from 1990 until 2008, with a rate of growth in prices that cannot be compared with the rate of growth of wages. In this moment, the mortgage banking sector is experiencing one of the longest period of tight liquidity. Certain policies such as the Bank of England’s Funding for Lending scheme and the government’s Help to Buy scheme are helping to increase the demand for housing. In the rental market conditions are little changed over the past months with landlord instructions more or less stable and moderate growth in tenant demand. Rent expectations are estimated to grow by 1.7%. See Appendix 1 and 8 for further details.

To analyze the development we start from the net rent, obtained from comparables, and the realized sale’s value. Given the risk premium, which for simplicity we assume to be the same for the residential and commercial part, we find a corresponding opportunity cost of 4% reflecting the tight condition of the mortgage market. Since inflation in the last 10 years averaged 2%, the 6% construction loan less inflation and opportunity cost calculate a 0% lender development premium. Thus, we can conclude that the financial costs are of difficult improvement. We have bootstrapped different yield curves to obtain estimates of the previous financial environment:

· with a lower opportunity costs we find corresponding property values that may or may not represent the real market value but that in some way point to the expected value that the RE market will adjust to.

· It is when demand in the RE market is growing that lenders start to support the property cycle.

We provide a simulation of a similar behavior with the stock flow model for the purpose of qualitatively reassume the argument. We suggest to use traditional and modern methods to valuate: RLV, SFFA and NPV of project to assess the initial viability of the scheme, DCF to analyze and appraise the real development. The main difference between DCF and the other models relates to the timing and extent of cash out flows since different patterns of expenditures have a strong impact on financial costs.

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