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Archive for August 24th, 2011

Quick someone, get the smelling salts. Ryanair’s Michael O’Leary has fainted at the news that a group of 16 influential and rich French businesspeople has written an open letter to their Government to seek the introduction of a temporary new tax on high incomes until such time as the French deficit is eliminated. And today the French government obliged and announced a temporary 3% levy on incomes over €500,000 which would apply until 2013 when the deficit is due to come back down from 5.7% today to 3% (by the way 3% is the ceiling in the EuroZone’s Stability and Growth Pact and although it’s not the same as eliminating the deficit, 3% is seen as a safe deficit level). It is not clear how much the new tax will raise as part ofFrance’s €10bn fiscal adjustment in 2012, but the letter and the new tax would certainly seem to promote solidarity.

The original letter in French is published today by the French weekly magazine, Le Nouvel Observateur. This is my translation

“We, the presidents or CEOs of industry, men or women in business, financial, professional or wealthy citizens, want the establishment of an “exceptional contribution” that would affect the most well-off French taxpayers. This contribution would be calculated within reasonable proportions, in order to avoid adverse economic effects such as capital flight and increased tax evasion.

We are conscious of having fully benefited from a French model of doing things and a European environment to which we are committed and which we want to help preserve. This “contribution” is not a solution in itself: it must be part of a broader effort to reform State expenditure just as much as taxation.

At this time when our fiscal deficit and the prospect of worsening government debt threatens the future ofFrance andEurope, when the government asks everyone for solidarity, it seems to us necessary to make a contribution.”

The letter was signed by 16 of France’s prominent business people, Jean-Paul Agon, CEO  L’Oréal, Liliane Bettencourt, shareholder L’Oréal, Antoine Frérot, CEO Veolia Environnement , Denis Hennequin, CEO Accor, Marc Ladreit de Lacharrière, President Fimalac Maurice Lévy, CEO Publicis, Christophe de Margerie, CEO Total Oil Frédéric Oudéa, CEO Société Générale, Louis Schweitzer, President Volvo and AstraZeneca, Marc Simoncini, President Meetic, founder Jaïna Capital  Jean-Cyril Spinetta, President Air France-KLM, Philippe Varin, President  PSA Peugeot Citroën, Claude Perdriel, président du conseil de surveillance du Nouvel Observateur, Jean Peyrelevade, Président de Leonardo & Co France  Franck Riboud, CEO Danone, Stéphane Richard, CEO Orange

I wonder will we see a similar letter from the great and good of Irish business and commerce in September 2011 in advance of Minister Noonan’s publication of his three-year plan in October 2011 which will set out in some detail the spending cuts and new taxation needed to eliminate the Irish deficit. I don’t recall seeing such a proposal in the Ireland First manifesto published in March 2011.

Michael O’Leary has threatened to be outtahere if the Government increases taxes on “the wealthy” to what he calls an “exorbitant level” but in the interview published in last week’s Sunday Independent  he does say that he would be prepared to pay a top rate of tax of 50%. The present top rate of income tax is 41% but the Universal Social Charge and PRSI might bring that to over 50% so it’s not clear if he is saying he would in fact be willing to pay more or if he is saying that present rates are high enough. Regardless of Michael’s view though, the question needs to be asked if there is scope for a tax increase which in the words of the French above would avoid capital flight and tax evasion but at the same time contribute to the elimination of the deficit?

UPDATE: 28th August, 2011. Odd that in the week that gave us the French letter above which grabbed the headlines in France, that an Irish letter has created as many headlines here. The Irish Times on Thursday published a letter from someone who signed the letter M.P. Mac Domhnaill who is from Co Kerry. This is the text of the letter

Sir, – As I write this letter I am hoping that sleep can provide me with some escape from the anxiety and pain that the economic situation is wreaking on me and my family.

Until recently I have been able to meet my mortgage repayments and provide for my young children. At this juncture, seeing as the part-time work on which I depended has entirely ceased, I have found myself and my loved ones having to cope with a new torment – hunger.

Today I have had nothing to give my children only bread and cereal. My dole payment is completely servicing my mortgage and my savings have run dry on essentials. I dread what each day will bring.

The wolf that I have been keeping from the door has finally moved in. – Yours, etc,”

On Saturday, the Irish Times carried a follow-up report having contacted the letter writer by phone. It’s a heart-breaking story, and today the Minister for Social Protection, Joan Burton asked that the man might contact his community welfare officer as there might be entitlements not presently being claimed by the man and his family. The Society of St Vincent de Paul aslo expressed concern and offered its emergency number to the man – 087 784 8825.

UPDATE: 6th September, 2011. Apparently Italy is now set to follow the lead in France and introduce its own 3% levy on incomes over €500,000.

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“So if a property bubble is about to pop, that’s good news for NAMA – all in all, a very good time for the agency to get the hell out of London.” Guardian’s Lisa Carroll writing on 19th August, 2011

[in the following blogpost, the term “yield” will be used a lot. Simplistically it refers to the rent on a property divided by its value eg property worth €1m generating €100,000 rent per annum has a 10% yield]

With news earlier this week that a shop in Knightsbridge generating GBP 400,000 a year in rent presently, has sold for GBP 13m, representing an initial yield of 3%; with upmarket residential agent, Knight Frank reporting that prime central London residential prices were up 9.6% in the year to the end of July 2011 and were now 35% up from the post-credit crunch trough in March 2009 and amidst a consensus that the London property market is red-hot, and given that NAMA has said that much of its UK portfolio is centred in London, now might be a good time to examine if the London property market is a bubble which might burst with unpleasant consequences for NAMA.

It should first be said that London comprises a number of markets. That may seem obvious but remember we are talking about a city whose urban area has a population of 8.3m. There is plenty of scope for segmentation of the market but this entry will really just consider two segments – prime commercial and residential. Prime typically refers to central London, the boroughs of the City of London (not technically a borough), the City of Westminster, Kensington and Chelsea. Other definitions might include outlying areas which maintain their values like Hampstead and DulwichVillage, but in the main “prime” equals “central”.

The NAMA transactions inLondonthat we have heard about so far have been in prime areas, Knightsbridge, Mayfair, St James’s, Oxford Street, Chelsea and the City of London. Having said that, NAMA has indicated that it has approved €3bn of disposals and the specific transactions that have been identified with NAMA in the media represent a fraction of that, so there may well have been disposals in non-prime parts ofLondonas well, it’s just that they might not have been reported.

In terms of commercial property overall the UK is still 35% off peak prices reached in 2007 but London prime property is down considerably less than that, but in general is still down from the peak eg City of London office rents were GBP 67.50 in 2007 and today are still hovering at the GBP 55 psf mark, the West End was GBP 120 psf in 2007 and is GBP 92.50 psf today, according to Capita Symonds and CB Richard Ellis. There are exceptions of course reflecting the fact that even the prime commercial market has many segments. Retail rents on London’s Bond Street for example continue to create new British records – GBP 900 psf in 2009 and the record is Piaget’s store at 169 Old Bond Street paying GBP 965 psf from a deal done in December 2009 – both values are for Zone A rent, that is the rent on the space closest to the shop-front.

Many property-market commentators point to yields as a guide to troughs and bubbles. Remember our very own Minister for Finance, the late Brian Lenihan holding forth on yields in September 2009 claiming that the historically high yields pointed to the bottom of the market – his rationale was that if property was delivering a yield of 8% and deposit accounts were paying 2% then people would naturally tend to withdraw their deposits and pile into property, and the increased demand for property would drive up prices. This was Baby Infants property economics and ignored the fact that the numerator in the yield calculation, rent, was also falling. The Minister’s mistake was to assume the economy had bottomed out and that rents were resilient. But the Minister and his advisers could have been partly forgiven for their faith in yields, remember 2-3% yield deals in Dublin’s commercial market just before the peak of the boom in 2007, like the 2.4% yield sale by Arnotts of 102-104 Grafton Street to David Daly for €115m. Irish property experts were looking at such deals with such low yields as evidence of a peak market, were they not entitled to view 8% yields in 2009 as indicative of the trough? And in London today with a 3% initial yield sale in Knightsbridge and with 4% being regarded as the going-rate in the West End and 5.25% in the City of London, you might be tempted to think that we were at the peak in London because investors might be able to get better returns on other classes of investment. But I don’t think that would be a safe conclusion. Here’s why.

(1) DTZ reported this week a re-assessment of investment returns in the UK commercial property market and their view of the outlook, particularly for prime property, is rosy. The rationale: other investment classes offer low return prospects, particularly UK Government bonds, for example the five-year bond currently pays 1.4% per annum. The full report – titled “DTZ Foresight UK Fair Value Q2 2011” – from DTZ is available here  (free registration required). Of course NAMA is not concerned about relative performance between asset classes, it has a finite lifespan with about nine years remaining but NAMA might be interested in DTZ’s forecasts which see rents rise by 6% per annum between 2011 and 2015 in London’s West End and 5% in the City of London and 4% in London Mid-Town (Holborn, Bloomsbury, King’s Cross, Euston)

(2) Prime central London estate agents Savills reported their preliminary H2, 2011 results last week and attributed the good performance to “strong growth in transaction advisory business driven by demand for Prime Central London Residential property and continued strength of Asia Pacific markets, particularly Greater China” and in terms of outlook “in the UK and continental Europe, we expect transaction markets to remain unsettled although the fundamentals of the Prime London Residential market remain positive”

(3) Supply, availability and vacancy is constantly cited as the reason for prime London’s robust performance. Property consultancy Driver Jonas Deloitte produce so-called “crane” surveys on the construction pipeline in UK cities. Their Summer 2011 central London report is available here.  On the commercial front, construction fell dramatically after the financial crisis in 2007 (Northern Rock heralded the start of the UK’s crisis, ours came a year later). And the immediate outlook for construction is not great until after 2015, and even then supply tends to be in non-prime areas – the Battersea Power Station development and the proposed Earl’s Court redevelopment and further developments in east London and Docklands would fall into the non-prime category. Truth be told, central London is a small area with difficult and expensive planning considerations and burdensome construction regulations. Lack of supply is cited by all the major property consultancies – Colliers International dwells on the subject more than is usual in its Q2 2011 central London offices report – as the prime driver for higher rents and capital values.

(4) Anecdotally, that is, speaking to agents and summarising personal observations, there is a lot of Chinese, Russian and Indian money coming into London residential property. The fourth member of the so-called BRIC countries, Brazil, seems to be curiously absent from the London property scene. This assessment is backed up by Knight Frank’s Spring 2011 outlook which claimed that 6% of Prime central London purchasers were from Russia and CIS countries, 5% from China/Hong Kong, 3% from India and only 0.1% from Brazil.

(5) Residential developers have grown more confident about prospects in central London, according to Jones Lang LaSalle which says  “we are now seeing increased activity from parties looking to develop in prime central London, from South East Asia, the Middle East and Turkey, with much of this being on the basis that the UK is seen as a stable and safe bet with by worldwide investors looking to diversify their assets during this uncertain period.”

(6) Inflation continues at an elevated level in the UK, running at 4-5% per annum, this despite the base rate of interest set by the Bank of England being at 0.5% since February 2009. Property is seen as a hedge against inflation and depending on NAMA’s foreign exchange hedging, property growing in value by 4%+ per annum might be worth holding onto rather than property dropping by 5-10% as in Ireland at present. Standard Life examined the resilience of property in the context of inflation here,

Of course one uniting connection between the above companies is that their businesses all depend on transactions for success, so an appropriate pinch of salt might be in order. Having said that, the independent Office for Budget Responsibility and the IMF are both modestly upbeat about fiscal management and growth in the UK.  UK Chancellor of the Exchequer, George Osborne recently claimed that the UK was seen as a safe-haven amidst the turbulence on both sides of the Atlantic. Despite facing extreme challenges with reducing a deficit which is worst than ours at over 10%, many commentators have been complimentary about the UK and its prospects. Recent revisions to economic estimates by the Bank of England might have taken some of the shine off of George’s rosy cheeks but compared with the ongoing train-wreck of the EuroZone and the uncertain handling of theUS economy, there is a basis for claiming theUK is, relatively, a safe haven.

So is there a bubble inLondon’s property market? I’d suggest it’s difficult to say. Low yields alone are not at all determinative of the future state of the market. However it will be very tempting for asset managers in NAMA to bag a profit in London now over the price paid by NAMA for loans, and to an extent in prime London that is almost like shooting fish in a barrel but a proper asset management approach would be to consider all of NAMA’s markets, as it might be financially better to offload non-performing assets in a falling market than to sell in a rising market. The Guardian last week suggested that now might be the time “to get the hell out of” London but on another view, “for heaven’s sake” stick in London and harvest profits in the years to come.

You might also be interested in this post on the “Asset Management Game”.

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