Where on earth is the market heading?

Uncertainty is creating an environment of indecision in the property market. Paul Windsor asks what strategies are the wise adopting in the face of the current turbulent economic climate?

As investors and developers look back over the last twelve months at their lower levels of activity and numerous postponed plans, what indicators can they use to give them any confidence about creating realistic strategic plans for 2010 and beyond?

How many times have we heard in the press recently that ‘a mood of cautious optimism has returned to the UK property market’?

A recent Lloyds Banking Group property confidence survey asked respondents how they expected activity in the UK property market overall to change in the next six months. The results indicated that ‘stay about the same’ or ‘pick up a little’ were the views of the vast majority. However it was, perhaps unsurprisingly, the advisor group and the London-based principals that had a strong majority in the ‘pick up a little’ category.

In support of this slightly optimistic stance, the Investment Property Databank  showed yield compression during the late summer for the first time in over two years, indicating that investment property prices had bottomed out. Naturally the headlines cover the reality behind the figures, which in most categories showed no change other than a small reduction in top grade prime properties – perhaps a function of the shortage of stock rather than anything more fundamental.

One thing that is very clear is that the differential between property yields (8 percent) and bond yields (4 percent) is sufficiently high to motivate investors. So with the average property fund having shed around 35 percent of its value over the last three years and down on average 41 percent since its peak in 2007, one would think that the time has come to take a more positive stance.

But the bears are still vocal. Talk of a double dip recession is widespread and with unemployment likely to continue in an upward direction well into the next decade, government spending being cut severely and the fiscal deficit still spiraling, there would seem to be precious little positive macro economic data.

Ernst & Young’s influential ITEM Club has indicated that the recent rise in house prices cannot be sustained - this is a comment on the residential market of course and not the commercial market – but it is forecasting price falls in the first half of 2010.

In the face of all this conflicting and uncertain evidence, individuals and businesses must, in my view, take a defensive stance and build plans upon the certainties that currently exist.

Defence will mean digging in and making sure that current assets and activities are secure and that the business operates as efficiently as possible. If this means cost cutting then it needs to be hard and deep, retaining only commercially justified operations and giving certainty for the future.

For what it’s worth, it is my view that there will be a long hard slog before confident positive plans for growth can be made. I may well be wrong, but it seems to me that in the new, post recessionary environment, the restraining factor will be finance. Gearing on property will be severely restrained for years to come with no likelihood of a return to the 80 percent plus loan-to-value deals of the past. 50 to 60 percent is going to be the norm for the much forseeable future.

Not only will gearing be restricted, but the cost of finance will become very much a crucial factor. Financial institutions will need to achieve historically highs margins in order to rebuild their balance sheets, while at the same time focusing on profitability rather than growth.

So batten down the hatches for the long haul and beware the siren calls of the bulls. Better to miss out on buying at the very bottom than to be caught exposed with unwanted assets.