Is real estate safe yet? How about renewables? And an innocuous Tulip.
All three of this week’s topics are notable for what they are not, Real Estate valuations do not reflect property markets or indeed replacement cost, Renewable Energy valuations do not reflect anything much, but include plenty of hope,  and the new City Minister seems to have no obvious purpose beyond being a safe and reasonably loyal supporter of all things welfare related.
Unreal Estate
As we have remarked before, somehow the RICS valuations of property assets, used to value quoted property companies, became heavily reliant on interest rates and comparable bond yields and rather less interested in the real property market. They also seem to have become a tool for bank lending, disregarding other more real-world factors. Which explains the paradox of falling valuations alongside robust occupancy levels and a level of visible new office construction, certainly in London, which remains unabated and indeed the wider market is  seemingly indifferent to the slump.
There is a lot behind those paradoxes, long lead times through planning, the desire to replace older stock if (as so often) it is to be leased out, the dominance of bank funding, not equity. Even so both collapsing valuations and the discounts then applied, have been damaging. This has been exacerbated by underlying fears about vanishing bank financing, in many ways a self-fulfilling prophecy.
We had something of a buyer’s strike where vendors can’t get bank finance to stay, and their potential buyers can’t finance to buy. The impact of working from home and the inevitable changes in business models adds to this.
Some areas, notably much of Docklands and many regional and secondary offices, have become untouchable. Closed end property vehicles have been forced to sell to meet bank covenants, and several open-ended ones have simply been forced to liquidate. Something of a perfect storm.
Yet, prime real estate has in the end, come through over time, and as we have noted before the residential market has been pretty immune from falls in at least nominal value.
In both UK and Europe valuations are now becoming more stable, and I would expect for the same reason they fell so fast, they will start to recover as rates fall.
For all that, in the equity market this year we have seen reasonable returns, as discounts to stated NAVs narrow, on both sides of the Atlantic. A number of activists are also pushing through mergers or reconstructions, which helps.
And yet nerves persist, the underlying discounts maybe less, but for Investment Trusts that own REITs, there are two tiers of discount (one underlying and one at the vehicle itself) and that top level has widened in cases.
Having endured that lot, and avoided earlier temptation, I am looking to re-stablish positions in half a dozen of these stocks in the UK and Europe, to work out the two that look like long term holds into the next cycle.
Not Renewed
Renewables have somewhat of the same issue, they are valued in part, again on the discount rate, so were driven down by rate rises, but also an odd view that energy prices are destined to fall over time. However, just as I have seldom seen prime city centre values fall for long, the hope of long run falling energy prices, runs counter to my experience.
There is also a great deal of uncertainty, both about what they produce, after numerous equipment and supplier failures, when they produce, and most of all, how to get product to the consumer with a credible margin.
But overall, the two sectors, property and renewables are quite similar, you have to get land, get planning, install infrastructure, hire builders, pay banks, realise your timescales were always far too optimistic, be nice to buyers, accept a discount, move on.
Having been wary of Renewables on the way down, I do now wonder if they are a separate asset class, or just a subset of several, including utilities, construction and distribution. If so, is it not better to leave that to the big multinationals with deep pockets?
Planting Tulips
So, to the new City Minister : Reading the current incumbent’s speech to the Stock Exchange, (not high on my list) it was of course indistinguishable from the last lot. The Treasury keeps these speeches, and the newest minister trots them out – often this is just an exercise in how well the next one mimics sincerity.
Has the Treasury orthodoxy changed? No. The allocation of capital remains the point of pain at the end of staggering amounts of hopelessly outdated regulation, some of them completely failing in their objectives. That much is unchanged.
Tulip herself is deeply worthy, UCL degree in Eng Lit, King’s London Masters in Politics, Policy, Government, so she should know how it all works and be able to write a good memo. But if we think the Government’s talk of “growth” is anything more than the illusory plug to stop the welfare budget draining us dry, a most implausible appointment. The milch cow must be kept placidly tethered, while it is milked.
The City will naturally be content, as ever, as long as no one rocks the boat.
But for all the ill-mannered sneering at the nice Mr. Draghi, and the EU’s failure to grow, we are in pretty much the same place. Now if Tulip wanted to be useful, and justify her principled disloyalty over leaving the EU, she should be mapping out how to join the Euro in 2030.
No road back to Rome exists, save through that thicket of joining the Euro first, the EU got that wrong before, it will not do so this time.
While of course half of Draghi’s capital market complaints are shorthand for saying that after all, Europe needs the City of London, not vice versa.