A willing buyer and a willing seller?

Posted by Morgan on 1st Feb 2012

The whole basis of the capitalist economic system is that there will be willing buyers and willing sellers. Demand and supply will see prices adjust until a price equilibrium is reached at which point buyers and seller will trade.

Unfortunately, in the property market today this equilibrium is missing. It seems to me that this is one of the unforeseen side effects of QE and the lowest interest rate environment that we have ever seen.

Vast amounts of the UK commercial property universe is now in negative equity, where this is not the case a further swathe is owned by funds that on paper have lost themselves, or more accurately their investors, a fortune. Theoretically this property should slowly be recycled through the market, as investors and banks recover what they can and move on to other opportunities but, like rain water falling on a glacier, capital is being frozen up and seemingly removed from the market.

One of the key factors facilitating this is negative real interest rates. Banks are funding themselves via central bank liquidity at nominal rates so they have limited funding pressure to de-leverage and dispose of their real estate loan books. Simultaneously funds are not seeing investors withdraw capital, despite often abysmal performance, as re-investing the capital anywhere that offers any yield is incredibly hard.

There is fresh equity desperate to invest in many asset classes, including real estate, but there is limited available opportunity to invest at what is deemed the appropriate risk weighted return in today's rather gloomy world.

So the demand and supply lines that always converged in my economic text books are now refusing to meet one another. If willing buyers and the willing sellers rarely meet there can not be any volume of tranasctional activity.

What is anything will break this cycle?

My hope was that governments would start to ween the banks off state funded liquidity, potentially in order to have the capital to fund a rescue of the Euro. This would force banks to reappraise their balance sheets, partially to meet new regulatory capital regimes but more importantly to win the faith in the market required to be able to fund themselves.

True market funding costs will be far higher than banks are currently paying for central bank liquidity. This will create two opportunities; investors will be offered a return on investing capital so they would start to trade out of legacy assets to reinvest in better priced opportunities and bank's will look at the poor returns generated from legacy loan positions and opt to exit them in order to reduce their funding requirements and maximise return on equity.

The return to rational economic decision making would create a convergence of the supply and demand lines and the market could begin to function again. It matters little at what price this is achieved as long as there is activity. The property industry is far more reliant on the volume of activity than it is as to the value of the transactions.

I had high hopes that this would happen in 2012 but with the ECB announcing it will make even more funds available (€1trillion mooted by Goldman) to bank's in their February money auction it seems that I may be very wrong. See here.

I fear that we may be a frustrated buyer for a good while longer.

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