April 2008

‘Buddy, can you spare a dime — or maybe $30 billion?’

CONSIDERING recent events, I have been humming ‘Buddy Can You Spare A Dime?’, the legendary tune about the 1930s Great Depression, as I write.

In 2008, however, it’s ‘Buddy can you lend me $30 billion?’, judging by the numbers involved in the Bear Stearns rescue.

I can’t predict events between the time of writing this column and its publication, but it’s clear that the US credit crisis will lead to dearer mortgage loans and tighter lending on this side of the Atlantic, with all that implies for housing turnover this year.

The tough spring predicted last winter for the estate agency business threatens to get even tougher.

Robin Savage, analyst at KBC Peel Hunt, said investors should realise share prices in general are depressed because there are more sellers than buyers.

He believes it’s difficult to predict how the housing market will perform this year and next and when it will recover, but thinks that firms with strong cash flow and balance sheets will survive.
However, some which enjoy good cash flow now may run into trouble later.

I agree. We simply don’t know how the housing market will pan out this year and next.

The volume of mortgage lending has fallen from 2007 and looks unlikely to recover. Lenders are reining in and for many buyers the problem is not the cost of the mortgage they are offered but whether they can obtain a loan in the first place.

In some respects, the “credit crunch” is like the mortgage famines of the bad old days.

This suggests the number of housing transactions may be below 900,000, with all that implies.

So, when I report the 2007 results from estate agency firms, I am reminded of that old adage “past performance is not necessarily a guide to the future”.

That said, full year 2007 results from Savills, LSL and Rightmove were all reassuring, and I must also add that the fortunes of each of these firms in their own way are not entirely dependent on how many homes are sold in the UK this year.

The Savills results pleased the City as they showed how the group is earning from international operations. Pre-tax profits were up 14 per cent to £85.5 million, at the very top end of analysts’ expectations.

Revenue was up 26 per cent to £650.5 million. Underlying basic earnings per share rose 13 per cent to 46.1p. Shareholders are to receive a final dividend of 12p per share, making 18p for the year, an increase of 12.5 per cent.

The results were a great swansong for Aubrey Adams who soon retires as group chief executive. He said the results “reflected the benefits of the group’s business and geographical diversification”.

Savills is now established in Europe, the USA and the Far East, including Taiwan and Vietnam. Jeremy Helsby, Adams’ designated successor as group chief executive, hinted that Savills will be looking to expand further, if opportunities arise. “We are well placed to take advantage of the opportunities that might arise in the months ahead as a result of the volatile financial markets,” he said.

Savills now have 90 residential offices in the UK, including a dozen new openings during 2007 and most recently a Jersey office. They have made no major acquisitions in building up this network and if they had wanted to buy the troubled AIM-listed firm Humberts, which I mentioned in my previous column, I think they would have gone ahead already.

Savills operate at the middle to top end of the property market, where the most obvious issue is the tax treatment of non-domiciled residents.

Rupert Sebag-Montefiore, chairman of Savills (L and P) Ltd with overall responsibility for UK residential business, said the Budget announcements had drawn “some of the sting” and at least removed uncertainty.

He added: “For example, children are exempted, so you will not have the situation where a family of five are liable to pay £150,000. It has also addressed the biggest concern — disclosure of offshore trusts.”

However, the issue has taken some of the “gilt off the perception of London”.

He added: “The major factor is of course the future of the financial markets, but so far residential property has proved resilient.

“The credit crunch has hit most turnover at the lower to middle end of the market, and first-time buyers in particular.”

I am not so sure, as many clients of Savills are not as rich this month as they were six months ago and many employees of City financial institutions who were collecting big bonuses this time last year are now worrying whether they will soon be collecting P45s.

I reckon the big question hanging over Savills’ shares is whether the share price has already factored in all the economic problems we could face. City analysts seem to think so. After the “St. Patrick’s Day Massacre” of Monday March 17, amid panic over banking stocks, Savills closed at 322p to show a yield of 5.6 and a price/earnings ratio of 7.1, very similar to the ratings of the major UK banks. But Savills enjoys a strong balance sheet, which I suggest is a key plus factor in these difficult times.

My remarks about uncertainty also apply to Rightmove and LSL Property Services, which both announced reassuring figures when they reported their full year profits for 2007 at the end of February.

Property web site Rightmove revealed revenue of £56.7 million, up 69 per cent on 2006, and pre-tax profit of £27.1 million, compared with £7.7 million.

Earnings per share worked out at 15.2p, and shareholders received 8p per share dividend.

The number of advertisers using Rightmove rose 18 per cent to 19,267 and average monthly revenue per advertiser rose 35 per cent from £192 to £259, as a result of an increase in charges.

More than one in five agents now use Rightmove Choice, a premium service introduced last year.

Rightmove managing director Ed Williams said the tougher housing market actually brought some benefits to Rightmove as estate agents found website advertising more cost effective than other media.

He admitted some agents had ceased to trade but they tended to be the weaker ones which contributed least to revenues.

Rightmove figures were right in line with the forecasts in its trading statement of early January and which were previously reported in the February City column.

However, immediate City reaction was a 27p fall in the share price to 502p, perhaps due to profit taking, and have since dipped below 500p amid the market crises. The shares ended 2007 at 464p.

The key factor in Rightmove’s favour is that its profits are not directly dependent on the number of housing transactions and that all the evidence suggests that Mr Williams is correct in suggesting a tougher housing market actually might benefit its business model.

Meanwhile, results from LSL Property Services, owners of Your Move and Reeds Rains, boosted the share price after they were announced.

They were better than might have been expected, following a trading statement in early January which admitted to a sharp downturn in estate agency business towards the end of last year, and a reduction in staff and branches (see February City column).

Since then, a 10-branch franchise in the South West has closed.

In the event, full-year profit from Your Move and Reeds Rains retreated 6.5 per cent to £13.7 million, as fee income from sales fell 8.8 per cent to £69.3 million and the number of exchanges fell 11.3 per cent to 35,255.

Ominously, during the second half of 2007, business was down by about a third compared to its peak.

The group’s development of the surveying business paid off as it now represents 72 per cent of operating profit.

The division’s operating profit rose 25 per cent to £26.3 million on turnover up 27 per cent to £90 million.

Overall, LSL’s underlying profit was up 13 per cent to £36.5 million and adjusted earnings per share rose 17 per cent to 23.3 pence.

Borrowings were up from £34 million to £49 million but net cash flow was £30 million.

I note that after LSL reported, group chief executive Simon Embley bought a further 33,000 shares, as did fellow director David Newnes, both paying 125.5p.

Mr Embley now holds 7.65 per cent and Mr Newnes 5.28 per cent and directors’ share purchases are usually a good sign.

Despite the stock market crisis since then, the shares have traded about the 130p mark, where they yield 5.3 per cent and show a price/earnings ratio of about 7.7.

I don’t see a dramatic recovery, given the state of the financial and housing markets, but by focusing on the surveying business, LSL has lessened the impact of the vagaries of estate agency.

Nothing of note in the Budget

IT’S fair to say the Budget has done absolutely nothing for the housing market.

There was some tinkering with shared ownership, and more talk about fixed rate mortgages.

I am indebted to Andy Hardy, development director of TaxCalc for pointing out the following: capital gains tax on property investment is of course based on the difference between the original purchase price and price at disposal. It’s not based on the amount of equity in the property.

Many buy-to-let investors have borrowings on all their properties and with the current credit crunch they may want to sell one or two to pay off the loans on the others.

But if they sell the first properties they bought, as these will have most equity, and show the most capital profit, they will attract more capital gains tax than those bought more recently.

It might even pay to sell a recent purchase at a loss as that can be offset against gains elsewhere