In extreme events, normal market functions and relationships tend to break down as new priorities emerge. Effectively the Maslow Hierarchy of Needs works in reverse as people try to move down the pyramid as quickly as possible, away from ‘self actualisation’ towards ‘food and shelter’. 

This movement causes changes in attitudes towards pricing and risk weighting, people may have briefly joked about toilet paper being the new gold, but in the joke there is a grain of truth.

So what happens with real estate? 

Well real estate, particularly residential real estate, is somewhat sheltered from the quick and painful movements of financial markets, however it is far from immune.

Historically real estate prices tend to react slower than transactions in real estate. It takes time for both sides of the market to accurately price in the new reality and so the easiest way to avoid mispricing is simply not to transact. So both sides tend to wait to see what the other side will do, and then gradually start the process of price discovery. 

Our twenty five years of data allows users to go back in time to see how market shocks have played out, to get an understanding of how those shocks might play out this time. 

The most recent major crisis was the 2007-2009 Subprime-Credit-Financial Crisis. Taking a look at Kensington in 2007-2010 it is easy to see the sales transactions were falling long before prices fell as a result of the financial crisis (light blue line in the graph below). Prices (dark blue line) only began declining in August 2008, almost a year after transactions started to fall. 

W8 Median £ sqft - Sales vs Median Sales Transactions

Fast forward to more recent times, the market has behaved somewhat differently. The expectation is that in the coming months, very few transactions will complete due to the restrictions on movement as well as more general pricing uncertainty. Our weekly market updates give clients access to this information via the REalyse platform. Sharing information from our weekly tracker of property listings put onto the market, which is a leading indicator of transactions, shows a collapse in the number of new listings, and the number of properties being removed from the market. This will likely feed through into lower transactions, and ultimately lower prices. 

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Something to keep in mind is that during major disruption, prices tend to correlate, more simply everything tends to move down all at the same time. Stocks, oil, currencies, property all move downwards, and very few locations are spared from these declines. 

Keeping with 2007-2009 period we can create a ‘correlation cross plot’ of different locations across the UK. In the graph below we show the price correlations between different locations listed on the vertical and horizontal axis. Don’t worry that you can’t see the individual names, it is the colouring which is important. 

The dark green colour indicates that in the 2007-2009 period, residential property prices were highly correlated, meaning that all prices were going down at the same time. There were a few notable exceptions, which you can see as the yellow-ish lines crossing the green box. Showing that a few areas did not have much of a correlation to other areas. These could be considered as potentially good, defensive locations where prices don’t tend to fall, even if the rest of the market is falling. 

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Looking at the correlations in the same locations over the past two years shows a very different picture. The yellow-ish colour of the ‘correlation cross plot’ shown below, indicates that between January 2018 to February 2020 different parts of the UK were not particularly correlated. This makes sense, the property market was still dealing with changes to stamp duty, help to buy, price declines in expensive areas and uncertainty around Brexit, and every location had its own independent pricing. Kensington was falling while Manchester was rising for example. 

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However with current changes in the market we would expect the correlations to increase, just as they did in 2007-2009 and as prices fall across the country. The correlation cross plot for 2020 is likely to be dark green as it was a decade ago. 

Just like a decade ago, there are areas which do not follow the rest of the market to the same extent. For example, the graph below shows the price falls in Newham and Great Yarmouth, neither of which was the most extreme value in the UK. While both areas declined in price, Newham’s decline was 300% greater than Great Yarmouth’s. For all real estate professionals this creates both enormous risks and opportunities.

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If those patterns are repeated this time around, then projects in construction and leveraged assets in Newham may be at risk of breaching their covenants and lenders may require additional equity from developers, or even foreclose on the loan. Those looking to purchase discounted assets should also look to those locations which have the greatest declines. Conversely, Great Yarmouth could create more stable opportunities if it follows a similar path to 2007-2009 with a more ‘modest’ price decline. 

Just as important as the decline is the subsequent rise. Make no mistake, people still need places to live, people will still have money to buy or rent and governments will mortgage the future to create voter satisfaction today, all of which combine to ensure that no negative change in price lasts forever. 

In 2007-2009 it took both Newham (first chart) and Great Yarmouth (second chart) just as long to recover in price. Other areas had different recovery patterns which users of the platform will be able to identify. 

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Looking at those areas today, both have very similar levels of leverage, however as a proportion of income spent on housing costs, Newham is 2x more expensive than Great Yarmouth, so it’s not impossible to imagine that we could be looking at something similar this time round. As Mark Twain is reputed to have said, history never repeats itself, but it does rhyme. 

REalyse (Treex Ltd) does not provide any form of investment advice or property advice or any other regulated function. Note that any information or opinions, presented or referred to in this article are for information purposes only. Any actions taken by a reader are done entirely at their own discretion, you are responsible for your own investment decisions and hold Treex Ltd harmless from the results of any such decisions. Whilst every effort has been made to ensure the accuracy of the information herein some inaccuracies may remain.

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