Jeremy Warner's Outlook: Miles thinks housing market a speculative bubble, but what about supply and demand?

ICI: another transforming deal; Qantas: a private equity model for BA?
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The Independent Online

Virtually everyone has got a view on the housing market, and, though this might seem a surprising observation, I suspect that most of us would quite like to see it crash - always assuming, of course, that this could be engineered without damage to the wider economy.

Relatively few people actually have much of an interest in constantly inflating house prices, for the effect is to making housing progressively less affordable. Many first-time buyers are already effectively priced out of the market.

Even those already on the housing ladder are finding it ever more of a stretch to reach the next rung up. Only householders who intend either to exit the housing market altogether, take substantial equity out of it, have bought as a buy-to-let investment, or those - admittedly a growing number - who regard their house as their pension, have a stake in seeing constantly rising prices.

For the rest of us, it would be a blessing to see them fall. All of a sudden, we might be able to afford that rather fine double fronted specimen up the road after all. For most people, low house price inflation is as desirable as low levels of general price inflation.

So it should be a relief to all that according to a new report by David Miles, chief UK economist at Morgan Stanley, salvation is at hand. He's concocted a model which shows that although some of the doubling in house prices in real terms over the past ten years is justified by rising income levels, lower interest rates, and shortage of supply, perhaps as much as a half is essentially speculative, in the sense that it is driven by the fact that people expect high levels of house price inflation and therefore pursue property as a form of saving.

Mr Miles reckons that once expectations of housing inflation fall, the bubble will be punctured, leading to real falls in house prices. He won't say when this will happen, but thinks it probable at some stage in the next year or two.

Mr Miles is much better qualified than me to pronounce on these matters. Three years back, he wrote a weighty tome on the mortgage market for the Chancellor, and even though nobody can quite recall what its conclusions were, it was at the time warmly welcomed as a valuable contribution to the debate before being shipped off to the Treasury vaults and quietly forgotten about.

Yet unfortunately, I doubt he's right in concluding that the housing market must fall. The main driver of house prices is not rising expectations, but pressure of demand on supply. In many of the most desirable areas of Britain, planning restrictions make it impossible to build more housing. As the population grows wealthier, housing is therefore bound to become an ever-more valuable commodity.

In the absence of a sudden change in the planning laws, a crippling rise in interest rates or a calamitous economic downturn, there is, regrettably, no reason to believe present trends are about to be broken.

ICI: another transforming deal

This dates me, I know, but when I first came into financial journalism, ICI, or Imperial Chemical Industries as it was then unashamedly known, was one of the biggest companies in the then FT 30 and universally acknowledged as a bellwether of the UK economy.

Today, only the company's name still connects it with this once glorious past - that and the Dulux dog, a symbol of continuity in a fast changing world. In all other respects, the company has been through so many trials and transformations that it is barely recognisable as the same thing.

Yesterday's sale of Quest, the flavours and fragrance business, is only the latest in an extraordinary litany of disposals which started with the enforced demerger of ICI's pharmaceuticals division, now known as AstraZeneca. As it turns out, the Zeneca spin-off proved to be a triumph of industrial restructuring. The same cannot be said of what came later.

In 1997, ICI paid a top-of-the- market price of £4.9bn in cash for Unilever's speciality chemicals business, the idea being that this would be financed by the disposal of the traditional bulk chemical operations and eventually make ICI a less cyclical business. Niall Fitzgerald, then chairman of Unilever, still regards it as one of his greatest coups. It was far from that for ICI, where it took much longer to sell off the commodity chemicals interests than anticipated. The speciality chemicals turned out to be not such a hot property either. Weighed down by a mountain of debt, ICI was soon disposing of these businesses too.

After yesterday's sale, ICI is reduced to essentially just two businesses - starch and paints. This might seem a shame, but those responsible for past disasters have already paid the price and, as the stock market correctly surmised, this latest disposal is a sensible transaction at a good price. Debts are cleared and there's even £230m left spare to help pay down the pensions deficit. What's more, the buyer, Givaudan of Switzerland, has agreed to take on the risk of the transaction being blocked by competition regulators by acquiring the business unconditionally. ICI's glory days of empire are long gone, but what has emerged is a decent enough company which still commands a position in the FTSE 100.

Another target for private equity now that it has cleaned up its act? Well, everyone is these days, aren't they.

Qantas: a private equity model for BA?

Much debate in the stock market yesterday post news of a private-equity approach for Qantas, the Australian flag carrier, about whether a similar offer might be made for British Airways here in the UK. The simple answer is why not? Private equity has more money than it knows what to do with, and virtually no target is now too large or challenging. Yet there are hurdles to surmount first.

Problem number one is the size of the pensions deficit. BA's chief executive, Willie Walsh, is making progress in addressing this issue, but private equity hates uncertainty, and BA's pensions liabilities will always be a big one. Furthermore, the company is already quite highly geared, limiting the scope for more leverage. It is also heavily unionised, making necessary reforms in working practices hard to achieve.

Yet all these problems are apparent in Qantas too. They don't seem to have deterred private equity in that instance. What's more, in the Qantas case, private equity has found a way round the ownership restrictions which in the past have limited the scope for airline takeovers. The Qantas deal involves Macquarie and other Australian investors taking 50 per cent of the equity with management owning a further 1 per cent. The rest goes to Texas Pacific and other international investors. Rules that prevent foreign nationals from controlling national flag carriers are thereby satisfied.

Even so, the ownership rules continue to make the acquisition of airlines a tricky business. It would make a lot of sense, for instance, for British Airways to merge with one of the low-cost but fast-growing airlines of the emerging markets, such as India or the Middle East. BA would get better exposure to the fast-growing markets of the developing world, plus the ability to leverage its lower cost base; the partner would gain access to lucrative first-world markets.

Yet as things stand this cannot happen. Conventions that date from when airlines were used as a tool of international diplomacy stipulate that bilaterally negotiated landing rights only apply to nationally recognised flag carriers. As it happens, the Civil Aviation Authority here in Britain recently proposed the abolition of the ownership rules, which are obviously archaic in a world which aspires to open skies.

Unfortunately, there is not much point in us abolishing the rules if they are maintained by everyone else. A foreign-controlled BA could take off from Britain as much as it likes, but it wouldn't be recognised as having landing rights almost everywhere else. Eventually sanity will prevail, but it may take many years.

j.warner@independent.co.uk

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