Friday Letter Return of the vultures

An Englishman’s home is his castle, so the saying goes, but as interest rates rise and property values cool, Britons may soon find that their castles offer little protection from the financial realities outside. 

Yesterday, the Bank of England unexpectedly raised its key interest rate to 5.25 percent, the highest point since May 2001 and the third such move in the past several months, as the central authority attempts to curb inflation and cool the country’s booming housing market.

Like many housing markets around the world, the UK residential sector has enjoyed a phenomenal run in recent years. According to data released earlier this week by the UK government’s Land Registry, house prices in England and Wales increased by 6.8 percent in the twelve months through November 2006, the largest increase seen since May 2005. At the same time, however, the run-up in property prices has enticed many individual investors to purchase houses for investment, the so-called “buy to let” investor.

With the latest increase in interest rates, it is these speculators that are increasingly coming under pressure. (A press release this morning from the Association of Residential Letting Agents disputes this, noting that the fundamentals of the buy to let market remain unchanged and that a “majority of buy to let investors make a long-term commitment that is measured over decades.)

Nevertheless, there are rumbling in the private equity real estate community that distress in the UK residential market is coming—and coming soon. And it raises the question whether firms should be forming vehicles to take advantage.

Michael Walton, chief executive of Rynda Property Investors, says: “Clearly the further rise in interest rates is going to cause stress in some areas of the UK property market and the first area is in those cities where there has been a large rise in new blocks of flats where a high proportion of those have been sold to investors.”

Walton and others believe that interest rates have to rise further and the employment market deteriorate significantly before distressed funds start emerging, but he adds that firms are bound to be considering opportunities.

“Private equity real estate firms will look at distressed funds once they see sufficient volume,” he says.

For clues as to what might happen, the UK should look towards the US market where the downturn in the housing market has been more pronounced. Late last year, Warburg Pincus announced a $200 million joint venture to invest in non performing loans and distressed multi-family properties. New York distressed investor Avenue Capital is raising a $250 million property vehicle. And Los Angeles-based Canyon Capital Realty Advisors has reportedly closed on $500 million for a fund that will invest in mezzanine, bridge and non-performing loans, as well as provide financing for distressed projects.

In the UK, these are testing times for buy-to-let investors, but perhaps it is just the beginning for private equity firms interested in distressed residential property.

PS: The polls for The 2006 Global PERE Awards are open until January 31st. Cast your vote for the industry’s leading personality of 2006, the year’s best exit and many other categories. To vote, go to