The Impact of Inflation on Real Estate Firms in the United Kingdom - Essay Example

Real E Survival Guide: United Kingdom Lecturer Inflation is characterized by decline in end user spending which results to decline in trade and industry activities (Jones, 2005.346). Consequently, business earning and job prospects decline as a result of decline in purchasing ability of the buyers. According to International Monetary Fund’s (IMF), economic recession occurs when international market development rate is below three percent (Sunday Mirror, 2011). There are numerous causes of uneconomic depression and the impact of this recession on real estate firms in United Kingdom. Also, the real estate firms have several approaches through which they regulate the detrimental effects of economic recession. The real estate firms should put in place measures to ease the effects of inflation on their firms to ensure smooth operations. These approaches could either be internal or external to the firm concerned (Ball, 2008, p. 126). Through use of fractions, firms are able to compare their own operations in relation to set objectives and assess the extent to which they were able to accomplish the set goals. Also, they will be able to assess their performance in relation to other players in the same industry and devise means to boost their performances (DTZ Holdings Plc, 2010, P.25). Just like the other trading activities, real estate businesses are influenced by the prevailing market forces (Sunday Mirror, 2011). The real estate must implement tactical decisions to ensure their survival during financial meltdown. Inflation has profound consequences on both businesses and individual consumers. Due to decline in purchasing power, the consumers tend to buy less of product and services with the same amount of money than what they could purchase before the occurrence of recession (DTZ Holdings Plc, 2010, P.46). This is caused by the fact that recession result to increase in prices of the basic consumer commodities which is similar to decline in consumers’ income. Therefore, consumers are required to spend more funds to acquire similar amount of goods and services they used to enjoy before the occurrence of recession. Recession also results to decline in saving ability of the consumers (DTZ Holdings Plc, 2010, P.46). As the prices of commodities and other facilities like housing goes high, the consumers have to allocate greater proportion of their earnings to the basic commodities like food, education and healthcare hence leaving small or no funds at all for savings. Both individuals and the organizations have to devise other means such as innovations to create resources. The effects of inflation on real estate are characterized by an escalation of house values to untenable level. The pace at which the value of the houses escalates is higher than the rate at which consumers demand increases (DTZ Holdings Plc, 2010, P.46). This may result to decline in demand of homes in relation to the number of housing units being constructed under a certain period of time. The proportion of the clients earning to the value of the houses determines whether the consumers can afford the houses or not. This is determined by comparing the average house prices with the average amount of earnings that consumers are willing to save. This ratio is presented in percentage form to ensure ease of prioritizing the firms’ activities. This comparison is used to determine the pricing of the houses (DTZ Holdings Plc, 2010, P.87). The earning of the consumer and the house price values are determined on an annual basis. This is in line with the market forces of supply and demand. In United Kingdom, “affordability index” is used to assess the value of the houses in comparison to the consumers monthly earning (Jones, 2005.346). The reason why this approach is popular in UK is because the interest rates of the money lenders are equivalent to charges for housing loans. This approach is more accurate since it relates the consumer’s earnings with the interest cost for the loan they use to acquire the houses. However, it is more complicated to work out these ratios hence decreased applicability. Another approach used to assess the ability of the consumers to purchase the houses in United Kingdom is “deposit to income ratio” (Western Mail, 2011). This is the lowest amount of initial payment in relation to the consumer’s monthly or annual income (DTZ Holdings Plc, 2010, P. 76). Higher ratios will discourage the buyers of the house from purchasing the houses especially if they are doing it for the first time. For example, in 2004, the proportion of the initial mortgage payment was similar to annual income of the average employees. Finally, the real estate firms use median multiple strategy which examines the annual average mortgage in relation to the average family annual income (Jones, 2005.346). In the recent past, this proportion has experienced unprecedented increase in value which indicates that most of the willing house consumers are unable to purchase the houses due to high interest charges on the mortgages in comparison to their family earnings. In United Kingdom, the prices of the houses have been staggering for the past two years. This has had detrimental effects to the consumers and the real estate organizations as well (DTZ Holdings Plc, 2010, p.16). In the year 2012, value of the houses in UK has stabilized with a steady value having been maintained since January to December (Western Mail, 2011). However, there has been no increase or decline in the value of the houses hence resulting to economic stagnation. This has been influenced by deliberate action of government which involves imposing high levies during inflation to reduce the amount of money in circulation. The economists are forecasting that economic situation will improve in the year 2013. Economic depression makes organizations to increase interest rates as one of the survival tactics against inflation (Jones, 2005.346). This burden is partially shared between the organizations and the individual consumers. For example the landlord as have to increase house rents in order to increase their purchasing power. Another tactical choice of the real estate firms during the financial crisis is to cut down the cost associated with hiring training of the workforce. If the situation is not conducive, they may decline to hire more workers hence increase in unemployment rate (Western Mail, 2011). In most cases, organizations react by scaling down the workforces in order to reduce the operations cost. This is considered as the last result by the organizations in order to avoid conflicts with the employer’s trade unions. However, this is considered inevitable for survival of the organization. The balance sheet recession occurs when the value of assets goes below the book value hence a decline in owner’s capital (DTZ Holdings Plc, 2010, P.47). For example if the prices of the real assets in UK goes down, the owners will have less capital than the original value invested. If they had taken loans or mortgages to acquire their real assets after the decline in market value of the real assets, the owners of the assets will have paid more to acquire the assets that what they are actually worth. This is referred to as balance sheet inflation. There are nine twenty thousand homes which are left vacant in UK. However, there is also a big shortage of houses in UK (Jones, 2005.346). There are thousands of other inhabitable houses in UK due to terrible conditions. Also there are other residential houses mixed with business premises and are unoccupied. UK has an estimated scarcity of more than one hundred houses annually. However, this year the government has planned to facilitate the construction of over fifty thousand houses to ease the scarcity of houses in UK (Western Mail, 2011). Also, the government is planning to purchase the unoccupied houses for renovation as an approach to ease the scarcity. During high inflation rate, UK real estate firms cut the operation cost by reducing the number of workforce. Also, they reduce the benefits they grant their workers during economic hardships (DTZ Holdings Plc, 2010, P.38). For example, DTZ offered their workers minimal wages during the year 2007 to 2009 economic recession in order to save cost on operation and mitigate the effects of low income for the organization to ensure their survival. The companies are strengthening their organization base to ensure smooth operations of the firms (Western Mail, 2011). For example, DTZ ensures that they hire and maintain experienced staff to eliminate hiring and training cost. They also involve their employees in managerial roles to ensure that all the workers are aware of the firms’ goals and pursue them. Another strategy used by UK real estate firms to ensure they thrive during economic hardships is engagement in construction of cheap houses for low income earners (Western Mail, 2011). For example, Persimmon Company has embarked on building timber houses which are cheaper and faster to construct so that they can provide quick solution to the housing problems in UK. However, there is a problem since some clients consider these houses to be of inferior quality and prefer brick houses. Real estate companies pay corporate tax from their earnings to the government. During economic meltdown, most companies make losses and are therefore exempted from paying tax (OECD, 2011, p.67). They also reduce dividend they pay to their shareholders. This ensures the companies survive even during the financial hardships through cost saving. The housing companies in United Kingdom are focusing on lowering the cost associated with hiring many staff members (Jones, 2005.145). In most cases, enormous resources are wasted through unqualified workforce. Experienced staff always makes maximum utilization of resources hence increase in efficiency. Also, the company only requires hiring fewer workers to perform the same amount of work which could otherwise require more workers for the same quantity of work. Innovative workers improve the profitability of the business due to efficiency use of resources (Carbaugh, 2012. P.113). The company can also grant discounts to encourage workers to devote extra time to complete additional units of work instead of recruiting new employees. This will save the company cost of hiring and training new workforce (Poynter, Macrury, and Calcutt, 2012. P.47). After all, trainee employees take time before they get fully accustomed to the work environment which hinders their efficiencies. Finally, the real estate companies in UK are encouraging their workers to upgrade their knowledge by undergoing further training (Sunday Mirror, 2011). Recruiting additional workers is expensive for the companies especially during economic recessions. Instead of sourcing for skilled workers from external sources, companies value their workers and encourage them to acquire further training. Sometimes the companies offer their employees on the job training to reduce the cost as well as equip them with knowledge relevant to their industry (Ball, 2008, 2012, p.86). In so doing, companies are able to survive economic hardships by maintaining the personnel cost as low as possible. The real estate companies are able to avoid high cost of maintaining redundant workers during economic meltdown. This is because; sometimes companies are compelled to maintain workers even when the work is low due to employers’ regulations. No country will be comfortable to reduce the number of employment through retrenchment exercises. This is because the economic progress is determined by the quality of life of her citizens. Therefore, retrenchment will result to underdevelopment of a nation. Furthermore, labour organizations restrict employers from treating their employees unfairly by either discharging them from their work (Western Mail, 2011). To avoid this confrontation with workers trade unions, real estate companies opt to maintain a small number of employees which they can easily manage even during economic recession. Therefore, they achieve this by ensuring the workers are adequately experienced in their work to achieve high efficiency. The company directors are scaling down their remunerations so as to reduce the operation expenses in line with the management tactic approaches to reduce the company’s expenses (Giudice, Kuenzel, and Springbett, 2012, p.97). The directors of the company also ensure they hire and train the best team of employees to advance the efficiency of their operations. This also lowers the cost of operation. The organization further ensures that the employees’ interest is taken care of as much as possible while the expenses are maintained as low as possible (OECD, 2011, p.67). The real estate firms are also reducing operations cost by disposing houses which are not needed any more, to ensures all resources are adequately utilized. The housing ownership ratio refers to percentage of people who have their own houses in relation to those who live in rented houses (Ball, 2008, 2012, p.76). As the family earnings go higher, the number of individuals who own houses continues to increase. This is because more people are able to save more capital to purchase their own homes. In UK, the government has continued to encourage people to purchase their own homes (DTZ Holdings Plc, 2010, P.86). This government is achieving this objective by reducing the levies they charge on earnings of the families and also by issuing mortgages at a reduced cost to make loan facilities more affordable. The other factor is price to earnings ratio. This is the percentage of the annual rental value of a house to the total rental value paid for the house after subtracting the expenditure associated with the house (OECD, 2011, p.34). In UK, gross rental yield is used which is the proportion of total annual rental value to the value of the entire home. The level of tenancy of houses is obtained by computing the percentage of the occupied houses to the total number of houses in a given area (Ball, 2008, 2012, p.45). This ratio is necessary to establish rate of the houses in relation to the occupants in a given area. Generally, the rental value varies according to the prevailing market conditions. The market forces of demand and supply also influence house ownership in UK (Poynter, Macrury, and Calcutt, 2012). When the demand for houses goes higher than the supply, the value of the houses goes high as well hence making houses too expensive for the common people. Consequently, increase in price puts a limit on the demand resulting to decrease in price. Another factor influencing the value for houses is the geographical position (OECD, 2011, p.67). Houses have values based on where it is situated hence this will determine the value of the homes in different localities. House built in highly valued land will have higher rental value or selling value than houses in lowly valued land. Real estate firms should adopt modern techniques in construction of both residential and commercial houses to meet the needs of the clients (Jones, 2005.324). This will result to an increase in demand for houses in UK and eventually the firms will be able to make greater earnings. Also the government should increase mortgage loans so that private and business developers can have access to affordable sources of funds, which will enable them to construct more houses to ease the housing scarcity in UK (Controller and Auditor General, 2010.p8). The real estate firms in UK should consider funding research and innovation through their earning in the building sector. Organizations can achieve this by hiring aggressive staff as an approach to lessen the operation expenditure related to workforce (Great Britain: Parliament, 2010.p.34). Another major cause of inflation is high interest charges imposed by lenders of money in the economy especially banking institutions. The real estate firms should seek an alternative source of funds to avoid causing inflation. This will ensure that the value of loan is not too high which would otherwise cause the value of houses to hike. In United Kingdom, real estate developers have to devise means and ways of thriving during inflation. The firms should build up their staff to ensure an organization is able to achieve its goals. They should also offer excellent products that suits clients’ needs such modern spacious and affordable houses. There is an immense need for real estate companies to establish strong relationship with their clients both in domestic and international level. The companies should cut down their expenses by reducing staff expenditure such as workers remunerations. Bibliography Ball, M. 2008. Markets and Institutions in Real Estate and Construction. John Willey & Sons. Pp.280 Carbaugh, R.J. 2012. International Economics, 13th Ed. South-Western Cengage Learning, USA. PP.432 Controller and Auditor General, 2010. Support to Business during a Recession. National Audit Office (NAO), UK. P.10 DTZ Holdings Plc, 2010. Annual Reports and Accounts.pp.88 Great Britain: Parliament, 2010. House of Commons Business, Innovation and Skills Committee, Exporting out of Recession: Third Report of Session 2009-2010.Vol. 1. PP.69 Jones, G. 2005. Multinationals and Global Capitalism: From the Nineteenth to the Twenty-First Century. Oxford: Oxford University press. PP. 352 OECD 2011, OECD Economic Surveys United kingdom, OECD Publishing. PP. 154 Poynter, G., Macrury, I. and Calcutt, A. 2012. London after Recession: A Fictitious Capital? Ashgate publishing Limited. PP. 362 Sunday Mirror, 2011.Bookies Defy The Odds As We Bet Our Blues Away; Who Wins And Losses In Recession: Newspaper Article. London: England Western Mail, 2011. Listen To The Views Of The Poorer People; Your Letters To The National Newspaper Of Wales & Comment Debate. Newspaper article: Cardiff, Wales Appendices Appendix II DTZ Balance sheet for the year ended 30th April 2010 fixed assets £ ‘000 £ ‘000 £ ‘000 Book value Acc/ Depreciation Net book value Leasehold improvement 14079 2515 11564 Furniture and equipment 11820 3356 8464 Motor vehicle 418 178 240 Total fixed assets 26317 6049 20268 Trade and other receivables 243266 Share of net assets (1350) Good will 1 Total associate undertakings (1349) Share in associates and subsidiary companies 31298 Total investment in associate and subsidiary companies 292134 Intangible asset Good will 134309 Brand 967 Customer relationship and contact 1067 Software 52 Licenses 2504 Total intangible assets 138899 Financial assets unlisted investment 403 associate company investment profit 2240 loss on equity shares (24,621) Companys net assets (409055) trade and other payables 53295 Bank loans 97680 150975 Net worth 258080 source: DTZ Holdings Plc, 2010, p.64 DTZ Profit And Loss Account For The Year Ended 30th April 2010 Income £’ 000 £’ 000 differed tax liability 73 associate income 22034 total income 22107 expenses interim divided 1693 share loss 24621 loss on disposal of assets 8464 -34205 net income 13098 Source: DTZ Holdings Plc, 2010, P.62 The DTZ has equity enough to cover all liabilities and a balance for the owner. In case the company was to wind up the investors would still have more than £258 million which they cloud share. Appendix III: Ratio Analysis Quick ratio is the proportion of the current assets less inventory to current liabilities. From our example, current ratio = 2,643,000/1,067,000 = 2.477 DTZ has enough current assets which can be easily converted into cash to cover for the current liabilities in case the owner request for them. Net profit margin = percentage of net income /Revenue, (13,098, 000/22,107,000)100 = 59.25% This depicts the efficiency in the investment of company’s resources to generate more resources. DTZ is utilizing its resources efficiently. Prime ratio = 34% of 258,080 =£ 87,747 Current ratio is the proportion of current assets to current liabilities. Therefore, current ratio =138899/ 116921=0.162 DTZ will be able to cover all its short term liabilities from the current assets but it will have solvency difficulties. Average Collection Period = 365/receivables turnover = 365/3.4= 107.35 days The company will take an average of 108 days to collect its debt. This should be improved in order to evade insolvency problems. Debt Equity Ratio =debtors/net worth =243,266/258,080= 0.943 The company is effectively is owned so much by the clients and should reduce debt collection period or the amount of lending otherwise, there will be insolvency problem. Source: DTZ Holdings Plc, 2010, P.64 DTZ company is doing fairly well because the current assets are enough to clear the short-term liabilities, though the assets are almost equivalent to liabilities. This however shows that the firm is operating mostly on borrowed resources. They are able to make some profit which enables the firm to survive the financial crisis. Read More