Extremely useful, deftly administered and beyond valuable to our client. This post will tell you how and why a forward contract is an essential consideration for any private client buying into or exiting the London property market using a foreign currency.
One thing I am extremely keen to impress is the extent to which simple logic and devastating reason compel both agents & solicitors to suggest these types of contract.
There is simply no downside and, as I will go on to explain, were one dealing as a UK buyer and holder of sterling, one would still do everything one can to fix, cement, solidify and protect one's position...international or non-GBP holders deserve and will benefit from the same tools but they have next to no exposure to them.
So, our client, 'Mr Snooks' is selling his apartment in Brussels and relocating to London. (For the sake of the families, the names and locations have been tweaked...but the figures, dates and such are all from a real matter).
Such is the Belgian sales process that once he has progressed beyond the UK equivalent of the exchanging of contracts, he stands to receive a significant sum if his buyer withdraws. This is crucial and serves as a form of protection for him.
He puts in an offer on a house in London. The offer of £4,300,000 is accepted and things move swiftly forward.
Prime Cap is introduced to the client by his solicitor a week after the offer is accepted. His solicited was in turn proposed by the estate agent selling the house. This is entirely common and (dare I say it) serves to emphasise both the speed with which buyers need to act as well as the speed with which brokers like us can react. One thing to note at this point is that the estate agent referring the conveyancing solicitor does, as a brand, have a formal partnership with a foreign exchange company. Evidently that relationship was never mentioned to the client - but, good for us!
One week after the £4,300,000 offer was accepted the pound had risen by 5% in value.
Therefore, the Belgian buyer realised (or was forced to confront the fact that) he needed to find an additional 5% more euros from his own sale in order to proceed.
Fortunately, his apartment had a sale price of €9,000,000, so he was comfortably covered, but, no one of sane mind would welcome a price increase of €25,000 in a single week.
To further unsettle the buyer, offers and deadlines were under discussion at a particularly volatile and unpredictable time for rates of exchange. All of the above was set against the backdrop of the UK's intended October 2019 EU departure date.
The buyer works in private equity. He is au fait with the potential for sterling to move in his favour and against him and, thankfully, he had reconciled himself to the certain need for mitigation of any exposure to such changes.
He was content to fix a rate and forego any potential for the euro to rally in his favour, such was his eagerness not to have to worry about the opposite occurring...
...the buyer had yet to exchange contracts on his purchase.
Sensibly, if not frustratingly, he did not want to commit to buying £4,300,000 for a property he was not yet contractually obliged to pay anything towards. Sensible yes, potentially costly, of course.
As well as not yet reaching the point of exchange, the completion date (a crucial facet of any forward contract pricing exercise) had yet to be determined. This meant that one (we) couldn't yet confirm to the client what rate they might expect were they to lock-in.
We do model these sorts of transactions. Think of it less as gold, silver and bronze and more of a now, near-term and long-term. The price for use of the product does not go up the longer the contract, but, the rate does get less competitive (so, swings and roundabouts I suppose).
One option might have been for the client to say "I am relocating to London, I know what I want to spend, therefore I will take a forward contract to protect me until the money from my Belgian sale has been realised, at which point I will pay for the £4,300,000 I've bought. C'est tout!"
Another option would be to take out as long a contract as possible (24 months) and to simply exit it as and when a property was found and bought. This would have been far more costly to the client because it would have meant buying that £4,300,000 at a price far removed from the present trading price of the pound...and yet, were the client convinced that the pound would strengthen by any considerable measure over the next 24 months, the buying of the £4,300,000 on such a long-dated contract might very well seem more and more sensible in line with GBP's appreciation.
Anyway, my advice tends to be "wait until you exchange" before entering a forward contract - I caveat that in this example by saying that it depends entirely on the preferences of the client, and I have to make sure I'm entirely sympathetic to the client's appetite for risk (amongst other things).
Whenever we enter into a forward contract I must confess to secretly hoping that the currency being bought (the one we're worried will rise and therefore cost a client more) rises fast and hard and stays high until the purchase completes. I try to make sure that the client is totally reconciled to the fact that the currency they want may drop in value, in which case they are committing themselves to a contract that costs them more when all is said and done than simply exchanging 'on the spot'. By and large, I make this plain enough for me to rest easy that the client is, in fact, using a forward contract because they don't want to pay more...the fact that they could have paid less is less valuable than knowing that the costs are fixed...and I am happy with that being the case.
Now to the numbers - after which I will wrap this up - the numbers are why you're still reading (I can tell!).
I shall now be precise.
The client secured the house for £4,300,000. At the point of exchange of contracts, we sent £430,000 directly to the client's solicitor using an exchange rate of 1.16. Simultaneously we bought £4,700,000 at a rate of 1.1630 for a contract running from 29th October 2019 until 3rd February 2020.
Things to note:
1 - the contract was taken out just days before the UK was due to leave the EU. Notwithstanding an overwhelming eagerness to make sure he was not going to pay more, the client feared that an extension to the negotiation period would see GBP increase in value...further adding to his costs. He was of course correct.
2 - the client bought £4.7 million rather than simply £3,870,000 (the purchase price less the deposit amount) - this was to allow for refurbishment works on the property, plus additional expenses. Rest assured we have connected him with a number of our trusted interiors clients/contacts.
3 - The date of maturity for the contract was 3rd February. In actual fact the date of completion for the purchase was mid-Jan