EPCs and Unemployment – Opportunities and Threats – 21/02/2021

Feb 21, 2021

Just like that – we are 8 supplements into 2021! Happy Sunday everyone.

For the micro segment this week I’m going to discuss EPCs since this discussion needs to be had sooner rather than later. For the macro, I want to talk about the spectre – or not – of unemployment.

I’ve been quietly tracking the EPC situation for several months, back when there was a consultation launched last year. The basic question being asked is “should the private rental sector unit be at grade C or above by 2025”. (For those looking for an exact date, they tend to use April fools day for these things, which may or may not amuse you). I strongly suspected there would be a push for a yes, for the following reasons:

1) the commitment to phasing out the petrol and diesel car and bringing that forwards 10 years.

2) more broadly Boris is an environmentally conscious leader given that most “traditional” conservatives are not.

3) when you get into the data, new builds have improved (based on the median score) by about 5% on their EPC scores over the last 6 years. Existing stock has performed more poorly only being improved by about 2% (and last years new stock becomes this years existing stock so it would drag the figures up as well, but not by much since less than 1% of the stock is added each year).

4) the government can see that one of the last bastions of gas demand will be home heating. (Note the difference between efficiency and “clean burn” fuels and then where you actually get the power from in the first place – I.e. you can ensure heat doesn’t leave or is a lot more efficiently held onto but that doesn’t guarantee it comes from a renewable source of course).

So we can see that things have moved very very slowly despite a push to do so. The push to eliminate the F and G slice of the rental stock was only targeting around 7% of dwellings to put it into context.

This is also a rare part of the rental market where social dwellings outperform the PRS because the stock does tend to be newer on average. Once again despite the push there has been very little movement in increasing the EPCs of the existing stock. The median PRS house at the end of 2019 had an EPC rating of 63 in England and 62 in Wales. In 2013 in both countries it was 61.

For those who don’t know, a C needs a score of 68.

Stating the obvious that means at least 50% of the stock needs a reasonably large amount of improvement to get to a bottom end C.

The actual number when considering all housing stock is 60% below that magic 68, and 70% of private rented stock.

So you are talking about something affecting 7 in 10 rental units. A massive, massive factor.

For those who have not followed the story, it has been suggested that the contribution from the landlord should be capped at a mere £10,000 per property.

You can understand why I’ve been sitting up and taking notice at this point, I’m sure. Others who are looking a long way into the future are obviously concerned about this. So – is the PRS over in 2025?

Of course not. The flip side of this is that the problem that is being addressed is so large that in reality there is only one body that can get this done in this timescale. And that’s the government. I can’t see any other way other than the mother of all grant schemes (just as I think we can all foresee the mother of all vehicle scrappage schemes coming at some point in the near future). Interestingly if you dissect the EPC (what else would you do during a lockdown weekend after all!) There is some very cheap and low hanging fruit and then the chunkier investments.

The chunky ones split into two. Both of these have significant impact on the EPC.

The first is EWI or solid wall insulation. This can also be done inside a property rather than just externally but of course it makes the space smaller. EWI is sometimes a blessing as it helps to sort out a nasty looking facade or sorts out water ingress issues so there are benefits outside of the insulation value. The cost is about £100/metre for comparison and is rising as labour and materials costs shoot up at this time. That’s a nationwide figure. It often is worth about 12-13 points so that would put the median up well above the required.

The other is solar PV. At the start of the bull run in domestic solar (brought to an end by an overenthusiastic government, a real cockup of a situation) a set of panels would be at around the 15k level in 2010. In 2021 they are down to around 4.5k as the tech has shifted to show the usual disinflation although the rate at which they now get cheaper has of course fallen dramatically. This is also a double digit improvement on a typical EPC.

For those unaware there was a generous feed in tariff scheme in place by the government until 2019. New solar installs paid money over 25 (and then 20) years as they tinkered the scheme into oblivion. Solar made financial sense and had a payback.

They didn’t see the big fall in prices coming (even though there was lots of precedent) and got the whole thing wrong. Some clever work could have kept it in bed but there you go.

EWI is lauded as the only way to get these EPCs up but I do not understand why. Let’s do what the government never do and do some joined up thinking:

1) EICRs. We are on the cusp of it being a legal requirement to have a satisfactory EICR to start a tenancy. No data yet but you can guarantee that more has been and will be spent on electrical upgrades in 2021 than ever before. When new properties are purchased for landlords there is a new focus on the electrical side that wasn’t there before, from what I’ve observed and the conversations I have every day.

2) the electric vehicle. As already mentioned 2030 is a hard deadline for new production and you have companies like jaguar saying no more petrol or diesel vehicles after 2025 as the land grab to look like the most environmentally responsible company will now rage. Need electricity to power these things and the current grid infrastructure simply doesn’t have the output.

3) roof spaces. PV lives on the roof in 99%+ of domestic installs. Roofs can be old and also let heat out…..loft insulation isn’t the only answer. Kill another bird with this stone…….

4) batteries. The powerwall (tesla) and other solutions do not yet have an economic argument for their
installation I.e. the payback is beyond the warranty period. This is very close to changing. If you imagine a grid with 10 million electric vehicles charging overnight when current demand is powering maybe one or two lights, and charging a few low power electronic devices, plus the fridge and the freezer overnight, there’s a massive consumption demand to change. Particularly between 6pm and 10pm/2am on current charging times. It will change the frame of some day/night tariffs but also mean there is a genuine need for power balancing in a house (from the grid’s perspective). A battery will be part of this solution.

So as always it is more complex than it first appears. I have been talking within our partners in property weekly masterminds about this and my belief that RICS will start at some point to recognise recognise the EPC when valuing a house (in fairness, you will already see comments about Fs and Gs). I’m talking about more than the status quo though because the EPC will become a more and more important document. A high D that needs a couple of hundred quid to get to a C – or a C already – could be worth 10k more than something that’s scraped into an E in order to stay rentable. On the flip side if you need EWI AND PV to get over the line you might be exempt (at the moment under current rules) but that doesn’t strike me as a sensible or scalable business model.

In conclusion for this section what’s needed is a shift in thinking and I know some will say “one more thing to worry about”. My mindset doesn’t work like that. It sees one more place to gain an edge and more opportunity than fallout here. Remember we are talking literally millions of homes here. Even Corbyn accepted he couldn’t destroy the PRS in one go despite possessing the ideology to want to do so, so any non-radical government will recognise a massive need to spport the rental sector in achieving this ambitious target.

Where the workforce will be to do all this is of course another matter…….but there’s some food for thought about what to focus on and a taste of the near future.

One more thing to mention on that front – I was heartened to see foundation home loans offering a green reward mortgage for those with Cs and above (cashback, lower product fee, lower rate)……my fear is that some lenders will start seeing particularly Es as unsuitable mortgage security sooner rather than later – not across the board but better to be ahead of the game than not. 100% of EPCs of stock that I buy can be easily improved by a few points and some by loads and loads. We tend to buy properties requiring improvement so perhaps that shouldn’t be a surprise. Putting all of that together – getting the low hanging fruit done for a budget of a few hundred pounds, right now, seems like good business to me.

So onto section 2 and unemployment.

I’ve been amused a few times over recent weeks when a few people have informed me that I’ve got this all wrong. Just as everyone is an epidemiologist at the moment, it seems economist isn’t far behind in their list of never ending talents! The problem is that most people are operating from a place where they believe:

A) all unemployment is bad

B) they forget one job isn’t worth the same as another

C) they only look and hear headline metrics.

Once again zooming out to the big picture, there are a few other things that we need to not lose sight of:

I) 6%. This was the unemployment number, when we go back 7-8 years, that was lauded as a point at which interest rates could go back up. You can of course forget about that happening at the moment but the focus is on the fact that getting it below 6% was seen as the Bank of England’s target figure.

II) a lot of jobs created since 2009 have been low productivity and low output. In a world where goliath companies like Facebook and Google employ a tiny fraction of the staff that large companies from 50 years ago would do, and a lot of other jobs created in the takeaway and coffee explosion of the 2010s alongside the gig economy are at minimum wage or below – productivity figures suffer compared to the “old world”

III) furlough has been a roaring success in comparison to layoffs and putting people into the (comparatively generous, certainly compared to the US) benefit system.

The most recently published figure is 5% for UK unemployment.

The bank of England are expecting 7.5% to be the peak but I’m expecting them to revise this figure downwards in the coming weeks.

Readers will no doubt have seen the speculation as we near the budget of the furlough scheme being extended yet again alongside the business rates holiday for beleaguered businesses.

There was a large tell when the extension from March to April was announced in late 2020. The astute observer knew that it was preparing us for the inevitable lockdown. This chatter at this point tells us that there will not be a complete unlocking by the end of April or May that the Covid Recovery Group within Parliament are pushing for.

Monday’s announcement is awaiting with bated breath but ultimately looks to be a relatively damp squib at this point (although the school reopening is massive for the economy and the parents under incredible stress at the moment of course).

My expectation for some time has been a job support scheme similar to what the chancellor attempted to launch in November 2020 but it looks like there may be a couple more months of furlough to allow aggregate demand to snap back as far as it can.

There is caution because of the ultimate failure of schemes like eat out to help out from a governmental level of course….but this government will seek to nudge behaviour and I also expect to see similar.

Another factor that’s not being taken into account (again – joined up thinking) is that some of the estimated 250bn in household savings could well be diverted to new businesses and franchises. There is an absolute explosion of this stuff coming. The budding entrepreneurs have not been sitting and waiting for an axe to swing but instead using the time to plot their next move which will stimulate activity and jobs.

This isn’t to say “don’t worry – all is well” – the number one threat right now remains an aggressive mutation of the virus which is not tackled sufficiently by the existing vaccines – but it isn’t like astrazeneca/Oxford and all the other vaccines are taking their eyes off the ball on that one….so we have to be positive and hope that they’ve got all that covered. Our genomic sequencing and vaccine prowess has showed why we are still the greatest nation on the planet in my view, despite a suboptimal handling of the crisis by our government.

But if you put all this together and react on fact not on hype and hearsay and newspaper headlines – I believe this is a sensible conclusion and unemployment is not the ghoul it was painted out to be. Of course, there WILL be job losses when the furlough scheme comes to an end (and more when the resultant job support scheme comes to an end).

But the likely outcome is an expansionary budget and room for the economy to rebound and consumer confidence to return. That will take at least as long as the duration from the first lockdown to the last (yes, I’m assuming this one is the last which isn’t a 100% certainty of course). So that’s another year. One good reason why even with significant economic firepower it won’t be a full V shaped recovery. But there is money out there – there is growth out there and there is opportunity out there – and there is liquidity. Combine this with negative real rates of return thanks to interest rates and expect economic activity of significant proportions in Q2 and Q3 of this year.

What will happen when we go into winter 2021? There’s twists and turns in that road yet. Currently we need to focus on the budget and hope that Rishi gets it right. Only one more supplement before the budget and next week there will be no choice but to put my neck on the line and say what I think will happen (not what I want to happen but what I think will happen!). Have a good week everyone!

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