Help! I need somebody! – What do I do?

Oct 2, 2022

“I’m ready to hit the ground from day one” – Liz Truss, Twitter, 20th July 2022


Welcome to the supplement and let’s all start by taking a breath and counting to 10. As many times as we need to. Then let’s get on with working out how we take our collective ships, boats, dinghies and rafts forwards through these choppy seas. Two things I want to say up front this week.


Firstly – thanks to all of those who I saw on Friday at the HMO awards who took the time to come up and tell me just how much they appreciate the supplement. I write this with no remuneration or agenda – so that’s really all of the pay I get! I wanted to take this opportunity to say thank you to you folks, who do read it and engage with it – it at least provides that warm fuzzy feeling and conversations like those make me strive to do more, and do better – so thank you.


Secondly – for those who are feeling anxious, or further afield than that – do not worry! Reach out. I’ve had a whole raft of messages this week and I can’t even reply to them all – a mixture of “thanks so much for banging on about fixing mortgages, you’ve saved me £xxxxx” and “I have this mortgage fixed rate term coming up, what do I do?”. Obviously I can’t give financial advice, and also it isn’t helpful to say “the best time was 6 months ago, but the second best time might be now”. However – I do want to be very clear. What you can do is assess your affordability, and not see this as a time to make the right move that will make the most money over the next 5 years, but see this as a time to insure against the upside risk. I’ve spoken of this a number of times over the past 6 months, and this week is just one example of it coming to fruition. There may be more “grey swans” (especially with PM “Pork Markets”), and this is what you are doing. Fixed rates are an INSURANCE over that period of time – not necessarily the optimal play from a trading perspective or similar. Make that distinction. Don’t have buyers remorse – “I could have fixed at x.xx%” – it is IRRELEVANT. That rate is gone. My view is that we’ve seen the end of sub-2% base for the medium term here, and the range over the next year could see base at 7.5% (COULD, not will). You need to be prepared for that. Don’t gamble everything on trying to save 1% here or there.


You also have options. Lower LTV. Slow down. Deleverage. Sell. List them all, cash flow forecasts are important. The opiate of the cheap bank money is no longer with us. 


So – anything happen last week?

OK – onto what has been another incredibly eventful week. Firstly a quick summary for those who found it more than a little confusing.


Last Friday we had a fiscal aberration (sorry, event). I went into line-by-line detail in last week’s supplement. It is fair to say I wasn’t impressed; it is also fair to say that not everything in there was bad. There is a true irony however to this statement: This Conservative administration, in the past 7 years, with the 4 PMs it has been comprised of, has pursued austerity when we should have pursued growth, and now wants to pursue growth when there’s a much stronger argument for austerity. Only a Brit can truly appreciate that level of schadenfreude.


The international markets reacted quickly, selling the £, and selling government bonds, driving the price down, and the yields up. On Monday morning when the Asian markets opened, Cable (the £/$ market) touched 1.035 or so. The lowest ever. This was very thinly traded. We did not see a close below 1.07, and are back over 1.10 now. Still – all time lows are not ideal and there was a lot of chatter about going below parity in freefall (personally, I think this is a bit emotional – £ looks great value to me now and if I was in the US, I’d be getting stuck into some UK businesses – but there you go).


There was then another grey swan that we didn’t know about. Pension funds have been using their large gilt positions as securities, involving derivatives (that scary word from 2008 – remember?), to try and force and squeeze returns. There was an insufficient level of risk control around this which caused them large losses as they had to sell bonds as the price was going down, forcing the price down even further, as margin calls came in. This left the Bank of England with no choice but to step in and do what Team Truss hasn’t been able to do, and calm the markets down.

QT to QE – just like that

This was a volte-face, of which not much has been made. Personally, quantitative tightening has never looked appropriate to me, this year. At other times, sure. Years have been wasted on this front. However, now – no. This position was reversed by Wednesday lunchtime as the Bank confirmed £65 billion of long-dated (10+ year) government bonds would be purchased by the Bank. They confirmed this was a temporary measure (as they have done every time they have done QE since 2009). 


This was good central banking. There was poor leadership and governorship earlier in the week by Andrew Bailey who has failed to impress and perhaps flattered to deceive (although a lot of the city has never liked Bailey nor had any confidence in him). The Chief Economist steadied the ship on Tuesday but by Wednesday we had a turnaround from £40bn of active disposals in the next year to £65bn of purchases and a promise that they would do “whatever it takes”. That phrase can be overused, you know……but I see why they did it.


£65bn is a relative drop in the ocean on the £860-odd bn still outstanding. Ridiculous though it seems to type those words. 7.5% or so. There are countries with far higher debt piles, worse economies, and lower gilt yields – which tells you just how emotional markets have been and doesn’t make sense. Nearly £5bn of debt was sold on Monday in a scheduled sale of 50-year gilts and traded at over 5%. I think that represents exceptional value and the 50-year bond is already below 3.25% again – much more realistic. 


The Union

This is still the United Kingdom. A great place to live. A fantastic legal system. Superb universities like Oxford, and Warwick, just to name a random two. Freedom. Yes, we queue, and we moan a lot – but that’s a small price to pay! To think that the UK government debt should be more expensive than Italy’s, or Greece’s – both with much larger debt mountains as a percentage of GDP, and both with no way out of their obligations to the EU which almost broke them last decade – is ridiculous. 


Later in the week, Team Truss sat down with the Office for Budgetary Responsibility (Presumably they had to ask for directions?). The OBR is the independent body that produces the data upon which a good budget is built. There’s a process. That process was disrespected and ignored by the Chancellor (Krazy Kwasi? We are still playing with the nicknames I think) who in the excitement to make his mark on the office, did some politically incomprehensible things at this time such as removing the additional rate of tax. Rishi Sunak’s predictions from his campaign – ridiculed in the Spectator, amongst others – came true almost to the letter within a few days. 


Further irony to heap on the irony bonfire this week – the free marketeers, who eschew regulation, then went on to describe the markets as “wrong” this week. Those who believe in the market to allocate resources. Wow. There was one poll with Labour 21 points ahead, and a further YouGov poll with Labour 33 points ahead – the biggest lead since the mid-1990s (and you will remember the landslide victory for “New Labour” in 1997 I’m sure). 


So what do we do?

So – that was the rundown. Interesting. Worrying. Frustrating. Some other emotions will come to the surface as well, I’m sure. What we need to move onto, now, is what to do about it.


Fix at Six? Really? Well, there are problems!

“Fix at Six” could become a phrase. This is a problem for investors who have preferred investments in the South/South-East of England, or higher quality properties in the Midlands, the North and anywhere else for that matter. In reality, if you are not receiving 8%+ gross yield on a property, you cannot leverage even sideways by fixing a mortgage at 6%. What do I mean by this?


Well, the commercial banks tend to use 25% as a proxy for costs of running a portfolio without considering financing. At a rent of £8000 per annum, and a property value of £100k, they would see likely non-finance running costs of £2000 per annum. If you had a mortgage of 75% of the value at 6%, that would be a loan of £75k, costing £4500 per annum (over 50% of rent on mortgage should always be a concern, in my view – the rental stress tests at 125% are simply not sufficient). That leaves £1500 per annum cashflow – 18.75% of rent – as a return on the £25k equity within the property, or (of course) 6% return on capital employed (I’m assuming you’ve just bought this, put £25k down as deposit, and ignoring frictional costs to keep it easy).


If that rent comes down to £7500 per annum – so still a 7.5% yield – theoretically the running costs come down to £1875 (you see the flaw in using a percentage as the driver here, but I am simply replicating what the commercial bank underwriters do); mortgage still £4500; cashflow down to £1,125. 4.5% on your 25k – at this point you are “leveraging down” – i.e. getting a lower return than the bank is getting, with far, far more risk. Start going lower and the rent coverage boundaries kick in and stop you doing anything more damaging.


Ah – but don’t you say that property is about total returns? Absolutely! And that is very pertinent here. The sensible forecasts at this time are that the market will go down over the next couple of years. That (hopefully) shouldn’t worry anyone – not a crash – in my view – but a softer landing. My forecast I’ve updated to -7% by the end of 2024, plus or minus 10% (so -17% to +3%). That’s pretty bearish but I’m comfortable with it. 


However over the next 5 years I still feel relatively confident at +10% (over the whole period) – plus or minus 10%.  


So what do you do if you are in this sort of spot? What if you already own the property and are refinancing, rather than buying new? What if you are hoping to buy in this market?


What if I’m buying right now?

Let us start with the last one. The price needs to come down if it isn’t already there. You have not, in the past decade or so, needed to protect yourself with the price that you are paying as much as you do today. If you’ve got a mortgage offer hanging at 4% or so – you are deep “in the money” on that as an options trader would say – you’ve got a great value product, and you can rework your numbers above – if the gross yield is 5.3% or above, you are OK (I am assuming this is a 5-year fix, rather than a 2-year, which has a chance of getting you in trouble in October 2024). 


If you are looking at a new purchase, then you need to factor in a few things. 1) Over 5 years, what will happen to the rents? In-house, we are factoring 3.5% per annum. Even under Starmer with a rent cap, we think that’s achievable, and could easily be front loaded (we could easily see rents up another 7% next year for example). 2) How much discount did you get? If you make £25k in discount on the way in, this must be accounted for – and how easy is it in normal conditions to get these deals? 3) Where’s your capital growth prediction for the next 5 years? Look at everything in concert. We can’t be bearish for the sake of being bearish – we will miss opportunity, and it will be knocking all over the place in the next several months. 


I think 6% is still an OK rate to be stress testing at, for exits in 3-9 months time. That’s on record now! You must remember that the base rate in situations at 6%+ tends to be about 1% above the bond yields, and that the pressure will be on the banks to keep the lending rates lower, and the savings rates lower, so that the housing market doesn’t collapse – and whilst in November the realistic spread for the Bank of England meeting is to go up between 1% and 1.5% (yes, really – those on base rate trackers, TAKE NOTE) – that will be somewhat anomalous and come back down to something more normal at the next meeting (it will still be a rise, but more like a 0.25-0.5%).


If I can buy at a 40% discount (I’ve done it – it isn’t easy – I would very happily keep doing it) on today’s prices – my range doesn’t cause me any worry in terms of capital growth etc. even at the bearish end of my forecast. I can also refinance out at 60% LTV at a slightly lower rate in 6 months time. With that discount I can sit on a bridge for 2 years if I need to. If I buy at a 50% discount… get the picture. Discount is a blunt tool but can protect you more than ever here.


Patience, grasshoppers

Vendors won’t be taking that, I hear you say! I agree with you. Not yet. Because we are looking into the future based on what we see now. You will lose to cash buyers! Yes, you will. You always do. But cash buyers will be being very cautious themselves and preserving equity in case of further grey swans…….


Remember a percentage of people are always very bearish and see the worst in everything. And also remember – a lot are sitting on a huge equity pile in some properties thanks to 25-30% increases in much of the UK since 1/1/2020. 


Refinancing – revise the ratio…..

Refinancing then – well, you need to get off those floating rates in my view. Remember my key ratio from some months ago: 


Floating (variable rate) Debt:Fixed Debt:Cash at Bank


I feel Cash at Bank needs to get to 20% or so here, and Fixed Debt to 80% – there’s no room for floating, right now. It will be a horrible ride. You still have a very nice amount of inflation-wasting debt. Hopefully for regular readers most of your debt is fixed by now!


If it doesn’t stack at 6%, consider selling it, and/or get the LTV down. Or you need to get money from other sources at lower than 6%. The average person is still not getting 3% in the bank on any savings and won’t be for a material time – so there’s now room between 3% and 6% to make hay, and win-win for both sides. 


Asset management time

Or – before sale – asset manage. Extra bedrooms? Rent increases? Other sources of income depending on the asset. Repurpose – HMO? Serviced accommodation? Social HMO? Etc. Repurpose before you get rid, unless you are bearing on that particular area for any reason – in which case, look at reinvesting elsewhere. Rent increase conversations are going to be a LOT sharper, driven by all of this, otherwise landlords will be in negative cashflow territory.


To find extra income, right now, that trading business element is going to be important. If it isn’t in property – the labour market is offering incredible, flexible opportunities right now. Go and work on a contract – go and sweat some human capital, while this all sorts itself out, if income gets squeezed to the point where you are struggling to get the lights on. 


What? Dynamite? Where?

Remember – form is temporary, class is permanent. After all this blows over, people still need houses. It is quite literally the very safest business of all, residential property – and this is why I got into it in the first place. The protection that higher yields offer is key right now – but affordability concerns are obviously rife, so high yield isn’t the answer on its own. Prudency is the answer – not overextending, not buying and hoping for the best – a rising tide lifts all boats, but we had a peek at one of my favourite Uncle Warren phrases this week:


“Only when the tide goes out do you discover who’s been swimming naked” – The Sage of Omaha, Warren Buffett.


The water didn’t get all the way out, but these choppy seas – represented by massive volatility – are meaning low tide is putting some at risk. I see the financial system as having pockets of TNT under the train tracks – when will the nitroglycerin go off, and how much is contained in there? I don’t know what the straw is that breaks the camel’s back – and it might well be avoided, although more by luck than judgement. Always remember this though – the fear of things happening is almost always worse than them actually happening. 


Survival time

Protect your margins. Don’t do deals for the sake of it or because you are a motivated buyer. Negotiate hard. Up your work rate. Read more supplements (!). Listen to more podcasts/Rodcasts. Despite the legislative noose tightening around us all, we’ve had it dead easy for years – even Covid didn’t harm, and in fact put massive ££££ on our balance sheets. Times really WILL be hard now, and this is the Olympics that we’ve been training for. We are two events into the Decathlon in the Olympic final – stick with the supplement, because I for one have been training for this all my life. I’m not saying I’ll always get it right – in fact the only thing I can say with true certainty is that I WON’T always get it right – but I will have researched it, thought about it, strategized about it, and dreamt about it (yes, really). I’ll be here, and so will the entire PIP community for those who need or want to share their concerns – talk to people! It helps so, so much. Until next week…….keep calm…….