As promised, we continue on the massive and relevant topic of inflation and the ultimate effect of it on property prices. Today we will be looking at real rates of return, as promised last week, and what has happened historically to property prices in times of inflation, so that we might prepare ourselves, if as the “inflationistas” are saying, we do enter into a sustained period of inflation following the enactment of some of the pandemic policy suite/fiscal policy response that appears to be particularly inflationary.
It is always valuable, as well, to look at what has actually happened in the past 10 years. This really serves 2 purposes – firstly, it addresses recency bias. What this effectively says is that we as humans are biased in our forecasting/predictions by what has happened particularly recently. I spoke about this quite specifically last year, because if I had a pound for every time I had heard the phrase “this will happen just like it did in 2009” I would have been a pretty penny better off. I was, in my typical style, at the time, quite decrying of this approach and I still am. We make a massive mistake in thinking that one recession will be the same as the next. There is no historical evidence of this at all. In reality, typically we will observe some very different phenomena, a different cause, a different bunch of effects and, quite critically, a very different policy response. Without going into all these in significant detail, I think the very different policy response is relatively obvious – let’s just say in 2008-9 we lived in denial, took 6+ months to really react in a meaningful way (in many ways, it was really around 18 months before we did anything when the writing was on the wall in late 2007), and took a peashooter to a gunfight – whereas in 2020 we bought all the bazookas we’ve ever had and borrowed a few more, to fight the invisible virus and the fear and partial mania that it created.
Secondly, it is always better to look at reality and data than our impression of it. Twice in recent weeks I have pointed out, during internet debates, what has actually happened. Both times, the people I’ve been talking with have been well-respected, very sensible commentators. However, they have been talking out of their respective hats, talking about the world as they see it rather than addressing what has actually, statistically happened. This is critical – we can often walk away from a situation/period of time thinking something has happened that actually hasn’t. A brilliant example of this is discussing house prices in London since 2016, especially if you discuss it with people who have invested heavily in London in 2016 itself. The only place to consider getting real figures from is the office for national statistics. Another good example is to talk to people who have made some wise property investments, or done developments, that have experienced some capital growth (the last 12 months might be particularly relevant here). There’s the reality – the market has done some of the legwork, and then of course there is the time, effort, risk and skill that goes into it. In a bull market, the returns from the bull market might outweigh the returns from the time, effort, skill and risk – but it takes a complete removal of ego to walk away from the situation with the conclusion that the market has helped out more, in this instance, than the value you’ve been able to add as a developer. I’m doing a development at the moment where this is absolutely the case – and I’m comfortable with it! The market hasn’t done that much legwork in the past 10 years for me whilst the value-adding phase has been going on (perhaps the South Wales market of 2016-2019 is a fair exception, in my own personal experience – and there was some skill in targeting that area specifically expecting a regional melt-up in prices of course). There’s nothing wrong with getting lucky – the key is understanding where luck meets skill, how to not bank on luck going forwards, and how to keep hold of “supernormal” profits that come about by luck.
So, off the soapbox regarding reality versus our own, often distorted, versions of it. What was the real market in the past decade? The Nationwide produced a report to kick off 2020 (without knowing what a year it was going to be, of course!) which stated that after inflation, house prices were down 1% in the 2010s. London (as a significant outperformer in the 2010s) outstripped inflation, but only by 24% (significant when being compared to 1% down). Removing London from all other figures would obviously see that 1% be a few percentage points lower. So – in reality – compared to the cost of living, housing got more affordable as a rule in the 10 years, on average (but not in London). A better piece of analysis would see house prices adjusted by average earnings increases (rather than by inflation), because that would be the true metric of affordability as that is what governs the mortgage market, and a huge huge majority of people get onto the housing ladder with their first purchase with as much leverage as they can obtain – this would not stack up particularly well in the 2010s in comparison to inflation, because, as you will have read and noticed, austerity happened and certainly public sector wages went down in real, inflation-adjusted terms. One good reason why a sustained period of austerity is particularly damaging to an economy, as has been widely documented by the IMF and other major (usually considered right-leaning) economic think tanks since 2012.
This really doesn’t fit with a lot of the narrative. What would the press write about if it wasn’t for unaffordable housing! But in reality, we had 10 years of it not really going anywhere, although it no doubt pushed more people out of London in terms of making a choice to relocate to London for work in their twenties (I certainly observed this, in my network, as a non-Londoner). After inflation, in more than 50% of the country (in terms of rooftops) it was cheaper after inflation to buy a house in 2020 than it was in 2010. If we look at the figures around wage progression, after inflation, they were down around 2.5% in the 2010s. So there was very little change in affordability – but not driven by house prices themselves, rather by poor economic performance and the translation of that into real earnings moving in a negative direction.
This, also, isn’t as relevant as you might think to you and I. As we progress over those 10 years, the hope is that we would have gained more skills, been promoted, and therefore earn more money than we did 10 years ago. This is the nature of a career – and this is why the house price “problem” is isolated often to discuss people in their 20s. A 21-year old may be in the same boat – pretty much – as they were in 2010 (although, if they are London-based, there is no denying it is harder) – but then there are many counters to this. One may be that with life expectancy up over that period by around 0.8 years – should a 21 year old in 2010 be more accurately compared to a 22 year old in 2020? This is just one example.
So this is, perhaps, bad news for property? Returns in the 2010s were weak,or flat at best, when put against inflation and wage increases. Speak to the average landlord and they will also scream about the cost of compliance ever racking up, let alone the section 24 mortgage relief changes. I would (as usual) have a slightly different take. If you made money on property, over and above returns on cash, or other investments, in 2010 – you likely had skill doing a lot of the work. You added value, bought well, sold well – invested well. It was a tough backdrop. The trend since the 1970s has been clear – 1980s – melt upwards in house prices, after inflation. 1990s saw a dip after inflation – down 24% in real terms. 2000s saw another melt upwards (67% up after inflation!). 2010s was flat, in a flat, elongated, zero interest rate environment. The 2020s (or the first part anyway) looks to continue the zero rate environment for some time. I know a fair few are expecting interest rates to follow inflation upwards, in the “traditional” way – although I’ve written several times recently about how this is unlikely to be the case, mostly driven by the debt time bomb that has been set thanks to the pandemic (and also by likely government fiscal and monetary policy to tackle it). My feeling is that they won’t – the Fed has said as much in the US – the Bank of England has been more tight-lipped but actions will speak, as they always do.
Government policy is also as pro-house-price as I can remember for a decade at least. SDLT holidays. Increases in % LTV of mortgages for borrowers (why are the government meddling in this market? They really have no business doing this. The answer of course is to win votes, but messing with markets like this is dangerous). What’s the result usually in these situations? Well, if you look at help to buy, for example, the result is a massive wealth transfer, paid for by the state (in risk premia, and also in real terms, in the long run) to the pockets of executives at very large housebuilders and their shareholders. This is one example of a piece of policy that is not being challenged because of the shadow of Covid, and also, arguably, a relatively inoffensive but impotent-seeming leader of the opposition who has spent more time agreeing than disagreeing in the past 12 months, and now seems the timing as correct to comment on the price of wallpaper in the PMs office rather than focusing on, let’s say, opening the country back up and letting the people taste a bit of the recovery that everyone is talking about??
I see Boris as a relatively simple individual when it comes to strategy (and that isn’t necessarily a bad thing). E.g. – there’s a pandemic – that’s like a war – so be like Churchill. There’s an economic crisis to come out of – build house prices and the wealth of the middle class – i.e. be like the Thatcher of the 1980s. The fallout (particularly of the housing strategy of the 80s) is well documented, but he is not too worried by that. Thatcher won 3 elections on the bounce after all……..and managed 11 years at the helm.
So in real terms – where do we expect prices to go based on the likely inflationary environment that I’ve been arguing for? Firstly we’ve got to look at the backdrop. We come off the back of an 8.5% (ONS) house price rise for 2020. This is overstating the fact somewhat – Dec 2019 was a bad month to measure because of the election, and Dec 2020 was also a bad month to measure because of Covid, stock shortages, and artificial stimulus including stamp duty holidays. But nonetheless, that’s the one in the history books now. The major point is, though – you’d struggle to find someone who would say prices SHOULD have gone up 8.5% in 2020. My own predictions at the start of 2020 were flat for London/SE and 4% rises in the midlands and some areas of the North/Scotland/Wales. I was above average (which was about 2%) and about 5-6% off what actually happened (of course, I didn’t see the pandemic coming, and even if I had done, I certainly didn’t foresee the effect on house prices until the unlocking started to unfold in front of my eyes, when I quickly changed my position on where the market would go). The real value is in unpicking that 8.5% – some to be dismissed based on a bad base month in December 2019 – and splitting into the component parts:
Demand – 2020 always looked good for demand. Some words pulled from an article written in very early Jan 2020 (but very similar to what I wrote myself at the start of 2020): “The result of the general election has brought a level of political certainty and a clear route, in the short-term at least, for the Brexit process.
Many experts suggest this could play out in the housing market with a release of some pent-up demand among buyers and sellers. People who put off making one of the biggest financial decisions of their lives may now feel more confident in making that step.”
The other thing to remember on the demand side is the reality of WHY people move. They need to be motivated. It costs a lot of time, effort and emotional energy to move house for a retail buyer (which, remember, is 80% of the market nationwide). Covid created more motivation than anything in the past 40 years. We are in the midst of seeing an “urban flight” due to proximity to office jobs (remember 84% of UK jobs are in the service industry) no longer being as important as it was. The Resolution Foundation have reported on this, and I quote them directly: “Since February 2020, house prices have risen by over 10 per cent in the least populous tenth of local authorities in the UK, compared to rises of ‘only’ 6 per cent for the highest density decile. This is a significant departure from the pre-crisis trend, with price growth by density decile varying little in the year to February 2020 (and prices in the lowest density areas actually falling in the run up to the pandemic).”
The things to watch are how long this trend goes on for, and how large that gap actually becomes. At this time, city centres ex-London are particularly struggling to sell flats (and flats are at a “perfect storm” level when you consider cladding, leasehold and the publicity, and urban flight) versus Cornwall and Devon which are seeing stock evaporate as soon as it hits the market, containing some of the hottest hotspots in the country right now.
Then we’ve got supply. The shortage of stock varies, depending on your source, between 18 and 35% compared to pre-pandemic levels. This is a HUGE factor, and it perhaps speaks to the silent majority who are, on average, more senior in years – own a property and would like to downsize or move to a more rural location – but have lived in fear during the pandemic. That decision can be deferred for a year, or two – I don’t expect a massive rubber band effect here, but that stock that would have organically come to market in 2020 and 2021 so far, and didn’t, will come back to market over the next couple of years or so. There’s still lots of people who are quite bearish about winter 2021 (personally, at this point, the data does not support such a position, when you consider the vaccine and its true impact on the numbers of cases – and also the lack of evidence surrounding temperature, and seasonality – but why start being logical about Covid now, because almost no-one has been logical about it throughout!). So many will wait to do things until 2022 – or at least, at the moment, they state that they will. The lack of negative commentary around the publicised pictures of the Liverpool gathering of 3000+ in a warehouse, carried out legally, speaks towards the overall sentiment at this point (versus the vitriol towards the “covidiots on the beach” of this time last year, for example).
So an unreasonable and unjustified 8.5%, but 8.5% nonetheless. That sort of number is of course not sustainable, nor would the government want it to be so. What we need is a strong underlying economy that can support decent house price rises – Boris will see that as desirable because many then remortgage and up their spending, living a life of cheap debt (not dissimilar to the life the government wants to live, at this time). Under the radar as usual is the fact that the cost of servicing the debt in 2020 was the lowest cost for the last 5 years, and is under the 3% threshold (compare this to the US, which is playing with the 8% threshold in its debt servicing costs – this is really significant and a debt fireball has really built there, with a president who has more Rooseveltian ideas, in a different time with different problems, and control of the legislature – I expect some eye-watering numbers out of the US over the next 4 years that’s for sure. It will serve as a great bellwether for Boris and we will see how far we can push it with a “free” early-warning system.
There is one thing missing for the picture to be complete, and the forecast to be able to really take shape. That is productivity. Currently, productivity numbers and graphs have got “Coviditis” – the numbers don’t really mean anything. Lockdowns, forced demand dropoffs, furlough – all of this is such a mess for the numbers, that there is really no point reading them at all. We have to speculate – and what we know historically is that from the relatively limited body of literature around productivity experiments and tests, not proven at a large scale of course, is that in the service industry working from home tends to increase productivity massively. We need to think back to some of the buzzwords from last year and the headlines around saving commuting time, employee satisfaction going up, and then also be realistic. The UK has had a really significant productivity problem since 2010. The average person is better off than they were because the benefits system took a savage step downwards, and battered people back into work, addressing some of the legacy of the 1980s when so many were made unemployed, and then told they were disabled in order to manipulate the statistics. The methodology may well make the toes curl, but the reversal of these statistical manipulations and the policies enacted moved more people from liabilities to the UK economy to assets to the economy than for many years. This, running alongside the quality of jobs created (which, per capita, was low – there is only one tech employee earning a 6 figure salary to every 20+ jobs created at or around the minimum wage, part time, etc.) meant very low unemployment, but part time work so often is lower paid – the drivers of high wages are the willingness to travel a long way to work/relocate, and the number of hours worked per week – the marginal benefit of working 50+ hours is disproportionate (only in wage terms, note – not in lifestyle terms!).
So where will the productivity puzzle end up? My suspicion, after seeing the incredible growth in some sectors that have talked about 5 and 10 year steps forwards in the size of their markets, and their revenues, is that it will have temporarily fixed the problem. Has covid fixed the underlying structural problems that led to the puzzle in the first place? No. But the (perhaps temporary) evaporation of austerity will also be massively helpful, once spending calms down and the velocity of money kicks back upwards as the economy truly gets back to its full potential. But when will that be………more on that (and this overall, massive, topic) next week!
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