Sunday Supplement – 05/12/2021

Dec 5, 2021


Welcome to the preantepenultimate supplement of 2021. I can’t believe we are there already – but we are. I’ve checked the calendar and everything! 2022 plans better be taking shape pretty soon folks, otherwise, if you struggle with goal-setting, visualising and all the other powerful tools that a lot of the 1% employ, it will be another year under potential.

Enough of the self-help mantra before I go “Full Guru”. This week, we’ve had some really significant (or potentially insignificant) news on the covid front – but I’m going to discuss the impact of the reaction, rather than the Omicron situation itself and speculate on its pervasiveness, vaccine evasion (can a virus be a non-dom? Clearly it can!), and potential fatality rates. Mostly because the latter would simply be educated guesswork anyway – and whilst I’m certainly no thought leader on covid matters, anything at this time is exactly this, educated guesswork and the reaction instead runs alongside fear and an overall lack of logic. It has changed the roadmap for next year and beyond once again, and remember – all good forecasters update their predictions when something changes!

I also want to get into the market in 2022 and some predictions on volume of transactions, where they might be, and the direction of travel in a few of the micro-markets. I want to talk a bit about where myself and my partners have focused the majority of our efforts this year, which has been the most challenging trading year so far for us – despite, generally, a very healthy supply of credit.

I’m also grateful to Lyn Alden who is an investor with an engineering background, and listening to her recently on one of my favourite podcasts (Macrovoices, with Erik Townsend) made me very annoyed that I had missed the very point that I’ve made a number of times before in a different context – it’s never like the last time, it is (largely) recency bias that leads us back to the last time, and cognitive gap/laziness/lack of correction of this bias that leads us not to look beyond this. Since I spent some significant time and effort on economic history study in the past 22 months, I’m pretty annoyed at myself. But nevertheless, once you see your mistakes you can either go “Full Boris” and ignore them or even celebrate them, or you can put your hands up and try to correct them and use them to shape your future thoughts. I’m going for the latter!

That will probably be more than enough for this week – but before we get into it, I wanted to say a huge thankyou to all of the Partners in Property members, sponsors, staff and those who just look in occasionally on our community – we’ve had a couple of tough years as a “proposition” and thanks to Omicron, I’m sure we aren’t through it all yet – but the spirit has never been better and the experience overall has been wonderful. Let’s get through this winter and into a great 2022 which I’m sure will see great things for our community.

Soooooo…..Omicron. A lesser-favoured greek letter, I’m sure most would agree. Alpha, Beta, Gamma, Delta, Epsilon, Theta, Kappa, Mu, Pi, Rho, Sigma, Psi (didn’t he do Gangnam Style?) and Omega – that was about the extent of my knowledge, some because of maths and trigonometry, some because of tracksuits – so Omicron was a new one on me. But it sure has had an effect without doing much as of yet.

What’s the overwhelming reaction been? Consensus. Does that consensus make sense? I will be arguing not. What’s the first consensus – rates are now less likely to go up at the next monetary policy meeting for the Bank of England (16th December). Around 10 days ago I was saying it was close to a mathematical certainty that they would be going up to 0.25%. The immediate rise is now not that any more, although the change in the swap markets’ expectations is that the next rise might be in the early Feb meeting in 2022, but the likelihood is still that rates will go over 1% in 2022 itself. I can’t agree with this for a minute – my view is that at least 66% of the committee do not want to see this happen nor do they think the economy can handle it – and, if Delta is much to go by, Omicron could be 3 or 4 months before we know much at all (or enough) about it. This doesn’t, to me, look anything like an environment for the most aggressive interest rate rises in a decade.

I’m not really falling in line with other economists here, although we seem to have arrived at the same destination it seems. I am saying, effectively, that I don’t buy what the central bank is saying at the moment. They HAVE to speak in a certain, political way and at the moment the MOST important thing is that it is credible to believe they might well raise rates relatively quickly to control an overheating economy. But the likelihood is that the supply chain disruptions are not over (and that Omicron will cause more – I’m not sure on the cause, but I believed they weren’t over anyway, so we end up in the same place), which could continue to affect some pricing upwards, but once the 2022 price rises are done/the repricing happens in some other sectors, which will filter through into February and March’s numbers, then I expect the commensurate fall in demand to make companies quite cautious of other prices rises too soon. Their January 2022 rises will also include significant consideration of the wages pressures that are already “baked-in” for next year – with the national minimum wage going up 6.6%, this has to force prices forwards around 1.3% just on its own, as staffing costs tend to make up around 20% of many businesses cost base – and not much has gone or is going down at the moment.

The Bank, reading between the lines in my opinion and that of a fellow attendee of the Bank of England briefing meetings, does not see the case for raising rates fast and hard. They are relatively soft on this line – but I feel it is there to be interpreted. The other point of interest is that last time out, there were more in favour of tapering off some of the QE (that vote was defeated 6-3, the rate rise vote was defeated 7-2) – so, unlike the US (which is pushing on under a hawkish and newly-buoyed/relected Powell), the direction of travel of what jumps first is not necessarily set as yet. I’d be surprised to see a little from column A and a little from Column B at the same time, because it will be difficult to measure the impact – but stranger things have happened and it might also be a statement of intent – the Bank also likes to shake up the markets and remind them that prediction is not necessarily reality – November’s meeting was fairly long odds-on to raise rates but they didn’t, and this was pre-Omicron.

A little more US, while we’ve touched on the subject. The phrase you would see this week would be “retirement of transitory” (although you might also see something about yield curves flattening too). This is basically what I amongst others have been saying for the whole year – this inflation isn’t transitory. Or, more accurately, this inflation isn’t ONLY transitory. There are secular, core parts which are likely to persist beyond the supply shocks, demand changes and stimulus as a direct result of the pandemic. Now Powell has said as much – the yield curves have reacted. The 5 year US inflation prediction touched above 3% for the first time this year (the prediction of the rate in 5 years time) but has come back under that now – so markets believe that the Fed and the fiscal policy will have inflation under control in the medium term. The short term bond yields have shot upwards, as holders demand better returns (still, interestingly, largely losing money in the long term) whilst the spread between the 2 and 10 years has narrowed. Yep, that means there is not much more in terms of returns for locking money away for 10 years rather than 2 – less than a 1% nominal difference.

Translating this directly to mortgages – IF this persists (and we really need to wait and see what happens on Dec 16th) – and if the UK mirrors the US as it sometimes does – then we would see even less difference between the rates available on 2 year fixed mortgages and 5 year (and longer) fixed rate mortgages.

One slight point of respite, mentioned a number of times this year because it is such a key driver of core inflation, is that Crude Oil has blown off its price top this week on the Omicron news, speculating that fuel demand will go downwards if there are more Delta-style disruptions to supply chains. This is bucking the trend of the year, although is likely temporary if my assessment that Omicron is largely being overblown is correct.

One more point here before we segue – I don’t remember seeing so much in terms of predictions and markets being ascribed to the end of a year as I am seeing right now in 2021. This is total balderdash. It is pure psychology – but it looks like it is working. Here’s my working theory – people are desperate to see the back of 2021 and were hoping 2022 would be a “non-pandemic” year. This is ultimately stupid, because there’s no doubt that winter in the Western world is the worst time to believe that the pandemic would actually end. It will end in a spring/early summer, simply because of the external healthcare challenges put upon healthcare systems by the weather. January 2022 will change nothing apart from calendars – believing otherwise is folly.

So – the time has come for people to start nailing their colours to the mast for 2022. What will happen with X, Y and Z. A few weeks ago, I put one of my infamous (dad-style) jokes on a facebook post – the opening poster had boldly asked for predictions of what the market would do in the next 2 years. I answered +8.74%. Yes, that’s my idea of a joke – the joke being multifaceted, as it goes. Firstly, who would be stupid enough to predict this to 2 decimal places? Ridiculous. Secondly, who can know with any particular degree of confidence? No-one. Last year remember, as recently as that, when Savills and Knight Frank confidently predicted of a 40% fall in real estate prices in the UK. At least twice as bad as the Great Recession of 2008. With what authority, and with what accuracy? Instead they were up 10%+, so they were 50% out. If you just predicted 0 every year, you would take a decade to be that far out, in aggregate. This is rather close to the primates and the complete works of Shakespeare in terms of an analogy, if you’ve heard that one.

In seriousness though, I couldn’t come up with a better number than +8.74% at this time. It is a manifestation of the market conditions that I see prevailing over the next couple of years – free available cheap money (tick), demand not completely subsided from covid-inspired reasons to move (different job, different working requirements/working patterns, different priorities), and supply remaining short. Those who have held their houses off the market because of the pandemic, that silent several hundred thousand items of stock, are not putting it on this coming week (or before spring or summer 2022) unless they are absolutely forced to. So – it is the manifestation in my mind of an express train that isn’t out of gas just yet.

There’s no guarantee of this of course. Far from it. We have been quick, this year, to bemoan 2020 as a base year for year-on-year statistics. And, quite rightly – it just can’t work like that. However, like always, the smart have gone one step further – whereas the brilliant have gone several steps further than that. It’s great to look at 2019 as a “normal” year – but it wasn’t. It was one of the weakest years of growth for some time. It was an election year in a particularly difficult to call election until about 8 weeks from the finishing line. With the election in December. With the Brexit sword of Damocles still hanging. It was “better” as a frame of reference than 2020, but still not up to much. More work is needed, at a higher level, to really remember the world before the pandemic, and what we might be or are still carrying in terms of “hangovers” into 2022 on the property market side.

This hangover, overall, leads me to predict 5% growth for next year nationwide, (a fairly useless average to all of us unless you are invested in nationwide REITs, for example), and 1.2 million transactions in the property market in the UK. We usually see around 1MM – 1.1MM, and in 2021 Zoopla has estimated this at instead around 1.5MM transactions. I don’t see that train coming off the tracks completely next year, and so I’m going for 1.2MM as part of the hangover. There’s still a ton of buyers ready to move with cash and cheap mortgages waiting – and they are motivated. If and when the debt pressure stock starts to make a difference, then that stock should be around to take some of the heat out of those price rises, but I still see more demand than supply.

That’s the dartboard filled for the year then. Rents I see continuing to rise as the pressures are not going to ease particularly on what’s forced up prices of late – I will be doing a longer piece devoted to rents by the end of this year, as I’ve done most but not all of some fascinating number-crunching which I’m keen to share with the readers of course. Some areas could easily see another 10% rise on new tenancies – which will be most of interest to new investors or those looking to add stock to existing portfolios.

And then – the mix. Flats or houses, they ask me? Should I buy new-build or existing (this question comes overwhelmingly from overseas buyers, but not always just overseas buyers). Spoiler alert – houses, existing. They have kicked the you-know-what out of new build flats (AVOID AT ALL COSTS – don’t make me shout – unless buying direct from a genuinely distressed developer at a snip) for many years and will, in my opinion, continue to do so. If you were going to make one of those two decisions – go existing over new-build, new build make poor investments when the developer is intelligent as they have squeezed so much out of the lemon, they’ve left very little of the rind for the investor “lucky” enough to be first in.

Detached has outperformed Semi, has outperformed terrace (although this is very close), has outperformed flats, since the start of the pandemic. This is also unlikely to change too quickly, but you get many years where semis and terraces perform best. Flats are about as unsexy as possible at the moment, let’s face it – no garden hurts in a pandemic world, leasehold is getting a hammering, cladding and EWS1 issues are widely published, ground rents and poor block management have always been an issue and they are right at the fore. This is exactly why I’ve bought a few flats this year – suburban rather than city centre, but that’s always been my preference and covid has just made that an even stronger preference than before. Short leases. No-one wants them. I posted the other day about a flat I bought around 3.5 years ago, a lift shaft issue that was forecast to cost £10k ended up costing me £250, in which time I’ve had c. 19k in rent, and paid £33k total for the flat. Not a bad little ROI – and those deals are out there. We are a handful of BRR deals in flats this year without much or any “first R” (refurb) – and these have been dead easy to find, auction stock that no-one else wants, basically. We’ve kept the faith, followed the process, and looked for the deals that would keep risks down in a rising market.

We are also developing a few sites, shops with uppers, an old bank, some asset management plays where the work is largely done but the tenancies and marketing are just all wrong – and also purchasing some limited companies with property assets in. Add in a smattering of direct to vendor, which has been very challenging – and a heavy refurb just purchased at auction – and we’ve stuck to the knitting on a fair few properties as well, buying well as a 2-bed but making an easy third bedroom – tried, tested and, I’d argue – better than ever before, because a lot of 2-bed demand has become 3-bed demand thanks to the pandemic and a hybrid working model, and there were never enough 3-beds in the first place (although, of course, some of the 3-bed demand has become 4-bed demand…..but if you thought there weren’t enough 3-beds, just check out how few 4-beds there are!!)

As I said last week – volume is definitely down – fewest acquisitions since 2016 (ouch), but deal quality is up. Margins are up. That’s a massive positive and also reflects the risk-based approach that I’ve always taken, and since risk has most definitely been “off” in the ideal world since Feb 2020, is my most pleasing stat for the year. There’s the large small matter of the paper money made on the existing portfolio as well of course – but I’m not counting a washer of that, because you can’t eat paper…….although one sale of a number of units is crystallising a nice paper profit.

So…..onto Lyn Alden and a Eureka moment. I’ve said time and again that the weakest approach to the next, or current, crisis moment, the most intellectually lazy approach is to say “it’s the same as last time”. No-one ACTUALLY says that, of course, but I lost track of how many times this was effectively said last year from large corporates down to respected individual commentators – I called it out wherever I could without getting blocked by too many people! It was nothing like 2008 in the end, and one reason for that was a complete obsession with not allowing credit to dry up – I’ve spoken before of some of the cloak and dagger progressions of credit throughout the worst and most uncertain days of April 2020, but we the laypeople will never know the truth, I’m sure. We can merely speculate……

This logic is sound, and serves you very well. I am yet to see an application of “it’s the same as last time” that offers any edge at all when we approach a crisis or look like we might be in the middle of one. The same, of course, goes for inflation. I’ve been guilty a number of times this year of mentioning the 1970s, and this is the intellectually lazy approach. I’ve been back and looked at what I have written, and happily I have mostly said that it wouldn’t be like the 70s. However, listening to Lyn has filled in that last piece of the puzzle.

When was the last time before the 70s that we dealt with secular (persistent) inflation? The post-war period. Now, I’ve discussed wars versus pandemics and historical analysis at some length this year, so you might remember some of the highlights – but in short, pandemics seem to offer better returns to workers in the immediate aftermath and for several decades, but weak returns on capital.

Ah, but it will be different this time. Will it? There’s so much capital, after all. Yes, but this is a good reason to see poor returns. So much money out there that needs a home, equities (certainly in the US) overpriced by almost any metric you could use, bonds losing money in real terms, even the junk bonds, commodities have been robust but are likely to remain volatile above all else and quite likely to take a bath next year at some point, in my view – and then there’s crypto…..a tiny tiny part of the global investment market, so not yet worth too much of a mention, but there’s been a December bloodbath which is not for the first time. Risk is “off” on crypto that’s for sure.

So the 40’s look a potentially better proxy – where we saw persistent low rates and inflation that at some points was ravaging away. Did I mention that “they” loved it of course? The central bankers and policymakers. Why? It inflated away that war debt. I’d be surprised if there isn’t a good eye on this – but with the post-pandemic world rather than the post-war world, there are different challenges, so this is no repeat of the 40s per se, but it is a probable scenario – low rates for perhaps even 10-15 years as we get beyond this, and – let’s face it – we hadn’t truly amortised 2008 yet (specifically in the UK) – in the US, perhaps they had but they have a “debt on all sides” mentality at the moment (although, you’d be forgiven for thinking the UK is exactly the same).

So struggling traditional investment returns, likely low interest rates, and potentially a strong environment for workers. Do you want me to give you a full diagram of what to do next? I think not, at this stage. But we all know those are some pretty reasonable ingredients for a “melt-up” in the medium term in property. The challenges will include legislation, EPCs, tax and that’s before you even start on a tenancy (and what structure to use!)……but one cheesy thought to leave it – don’t wait to buy property, buy property and wait! Until next week….