Sunday Supplement – 07/02/2021

Feb 7, 2021

Sunday means one thing……the supplement.

Today’s roundup is going to take aim at two significant subjects at this time. Some on the ground news and some big picture thinking.

The backdrop for the news in the now is auction, and also BMV/cash sale leads. For those who aren’t used to either method, the best way to understand it is to understand the framework that a RICS surveyor uses. If you’ve ever had an asset valued for a bridging loan, or something that is non-vanilla like a mixed use / “shop and top” or a small block of flats, your valuation will almost certainly contain 3 prices in it when instructed by your lender:

1) 180-day price. This is typically the number that will be used for a vanilla mortgage valuation. The implication is that if you are willing to wait for top price/the “right buyer” (or maybe the biggest idiot), then this is the price you should achieve.
2) 90-day price. This is a price, usually less than the 180-day price unless the market is very hot, that would be achieved in a faster sale/lower marketing start price situation. For motivated sellers that are using agents, basically.
3) vacant possession value. This is when your assets are being sold with tenants in situ that add value (or sometimes destroy value), and the surveyor instead values it as an empty building.

If you don’t deal in fast stock these are the prices you will see and be aware of. But, the x-day price concept exists all the way down to 1-day. If you need to sell it TODAY you will find someone who will make an offer. It will be a significant haircut, not least because you are asking the buyer to take on some massive risks.

Auction is sometimes referred to as 45-day pricing because the transaction should be settled by then (some auctions can of course be faster), the 28-day price is commonly quoted by cash buying companies and the 7-day is also used. This is the ultimate tradeoff between price and speed – one that people often don’t understand when they don’t deal with it day in, day out.

So what? Well, it stands to reason that when pricing and markets change, the shorter xx-day prices change first as a forward indicator. Cash buying companies work to margins and many have been relatively quiet since May last year. Leads have been fewer and quality has been down. Why? Because the market has been so healthy. Many have commented how well things have been selling at auction in the past 6 months.

The cash buyers don’t change their pricing massively, they are working “in the now” and working to set margins. They are smart cookies and if they notice stock flooding in they WILL cut their pricing but they are built to do deals and as long as they can sell on they are not overly worried.

Auction is slower of course but still much faster than typical “traditional” property purchasing. It is also a different bellwether. There are a lot of retail punters that get dragged into auction usually by perceived value (or if you want to be harsh – by greed). There are however a lot of smart operators buying at auction too.

The other significant difference is liquidity. When there is easy money around (bounceback loans probably our greatest example ever, but it would include tax cuts as another reason for easier investment funds to be around) pricing does change.

This needs understanding in the context of my roadmap for the year laid out a few months ago. My prediction was volatility, and for volatility, the wind needs to change a few times. The past 6 months have been relatively relentless, with times around November and December being far hotter and busier than they would normally be.

There are two phenomena that can occur when a bull market or mini-bubble reaches a peak. One is that sellers can be attracted to the market who are really tyre-kickers. This is common but more likely on the open market, because the open market is free to list on and has few negative consequences if you fancy “chancing your arm”. It is less likely at auction but it does happen. In my locale in the super premium roads, this has been happening since around September last year. The tyre kicker pricing is 10-20% AMV (above) and unsurprisingly, very little stock moves because people as a rule spending 7 figures on a house are not stupid. They are usually highly intelligent.

The other is that auction, despite the constant battle for stock, sells fewer lots. The best way to assess this is always data, but data takes a little while to settle. This note is before all the results are in, as an early warning if you will.

Things have not as a rule sold well at the recent auctions. There are far more noises from those who watch the auctions closely that the top has come off.

Does this mean a crash? Will you suddenly be able to buy lots of bargains, will it be a fire sale? Not necessarily. This is a great time to up your work rate and be combing through unsold lots, however. Some good stuff is always left on the shelf in these situations.

How do I know it isn’t the beginning of a crash? I don’t. But we need to distinguish between false heat coming out of the auction market and fundamental downward spirals. I’m simply seeing this as a gap downwards in what will be a volatile and difficult year to predict. The SDLT holiday deadline is now really looming and you’d expect the heat to be coming out of the 300k-1m market. I’ve not seen or heard the agents talking of that yet but it may be next week before we start to hear chatter on that front. Open market agents are always a bit behind for the reasons laid out above.

As always, sit and wait for the crash? No. I remember well and have used the example multiple times of the famous economist article in the early 2000s which put into context how overpriced the UK property market was, making international comparisons. People who listened missed a bull market of about 85% before the crash in 2008-9 which took back 25-35% of those gains. Not much use sitting and waiting for crashes like that. And in many ways, this leads nicely onto my bigger picture slot.

The phrase that started to be mentioned in around September last year was financial repression. This isn’t a widely used term and largely went unnoticed with a few exceptions. Even the smartest sometimes take time to catch up and also they like to wait until the writing is on the wall before making bold predictions. Financial repression is one such prediction, but like a lot of these phenomena, will be difficult to “see”.

Similar to Brexit, or austerity, or other significant policy decisions of the last decade. The difference with this one is that it CANNOT be put into words or even be made public, because of the consequences of it.
Also like brexit or austerity, we can only theorise or build models that say “if we HADN’T cut gov spending” or “if we were still in the EU”……we don’t know. We only live one reality, and what happens has happened. We can’t see for certain what would have happened if……

So – financial repression. There have been some significant steps and tipoffs.

1) the BoE checking with banks how they will respond to negative interest rates within 6 months. Headline grabbing but they pretty much know. This isn’t unprecedented worldwide, isn’t unprecedented in large economies, isn’t unprecedented in western economies, etc.
2) the BoE also announcing that rates will stay low for some time and inflation will be allowed to go above target for a period of time. This is effectively surrendering traditional monetary policy for a period.
3) the realisation that 2021s bond maturity will see the cost of servicing the debt plummet. Bonds issued in 1991, 2001, 2011 (alongside many other years) will mature this year. 1991……imagine what rates they were issued at! They will be being reissued at a tiny fraction of those yields. The debt servicing bill goes down the longer we keep the rates down and the market demands only very thin yields indeed.

What does repression actually mean? It is effectively capping the yields (as and when that is needed) meaning that savers are getting zero or near-zero returns. At the same time it is pursuing inflationary policies to inflate the debt away. If inflation is 3% and interest rates are zero:
If you owe 2 trillion at the start of the year the real price of that debt at the end of the year is 1.94 trillion. That’s attractive for obvious reasons. Doesn’t it seem like a victimless crime?

Easy answer – no. No it isn’t. Those who are hurt are the savers. That relationship (inflation and interest rates) needs significant scrutiny. The situation above (3% inflation, 0% interest) means everyone with money in the bank is losing purchasing power at a significant rate. The real rate of return (interest rate minus inflation) is -3%. This is the situation that is effectively being targeted at the moment without saying it.

Over 5 years people will lose nearly 20% of their purchasing power if the money sits in the bank. This is why repression is described by some as stealing from the old to give to the government.

It is very clever as long as you are an active investor, able to return inflation-beating returns. If you aren’t – you have problems. This leads to a retail investor bloodbath. Look at the massive losses in Blackstone and magna and similar style investments – people chasing returns in a zero return environment (as we’ve been in for years as far as interest rates vs inflation are concerned). This is now heading to a significantly negative real return environment and people will be taking massive risks to get 5-6% returns. It is very sad and the FCA will be very busy.

So if you do have significant savings how do you protect yourself! See a financial advisor who understands this stuff and can help you build a “cockroach” portfolio – so named because it can survive a nuclear bomb. It will include exposure to gold, equities, possibly property and also cash. What you can’t do is do nothing because otherwise your savings in the building society will die a slow death.

Hard to see, easy for the government to pull off… see the attractiveness.

What is one of the other relevant spinoffs…..taxation. In the 1970s (the last time we had any significant issues in controlling inflation for any significant period of time) inflation was rife and we were talking huge numbers. Now, 3% would be MASSIVELY significant. So it isn’t the quantum itself, but the relative impact of it that we should be watching. Yes, inflation can be like a wild horse when released and there’s also a danger there, but hyperinflation is unlikely (or you might argue that in the zero-returns environment, 4%+ WOULD be hyperinflation). So what does that mean for tax?

Taxation is an inflation curb, traditionally. Take more money out of people’s pockets and that means they can and do spend less. It cools the economy and lowers demand. The obverse is also true – so right now you might be thinking tax cuts are on the horizon!

However – we are starting from a low base. The “real” taxes of consideration in the UK at a national level are income tax (include national insurance for the purposes of this conversation) and VAT (and to a lesser extent, corporation tax). Next year’s allowances are set and there’s been a tendency to want to move to a set increase in tax free thresholds (although inflation might change that too!). But the rates are not.

So there’s a strong case to put taxes down to inflate the economy here and the government will secretly get what they want. But then you have to consider politics.

We have a couple of years before the government start trying very hard to be re-elected. Tax hikes next month are unlikely for economic reasons but vote-winning or pump priming tax raises are highly likely. This leads us to CGT and the likely rise in that tax. It will encourage people not to crystallise and instead refinance, when it comes to second homes/BTLs. However a massive number of 1-2 property landlords won’t even have seen this coming and won’t even realise they have a bill to pay within 30 days after the disposal of an asset.

There’s even a case for a VAT cut as already performed on a sector basis. There’s a far greater case than for a VAT rise. Politics may also lead to a rise in corporation tax (but perhaps not yet). You have to split the two. Trying to do the right thing for the country and the economy – and trying to be re-elected/to stay in a job.

The treasury has one more concern. It still needs to look like a spectacular covenant to international banks and investors. It has to look like a great credit risk. Why? It keeps the price of debt down.

So there’s a few teasers there as to what might happen from a tax perspective at a high level in the budget. Those expecting tax increases across the board are coming from a lack of understanding of macroeconomics. Those thinking it will be what is best for the country are coming from a place of naivety and lack of understanding of politics!

Throw in the massive stimulus in the US and Rishi and his team might also see that sort of action as a vote winner. Overall I think it could be OK news but if you have large latent CGT bills I would strongly consider taking action via auction that will settle before 31st March!!

Financial repression is coming. There’s no other way out of this. Understand it and be prepared for it and it can be turned into the opportunity of a generation. Let me be very clear – property prices overall will rise significantly this decade. Be on the gravy train – not at any cost – and do not overleverage – but if you are sitting on the sidelines with disproportionate cash versus your asset base – take action to do something about it. Thank me in 2029.

Most importantly of all – please like, comment, share, challenge me and stay safe and well!