Sunday Supplement – 07/11/2021

Nov 7, 2021

Welcome to the supplement as we enter November, and notably temperatures have plummeted this week. This marks the start of “boiler season proper” for those with resi portfolios – and the heating engineers get ever more in demand for their Christmas week/day in the sun! So far we seem to have escaped with a light beating – hopefully I’m not tempting fate too much……

This week we will take on the surprise Bank of England announcement to keep rates the same for another cycle (6 weeks until the next meeting) – take a look at October’s figures as the first since the stamp duty dropoff, and then get into the micro and an update on our geographic focus areas to take the temperature of the stock availability (or not!) – I also want to take a look at rents which will be the high-level thoughts, leaving the deeper dive for another week.

At our Birmingham meeting on Friday I was privileged to be invited to the debrief call with the central bank thanks to Peter Vandervennin, our mortgage broker sponsor. The primary contributor this month was Huw Pill, the recently promoted Chief Economist. It was my first “look” at him closer up, having only read about him before, and I must say he didn’t come across at all like he did in the articles. The writeups have been of a hawkish chief economist – one who wants to get rates up sooner rather than later – and that’s not what I heard or saw in front of me. Indeed, there are 9 people on the Monetary Policy Committee who make the decisions and cast the votes on the movement of the interest rate (or not), and the result this meeting was 7-2 in favour of holding the base rate at 0.1%. Huw was NOT one of the 2 dissenting voices, so just how hawkish he can be I don’t really know.

What Peter and I heard was a Bank that really doesn’t want to put the rates up, but accepts that it needs to be done sooner rather than later. The reasoning ultimately comes down to the mathematical model – the Bank likes to use “fan charts” which are graphs that reflect quite how far out they can be on their forecasts (of course, a forecast of the sort that they attempt to do is basically guaranteed to be wrong, in absolute terms, but wants to be very nearly right in terms of the range). The 5 years pre-pandemic, for example, showed a trend for the economy to grow at the bottom of the tightest range of the Bank’s forecasts. So, we continually underachieved, basically!

To get the fan chart for inflation, still the number one consideration for the Bank (bearing in mind unemployment is also a large driver, although they do not set fiscal policy of course), down to 2% smack bank in the middle of their range, the models accept that the rate needs to move to more like 1% over the next few years. The real pain on inflation is predicted, by them, to hit early next year. The news hasn’t broken yet and some won’t believe it until they see it, but the bank is predicting around 4.25% inflation for November (and you would expect this to be within 0.25%, given we are in November already) and around 5% in spring 2022.

The longer term (not defined) still sees, in the bank’s eyes, a rate around 2.5-3%. This has been the party line from the bank since around 2013-14 (or from some of the senior members of the MPC, anyway). Markets disagree a touch and see the base rate at around 1% at the end of 2022 (I disagree, I am at 0.5-0.75%, but I am bearish for economic performance next year as discussed, compared to forecasts anyway – not bearish enough to be predicting recession, to be clear!) – markets got it very wrong on Thursday (as did I) as they expected that the base rate would be raised. The adjustment due to not meeting expectations was around a 1.5% movement downwards for sterling against the dollar, such was the confidence that the rate would go up.

There was a side point which pertains to some of the recent commentary as well. The gas price. I mentioned last week that the US was paying around $6 per unit, compared to Europe paying $30 per unit. Good news for the US that has much larger inflationary struggles already than we do. The bank does not attempt to predict things like commodity prices, so its model just does what statisticians call a “random walk” from the price today. Since the price today is hundreds of percent out from its historical highs before this year, the random walk sees it go potentially up and potentially down from here, in the medium term.

That’s unlikely – highly unlikely, in fact, but that’s what the model does, and that’s what policy says. They recognise this of course, and don’t make decisions without looking at the big picture. They prefer to recognise what the market is predicting (there are, of course, significantly liquid futures prices in gas). You can buy gas in 6-12 months time at prices far, far lower than it is trading at now.

The bank shared an interesting graph which showed just how much it would impact inflation (downwards) if the path of the gas price follows its futures curve, rather than the random walk. It was really significant, far more than I would have thought – worth more than half a percent at certain points in the next 2 years. Given the likelihood that the futures market is far more accurate than the random walk, although with the caveat that there are more shocks left to play out within this system and the supply chain shocks caused or exacerbated by the pandemic – this suggests that inflation could actually come down lower than forecast, presuming that the gas price does calm down.

So – the headlines will look bad, and over 4% is really a place where no-one is particularly comfortable. We saw this skirted around in 2016 after the referendum (sponsored primarily by the movements in the currency markets after the result) and in 2011 we were at 5.2% at some point. So, not exactly uncharted territory – and indeed, a bit of a factor of the base year effect we’ve discussed a few times this year. The base year of 2021 will provide very high prices in some months to be working from – for fuel, building materials, and anything else that suffered supply chain stocks – so the opposite of the 2020 effect when the economy was literally frozen or on pause.

There’s another thing to consider too – the supply see-saw. Lots of commodity providers stopped producing in 2020 expecting a massive demand slump and the world’s biggest ever recession. Thanks to government response worldwide, on an unprecedented (sorry) scale, this didn’t happen and instead demand started to explode when lockdowns were lifted/diluted. This meant a lot of production was started. As you would expect, as prices have really soared, demand has gone right down – people don’t pay the higher prices, they hold off on purchasing (one reason why significant inflation hurts an economy) – they change their behaviour. This leads to the see-saw – everyone wants to produce at the new market price, but there is too much supply then – and oversupply sees to a reduction in prices. There will be some strange price movements in the next 6-9 months on the back of this, and in a small way, it will impact inflation downwards. We won’t return to “normality” or the “old normal” anytime soon – that’s also important to understand.

It’s also worth making the point that the transitory inflation – transitory being the buzzword of the past 6 months – doesn’t mean that when it has passed, prices will go DOWN – it just means they won’t go up at the same rate. Deflation currently looks unlikely, but that discussion might be closer than we might think because of some of these anomalies, and also if the economy does slow significantly/underperform against expectations next year, which I think is a very live probability.

Let’s switch back to very plain English for a moment. The propaganda (it is more clickbait than propaganda, but I thought it might make readers sit up a bit) around interest rate rises is exactly that. Hogwash. Yes, rates are not going down anymore (we established in February 2021 that going negative on rates looked very unlikely, and we’ve moved even further from that position as we’ve gone through the year). If the base rate “DOUBLES” as they scream at this point, it goes from 0.1% to 0.2%. 10 basis points (the correct way of defining that) means a mortgage might go from 2.95% to 3.05%. (Mortgage rates are not set on the base rates, they are set on the swap rates, but stay with me). So the impact there would be 0.1%/2.95% = 3.34%. That’s the order of magnitude you are talking about.

There has been a complete price war with residential mortgages seeing rates at 0.8% or even lower. This, anyone can calculate, even if “buying” the money at 0.1%, is extremely low margin business. The bank/lender has an operational cost of funds deployment to consider – staff, shareholders want returns, etc. etc. Why the price war?

Well – what happens generally is around 30% (as a rule of thumb) don’t re-fix their mortgages when they drop off. This number is widely accepted in the industry. What happens then? The rate/margin gets very profitable for the bank. So you might issue at 0.8% now and make no money, or even lose a bit, but you might make 2-3%+ on 30% of those loans when the rates drop off onto your standard variable rate. Good long-term business.

What do the media do? As soon as the price war comes under pressure – it is “here we go”. Ideologically some publications are against our credit-based economy (as are some people) and are looking for the “a-ha moment” or the “I told you so”. This is a bit like the people who cry recession every 5 minutes – not that I have any particular YouTubers in mind here, honest – and leads to one of my favourite quips at their expense – “He’s predicted 9 of the last 2 recessions”. RATES SET TO DOUBLE – so, we might go from 0.8% mortgages, to 1.6% mortgages. Hardly an avalanche starter.

Instead the focus should be on what the true costs of funds is. If you are borrowing at below the rate of inflation, you are being paid to borrow the money. My advice would, of course, be to invest it at a rate above inflation – direct property investment works well for me and many readers of course, stocks (tracker funds unless you are one of the 0.1% who can beat market returns AND enjoy the amount of effort that takes) – perhaps also some room for insurance with Gold or other chosen uncorrelated assets.

Now, go back to the start. The Bank of England are very cautious over their messaging. It is scrutinized heavily. The underlying (but visible) message from yesterday was “we don’t want to put rates up, but of course we will to be prudent guardians of the economy and monetary policy”. That’s absolutely deliberate. I don’t believe everything I see, and understand they are trying to manage expectations and headlines (and, of course, mostly the world plays ball with that). But there were some good logical parts of the pie yesterday talking inflation down, and zero analysis included as to why inflation might OVERSHOOT expectations. I’m sure there’s plenty of internal work at the bank on things that might make that happen, but that research won’t see the light of day……..they also decline to comment on what percentage of inflation they think is transitory versus (potentially) secular – but if they even mentioned the word secular, bond markets would move and perhaps panic because they are currently losing money in real terms at the rate of absolute knots – on government bonds, and even on some junk bonds (lower grade corporate debt).

The 10 year breakeven (which measured the gap between an inflation protected gilt, and a standard coupon gilt) is around 4% – so they have not yet managed those expectations downwards. Of course not – the market is too smart. But the people react differently depending on what they hear – that is how expectations work. Sometimes that’s unconscious – sometimes it is conscious.

Anyway – I could go on for another 10000 words on that topic quite happily – but will park it up until after the next meeting (no promises!). Let’s move on to October.

Auction wise, we saw some promise in October’s results – I await the “industry bible” of the EIG newsletter, but what I would say to readers is simple – if you are still operating on the basis that “the auction market is bonkers” I would take another look. There is a longer term structural issue however that is worth flagging.

If house prices go up 10% but refurbs go up 30% (which is the number I keep hearing from others, even if I don’t accept it!) – then houses that need significant work, and indeed plots of land, actually go down in value. Vendors rarely accept this, but ultimately, the market speaks. This is in a nutshell the reason why at an internal level our number of refurbs has fallen off a cliff this year – we saw the dangers on pricing very early on, and upped our estimates in our numbers, and that protected us from making too many mistakes (we always make them, of course!). What have we done? Focused on tenanted stock, and the things that the others don’t want. The shape of demand has changed massively, but our contrarian mindset has not – it has just pointed and steered us in a different direction.

Anyway – back to October. Firstly to the Nationwide – always first out of the blocks. I was surprised to see a 0.7% increase as I would have expected a flatter month thanks to the end of the Stamp holiday in England. Too early to tell as Nationwide is by no means as good as the ONS, but this was above my expectations and speaks to how much the ongoing structural supply problems are biting versus the chatter around how much the SDLT holiday created “all the demand”.

Annual growth was at 9.9% – and one more piece of interesting data picked out of this month’s report. The percentage of mortgages that are issued on fixed rates these days is close to 100%. As recently at 2011, it was more like 60%. So what? So, the vast majority of households are significantly insulated from an increase in interest rates in the immediate future. It will affect car financing, as the next biggest payment (these days, car payments and mortgage payments can be reasonably close to one another!) and several other areas, but not housing immediately.

Halifax are at a more conservative 8.1% for the year (still massive, of course). They see an increase since pre-pandemic of just over 13% (Nationwide are closer to 14%). They also recorded a 0.9% increase month on month, and stock continues to dwindle. Wales has hit 12.9% year on year growth on their figures, and the North West is back to the top of the regions in England with a 10.4% YOY growth). Again, a bit hotter than I thought.

The ONS will not have September figures out for another couple of weeks – but of course, they are more accurate. However the picture is fairly congruent and clear – business as usual as far as this year is concerned!

Onto our micro areas – and the never-ending story continues on the supply front (our last look under this hood was on 10th October). Supply DOWN across the board (other than some tiny anomalies), up to 5% with quite a few 4% drops. Put this into context – very typical for an October to November period. Some agents have already started their campaigns to list nothing before Christmas, or at least started raising awareness of the lack of likely decent activity in November and the importance of getting maximum impact upon launch.

EVERY SINGLE area under monitoring is showing an improved SSTC percentage with the Ilkeston micro-market winning the current “hottest market” prize with nearly 80% SSTC. Sheffield also remains very warm, and anything over 75% can rightly be considered very difficult indeed or a strong seller’s market. Banbury gained the most absolute ground, and whilst these small volume local markets can be quite statistically noisy, it’s worth keeping an eye on. My own pick from the M40 corridor selection though would be High Wycombe, the SSTC percentage is suggesting that significant value is being seen in that market in the now. Now just the difficulty of doing a decent deal there……..

What has to be the overall conclusion – once again – is that there is no particular end in sight to the supply side crisis. Indeed, the number of properties for sale per surveyor, a statistic that RICS publish, after a big wobble thanks to the pandemic, seems to just be following its trend of the past 4 years – downwards, relatively slowly, but downwards. The trend is clear.

Other interesting things to pull from that RICS report (which was released early September) are: demand is weakening but lack of supply is holding prices up; the rent rise over the next 12 months is forecast to be 3%+ which is the largest forecast since 2016; RICS have rents going up 4% per year on average in the next 5 years and house price growth at 5% per year on average in the next 5 years. The net balance (those who think rents will rise versus those thinking they will fall) is +64% (so this would mean that, for example, no-one answered “no change” and 82% think rise and 18% think fall) for rents over the next 12 months, which is the highest number that has been posted since that started being asked in the RICS members’ survey in 2013.

So – that leads us on to rents in conclusion. I am more than grateful to one reader of the supplement who emailed me over some analysis and would like to credit Kimberley Mee for doing so! Thanks Kim. I just wanted to summarise our back and forth around it. I had already noted the DPS rent index recently (and I always do this, but I bemoan the quality or lack of it around the ONS data on this subject, although of course there is no transparency). Obviously the DPS register a lot of deposits and you would expect reasonably good data (just as per the Halifax and Nationwide) – there will also be biases. With the Halifax some bias is inevitable regarding geography. With the Nationwide the bias is more likely on LTV. With the DPS they will be biased towards properties that actually take deposits (many don’t in HMOs, some don’t even on ASTs and have their own fair reasons for doing so). I would suggest those are likely to be more expensive properties in general. Anyway – their number as previously reported at the end of Q3 was 4.87% increase year on year.

Onto what Kim sent over to me – Homelet’s index is up 8.7% year on year (yes, 8.7!). This to me seems more reflective of reality and I can’t remember an old let that, despite being managed under our asset management strategy to do rent rises in a “small but often” way (annual reviews, but no rent rise in 2020), has come to market recently and not gone out at well over 10% rent increase (and are still getting knocked off the boards nationwide). Homelet are 8.2% up excluding London – although London had a bad base year there because rents were hit by at-the-time ex-short let units hitting the AST market. Welsh rents are up 12.9% year on year (matching the capital growth, according to Homelet).

Also interesting from Homelet is the affordability measure – 28.6% of gross income ex-London nationwide. Plenty of affordability remains…with massive upward pressure on minimum wage and any inflation-linked schemes too. Quality reporting from Homelet there.

The ONS has the rise at 1.3% annually in the year to September. Frankly, their data sources on this are an embarrassment for the office of national statistics. I’m a big fan of the ONS but this needs sorting – and they need to look to the US for data quality. When the English nationwide licensing scheme comes – and it will, make no mistake – that should at least up the data quality piece (once it has burnt through goodness knows how much of my reserves and those of the readers, of course!). It is worth making the point that of course Homelet and the DPS are likely measuring new rents only, where the ONS may think it is measuring all rents (by polling a sample – the size of which is nearly 500,000 pieces of rental data already collected for other purposes by other organisations like the VOA, or the Scottish Government for example).

So, it could be, with low turnover and us still in an unsophisticated non-corporate letting market that almost no-one raises rents in an existing tenancy (and/or that the pandemic has seen clemency on rental increases). Anecdotally I see that story an awful lot on social media. The ONS do recognise the low quality of their data and also have a timetable to improve it – if we knew this was the methodology then it would have some use (if just as a bellwether) – but the methodology will be changing and thus perhaps I should call off the dogs just yet…….

Kim also linked to an index that I wasn’t previously aware of – the rent index ( There is less transparency around the data sources but their 12 month number is currently 5.865% upwards, UK-wide. We then went on to discuss the supply pipeline and the structural challenges, including the post-section 24 world, and then the pandemic-specific ones, and then Kim also reminded me of the growing short-let sector (now forecast to be growing at 8%+ per year for the next 5 years) taking units out of the BTL space, and also the specific immigration from Hong Kong specifically – we’ve had 70,000 since February and the Government forecast was 120,000 in the first 12 months, so we are about on course for that I would say (or a shade under). We both bemoan the lack of quality of that data (and the timeliness of it) but there are certain areas of the country where the micromarkets are being affected quite significantly.

I’ve got to draw a line under it there – much more to say, as always, but that will have to wait until next week. Also – tune in at 10am on Piotr’s timeline, or on Youtube, for the return of the Sunday Special…..if you haven’t seen it before, it is 47 minutes of me spouting hot air and 4 other extremely talented souls desperately trying to get a word in…….but it is usually well received – we are back!!