Sunday Supplement – 10/10/2021

Oct 10, 2021

Sunday is upon us once again and this week I can’t resist a foray back into inflation, but with a different goal, objective and slant – and then a look at our micro-market trends also to see, in data terms, whether stock shortages are easing, and also a look at the auction and house price reports for September ‘21.

Inflation is a word I’ve typed surely several hundred times this year, and various “big data” tools can help you see just how much it has been on everyone’s mind. Stagflation has been the particular concern as people who can’t remember the 70’s speculate on whether we are going back to the 70s – I wrote about this midweek. (No, there isn’t a new midweek supplement…..yet……there’s just been plenty to look at and write about this week as the summer silly season is clearly officially over, and the conferences also provoke some news and speculation of course).

However, what I thought would be useful is just a rundown of why I’m so obsessed with it and whether you should be rolling your eyes at another inflation piece or sitting up and taking note. So – for those who the article is primarily aimed at, property investors with exposure to UK property, here we go……

Firstly – I have commented about the different types of inflation that we have seen over the past 5 years or so. There are many, many ways to slice this lemon. Cyclical and acyclical, for example (one goes with the business cycle, one is driven by “other events” of which an EU membership referendum and a global pandemic would be two very strong examples). We can go so far into these details that we get lost, and also, as always, can find 50 reasons why inflation is about to destroy us all, and 50 reasons why we shouldn’t be concerned at all (and probably if we look hard enough, 50 reasons why deflation is a bigger threat than inflation!).

I prefer a more maverick approach. Rather than the official terminology, I’ve spoken before about “fakeflation” – i.e. that caused by a one-off event, such as the referendum – what I mean by this is inflation caused by anything other than a healthy underlying economy. It serves us to remember here that we haven’t had much of a healthy underlying economy since the financial crisis – and we can put all sorts of interpretations on that. Austerity wasn’t a good policy, for example – rather than get political, I would just point you to the organisations (that are primarily thought of as centre-right) that started publishing this opinion and backing it up with data as far back as 2012. Another way of interpreting it might be to say “well, we knew there was a huge meteorite to deal with – and what happened is, although the mistakes had been made by a few bankers dealing in products that no-one, including themselves, truly understood, the people have dealt with the pain with a “lost decade””. This is an opinion which I’d have some sympathy with, and it makes sense – you don’t see global markets lose tens of trillions in value and not have some impact. Doesn’t mean it has been fair – by any stretch – but this is why financial repression, “bad” inflation and various other factors are the equivalent to carbon monoxide – people can’t see it hurting them and that’s what makes it so dangerous. The average person who relies on the financial education they don’t provide us at school has no idea, and it is drawn out over such a long time, it is very difficult to monitor (and, therefore, get that angry about, politically).

What has happened is asset inflation thanks to cheap credit, and that’s been reflected in the stock market performance since 2009. There are many ways to value a company (and a market) and very low interest rates mean lower rates of return in general, but of course it is easier to make money borrowing at 1% than borrowing at 6-7% as a large corporation. Projects returning 5% look good in the first instance and bad in the second, at the simplest level.

What would we all like to see as property investors? Average earnings increasing, of course – because that increases the price of property, and the affordability of renters. Inflation is helpful (to a point) without considering anything else because it drives up wage increase demands, which drives up potential rents. It also means that debt we are carrying is deflating – which is, of course, how the government is also looking at the situation.

But would we want inflation at all costs? Would we want fakeflation, or any other type of “side-effect” inflation? Not necessarily. A lot depends on the underlying rate of inflation. Here’s a snapshot of the current situation as it has emerged over the past 18 months:

Property is up in value by a double digit percentage
Construction and labour costs are up by a double digit percentage
Rents are up by a single digit percentage
Wages are up by a single digit percentage
Inflation is (on official figures) up by a single digit percentage

This confluence of circumstances squashes yields and increases risk overall – so, it really depends on your outlook or situation. If you are sitting on a rental house or portfolio of houses and rarely or never expand it, you would overall be sitting fairly pretty. Capital growth achieved – rental increases achieved or there to be done – maintenance costs increased but more than made up for by the other two factors.

If, however, you are trying to buy then this sort of set of circumstances really isn’t ideal – and that goes for owner occupiers as well as investors. In the backdrop of the likely blueprint for the next few decades – returns on capital suppressed in a post-pandemic world, and labour more likely to rise in cost at the expense of returns on capital – this is perhaps how it will go on. Yield chased further down by a wall of money. But that might well be the story on the surface, not our individual realities.

Let’s zoom right back up for a moment. Houses make great returns as a blanket statement. Flats, generally, make lower returns – for several reasons. Firstly, they are often newer and therefore contain more new-build premium. I looked at a development the other day which was done by 2 lauded developers around 14 years ago (pre-crash). Top quality, top of the market in its city. A great place to live I’m sure. 8 of the 12 flats have traded again since 2007, and every single one (despite quality prime city centre location) has traded lower than its initial asking price. Developers did a great job for themselves – and took all the value.

Those figures also don’t include a) inflation (they are a loss in real terms) and b) service charges and ground rent, which have been considerable. Nothing wrong with the city either – flats in the city are up 27.5% in the same period, semis in the city are up 57.5% in the same period. So – these new build luxury flats have underperformed the market in flats by around 40%, and the overall housing market by over 50%. New houses would, I would venture, be the second worst performer, then existing flats, then secondary market houses.

But, you have to look at the other side of that argument too. How much maintenance would a secondary market house have taken in that time, in 14 years? You can assume both would likely need a new kitchen and bathroom although you might well squeeze 20+ years out of a bathroom and a kitchen if they are looked after. You might, if unlucky, have had to change the boiler twice versus perhaps once in the flat. The running costs might have been a lot higher (but not after considering service charge and ground rent, I’d wager).

So, we can get a head start by putting a line through buying new build flats, or houses (unless we can access them at a discount/find genuinely distressed developer stock or buy off-plan to help a developer hedge exposure). Then we can look at what the large Build to rent companies are doing, and discount competing with them. Their yield expectations are a few per cent, and they are exposed to a specific tenant type in terms of age and employment. We can look at doing what they can’t.

That leads us to a refurbing houses model as one solid example. It has its own challenges at the moment, labour, materials, prices, and availability. But if it was always easy everyone would always do it.

There’s lots of live examples of inflation in reality there. One more would be current energy prices and some bad news with numbers such as £400 next year being mooted as the average energy bill rise. Time to consider solar?? Great hedging tool for household exposure – if you can afford it.

What would we love to see – sustained inflation as a symptom of a growing and healthy economy with increasing productivity. Chance of that? Limited – not none, but limited. What do we need? Inflation under control. The incentive for the central bankers to talk down inflation has been discussed before at length here, and elsewhere, and is impossible to ignore. The treasury would be right on board with that too. However, it is the control side that concerns the risk-averse – out of control inflation would be very dangerous indeed.

With the selfish hat on for the moment – what would the landlord love to see (assume “the landlord” lives off their portfolio, and has no other business interests). Wages up, so that the state is less tax-hungry and a huge amount of benefits money is not gulped up by those in work on low-pay. That would see prices up too, as wage is a great driver of house prices. It also sees affordability up, so rents can increase. A near-virtuous circle (for the landlord). Is it likely to be as smooth as all this in the next few years? No chance, I’d say. There’s far too many wriggles left in the pipeline, and the worst is yet to come I’m sure (from an economic perspective).

So – hopefully a different take on inflation and why we should care. Onto the local markets as it has been a few weeks since the last update – with some new entrants, by request.

The message looks relatively clear. We are seeing the winter cooling start, despite the low starting point of stock. Some areas have cooled a little more quickly in terms of listing, but SSTC percentages have cooled or are unchanged, so a small amount of heat is out of the market. Not as much as you might have expected, to be honest, given the end of SDLT and furlough. New entrant Sheffield looks to have the hottest house market from all those in our list right now, and there is also limited respite for the anaemic flats market in central Birmingham. A little surprised at the M40 corridor performance south of Solihull, too, although micro-markets will always have their nuances – but several of those look like potential buyers’ markets relatively soon. The East Midlands and South Yorkshire seem particularly healthy, though.

At the risk of something looking somewhat normal, this does seem in line with what we might expect at this time of year, although SSTC percentages remain so high that some markets are extremely frustrating for buyers at the moment.

September also saw Nationwide’s house price index slow to 10% year-on-year (still – yikes!) – with a 0.1% change in prices monthly. Their number is 13% growth since the start of the pandemic. The end of the quarter also offered some other comment, with England up 8.5% year on year, whereas Wales, Northern Ireland, and Scotland achieved 15.3%, 14.3% and 11.6% respectively. London growth fell to 4.2% year on year versus 7.3% last quarter YOY – whereas Yorkshire and then the North West continued to lead the way at 12.3% and 11.4% accordingly. For the first time I can remember reading it, Nationwide have recognised that affordability has been a big driving factor in the recent price movements but 10 of 13 regions are now above their long run affordability averages, whereas that was only 1 region of 13 pre-pandemic (London). The midlands engines still quietly roar on at about 10% year on year, but still looking affordable at 15-20% below the average UK house price.

Auction lots were still down 11% on 2 years ago in the last full month reported (which is August, they are a month behind), according to the auction data aggregator EIG. The year on year has not been meaningful because of the collapse in volume in 2020 of course. 71.7% were sold compared to 69% in 2019. Even more interestingly, the 2019 offerings were down 9.9% YOY at the time, so 2019 was already a slow year (so perhaps is not the best base year). No wonder stock is tight. Quarterly, though, across the regions, saw a 15%+ increase in lots offered, which indicates good news for auction buyers and the end of the ridiculous heat of Q2 2021 is clearly over now – we are not seeing open market stock go the same way quite yet!

Halifax was the index that made the headlines advertising a 1.7% month on month rise in September (might be more what we would expect at the end of a stamp duty holiday) – but are “only” reporting a 7.4% year on year rise.

The feeling at the moment at the coal face, and talking to professional services, is that things have slowed a little but the stamp holiday has now passed without incredible events/a huge downturn, although that will play out over the next few weeks if it is to play out. The end of furlough has not been the nuclear bomb some forecast – although the effects will take time to play out. Right now there will be many concerned about winter fuel bills, and with the outside temperature still freakishly high at around 20 degrees, those concerns really have not started to bite yet. I remain “non-bearish” (rather than bullish) but I can still see some wobbles coming…… until next week!