Property Management Done Right – Fiscal Vs Monetary Dominance – 21/03/2021

Mar 21, 2021

Welcome to the supplement folks, the fastest growing property and economics article in the West Midlands! (or equal impressive claim that can never be substantiated).

The bell tolls on the tax year, and what a tax year it has been. This week we will spend some time on the granular detail of property management and the real costs of doing that properly in your portfolios (and some of the mistakes that people make on the back of it) – and then for the macro, we are going to talk about fiscal vs. monetary dominance, a concept that many are not really aware of but it is incredibly relevant at this time. I know, you can hardly contain yourselves with the excitement!

There have been a few great posts about this on social media this week, and that’s why I wanted to cover the true cost of maintenance and why people are so often over-optimistic in this department.

I think there’s only two main points to really cover here. Firstly, the reality of how long things last in a property. A combi boiler will have an average lifetime of around 12-15 years, so if we call that 13.5 years and say that in today’s money, a like for like boiler swap can be done for £1350 (and some may balk at that, but it can be done), then that’s £100/year at 2021 prices and the relevant part isn’t when you actually PAY it, it is how you account for it. We can do the same for electrical wiring installations – modern installations should really last 70 years, old ones are more like 30 years – if we took 50 years as the average and the cost of a rewire in today’s money as £3500 on an average rental, that would be £70/year.

You can and should repeat this for every part of the structure, and internal decor. If you do, you will start to get a clear picture.

Now of course, if you follow a classic BRR path, you will have done a lot of this straight away. So the worst is behind you, and you have maintenance. It isn’t a linear path after a full refurb of course – there will be a snagging period, and then all should be fine for years. But then the costs will start to creep in. If you economise in the first place, then you will pay for it in the longer run. Cheaper rents. More turnover of tenants (the real enemy of the landlord). Taking worse tenants because other standards rise and those who have affordability will choose better and brighter. I’ve seen many a landlord follow this path and then marvel at the returns we are getting, and try to justify why they cannot match those returns.

The other point I would cover is where that cost normally sits. Lloyds bank will expect to see about 25% of a portfolio’s full rent being burnt up in running costs. That would include agency fees/property management costs, insurance, and maintenance. The maintenance element alone, two large portfolio landlords have told me they achieve around 6% of their rent roll spent on maintenance every year. I think this is gold standard/best in class and I would suggest 8.5% or so is closer, but the reality is this is not one percentage – if you have an average rent of £1000 per property and 100 properties, your rent roll will be £1.2m and your maintenance bill might well be £72k (6%). If you have an average rent of £500 per property and 200 properties, you have the same rent roll but you will not be spending £72k. You likely won’t be spending as much as £144k either (although it will depend on the age of the portfolio) IF you have managed to get some further economies of scale that the other landlord hasn’t. Also my experience is that £1000/pcm tenancies contain at least as many problems as £500/pcm ones and there is a much higher expectation of those tenants and what they should call the agency to fix. At the £2500/month level I’ve known landlords going round to change light bulbs because the rent is so high, which at the £500 level is a question that just doesn’t get asked. We’ve had more problematic tenants at the £800/month level and above than at any other level OTHER than the £350/month and below level.

I can’t talk maintenance without talking about other purposes for the building – HMO is a classic. The costs start to rack up on the maintenance side a LOT faster than a single let. You should really be using commercial grade materials, and if you aren’t, the building will be creaking several times faster than it would be as a single let. Redecoration work starts in month 7 when the first lot of tenants move out (at the sharp end) and after 3 years a significant refresh is needed. Just ask any experienced student landlord about the amortisation required on a kitchen in a student let and go from there!

SA is interesting, because although it is more operational, the maintenance demands are usually lower. This is because the unit isn’t lived in anywhere near as hard, isn’t always occupied and normally has a higher standard of clientele than HMO (not always!). So there is an edge here for SA over HMO that many don’t consider, in my view.

In summary – be realistic. Don’t scrimp and put a sticking plaster on when a full repair is needed. Don’t do a full repair when a sticking plaster is the right solution! But sort your mindset out in the first place – a key goal in BRR is to maximise the remortgage value on first refinance. Do that sensibly and pragmatically. Understand and research what things should cost! Do that bit of the job that is required – an amateur QS if you will. The numbers work, BUT you need to get them right.

So, onto our macro section and fiscal vs. monetary dominance as promised. There are a few key things to understand – firstly a quick definition. Fiscal policy is basically the policies that attempt to manage the economy involving government spending and taxes. Government spending will boost GDP (by definition) but, if running a deficit, will make that deficit wider (and make the cost of servicing that debt go up, if the rates remain the same). Taxes will curb inflation and economic growth, but increase the tax take (potentially, if done well – that is not always the case – at the extreme, 100% tax, no-one bothers to work any harder, because they see no economic benefit). Fiscal policy is controlled by the government – there will be political factors of course, but it is under the control of the elected representatives.

Monetary policy is, by contrast, controlled by the central bank who are independent of the government (political factors aside – solely from an economic perspective). It is the part of policy that controls the borrowing costs by setting rates, and also controls the amount of money in the economy (the money supply) – and also seeks to influence inflation, unemployment and overall economic stability using these tools.

It is fairly obvious I’m sure that both have to live with one another, and in such relationships, it will be no surprise that one tends to dominate the other. However, since before Covid, there have been noises from some highly educated quarters suggesting that an era of monetary policy dominance (so this would describe for example the way out of the 2008 Great Financial Crisis – dropping rates drastically to reduce the cost of government debt/borrowing, and also pumping money into the system via various policies such as Quantitative Easing, Funding for Lending, etc. etc with varying degrees of success) will soon be replaced by an era of fiscal policy dominance.

Pre-covid you may well remember a stuttering economy and a lot of people predicting a recession in 2020. It feels like a lifetime ago, but I certainly remember a lot of bearish comments around the middle and end of 2019. The property market was flat, the GDP growth was flattening and it felt like things had run out of steam, generally. The monetary policy dominance had been in place for 10+ years, and it did feel a bit like central bank policy makers were out of ideas.

The major effect that Covid has had is that instead of being primarily concerned with deflation (of the world’s economic superpowers, the EU had wrestled with this in the 2010s more than any other, hence their negative interest rates), the concern has now shifted to inflation.

What has happened in the Covid era of course is that because monetary policy was on its last legs already, with most of the chamber empty, the first shots were to absolutely empty the chamber. In the UK – rates down to 0.1%, a new historic low (with steps already in place to go negative this year if required). More QE straight away. Similarly in the US. When the chamber is completely empty, it moves to a monetary and fiscal policy blend – such as the grant schemes in the UK or, more aggressively, the “helicopter money” cheques that were distributed/are being distributed in the US – or it carries on with negative rates.

So fiscal policy becomes dominant by definition. In the UK we’ve sent money to businesses and employees – the spend is in the hundreds of billions. Loans, grants, furlough, etc. Disappointingly for the government, we’ve saved a lot of it as a people. Which is rare – we have a very consumption driven economy. That’s meant that MORE money has been needed to get some of it spent. Many property investors will lament that this money has led to the price rises we have seen in the past 12 months – but they are not necessarily considering the shortage of supply of stock that there has been that has created a bit of a monster bull run. We won’t be waiting for the investors to run out of money – they’ve got more of it than they’ve ever had – but we will be waiting for the stock levels to return to normal.

In theory (and it depends which schools of economics you follow, I try not to nail my colours to the mast on anything because all sides have some relevant points, and some ideological idiocy as well if you want to find that) now is the greatest time ever to borrow, and it would be comparatively simple to put money into large infrastructure projects with positive returns when you can borrow at 0%.

I dislike comparisons of the government to your individual wallet, or even to running a business, although the latter is much more acceptable – because they tend to be used to make political or ideological points that are not grounded in true fact, but in bias. However, if we do consider the government to be like a business for the purpose of this exercise, there might be some mileage in it.

So, the business of UK PLC has incredible resources. It can borrow almost unlimited sums of money. It can strongly influence (or, in a time of strong fiscal dominance, almost utterly control) the price it pays on its new borrowing (although it has long standing existing debts which are at old rates too). Its assets are fixed capital such as infrastructure, and even shares in private companies sometimes (that is done horrifically badly in the UK, for no good reason – see “Norway Sovereign Wealth fund” for how to do it well), and it also has its human capital base too.

It wants a skilled workforce (and also wants an unskilled workforce, to serve the skilled workforce, but that’s for another day). It collects the vast majority of its revenue from taxation – primarily income tax via the PAYE system (and indeed it has clipped wings recently on those brave enough to try and break out of the PAYE system via IR35), VAT (sales tax in most other countries), National Insurance (another name for income tax, let’s face it, but also paid by companies as well as individuals) and Corporation tax. The other taxes, whilst they can be emotive, and do have an impact (e.g. Stamp duty, widely evidenced as distortionary and bad for the market overall), are not really of concern – as usual the Pareto principle applies and over 80% of the work is done by under 20% of the taxes!

Seems simple at this level doesn’t it? Borrow to invest in people, and in fixed assets, and arguably even for a sovereign wealth fund – and increase the tax take produced by our individual and company assets in the future. UK PLC is the ultimate conglomerate – it has a finger in every tax-paying pie. It is on a brilliant commission for success!

Politics, of course, gets involved. The popular characterisation is that this would be a Labour policy – and Labour wouldn’t be trusted to get it right (I must be honest – I wouldn’t have trusted John McDonnell to get this right!). The Conservative viewpoint would be different – tax as little as possible, let people allocate their own resources, and the tax take will come because people will consume and sales tax will get them even if the other taxes don’t. It provides the ultimate incentive to set up and invest in businesses. However, MMT (modern monetary theory) blows that out of the water a little bit, and indeed I’m sure most would agree that the last 12 months have seen Conservative policies that many would never have believed in a million years!

The rule of the game that is unstated there is that perception is reality. Internationally, the UK like all governments needs to be seen to be fiscally prudent and can’t just go around with a cash shotgun funding every project that looks like it has a positive return. Borrowing costs would go up which would be counterproductive, and credit ratings would go down. So we need to play the game, and look as though we have a plan! Of course, there is gigantic safety in numbers at the moment because nearly all major world economies are doing the same thing – so the comparative behaviour is providing a safety net. This is really the global version of the old political cliche “never waste a good crisis”.

There are so many reasons to be cautious however. High tax burdens historically don’t lead to good outcomes – the UK tax burden is now the highest it has been since the 1960s, and if the incidence of it is unfair, there is inequality to come in this decade that will put the 2010s to shame, and anyone who hasn’t noticed the “anti-capitalist” and indeed anti-society movements that have been active since 2009 and much more so since 2016 or so, is asleep at the wheel. I’m not saying the pitchforks are coming but I am saying we better watch the pitchfork supplies and check if they start getting run down!

Over coming weeks I want to produce an analysis of the furlough scheme, which will only be an interim one of course – and also talk about the likely path the tax system will be following this decade and whether what’s already in place is sufficient, or not.

Well done if you got to the end and I appreciate all of the likes, comments and shares every weekend – it is what makes it worthwhile writing these!