Supplement 020423 – the next chapter

Apr 2, 2023

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning” – Winston Churchill, November 10, 1942


Welcome to the supplement – for those who fell for the April fool yesterday, this might be a surprise! For the rest……this week’s quote feels pertinent. I’ve been pointing towards 01/04/2023 for some time, because of the significant bump that is happening to certain benefits this month in the double digit region – and a similar rise in the minimum wage. 


As if by magic, in the past 7 days I have become hyper-aware of the number of large corporates raising their prices again. They really do seem to have gone for it this time. We are not where I would love us to be on “nowcasting” inflation in the UK, so the evidence will simply have to wait; however, I’d be surprised if I’m a long way off on this call. This recent bout of price rises feels like the largest single hike thus far in this entire cycle.


This isn’t accidental of course. Any company worth anywhere near its salt will have been licking its lips as its customer base gets a nice, lumpy pay rise, and raising prices accordingly. Some bellwether items are now very definitely a full 50%+ ahead of where they were before the pandemic started, with limited signs of this abating any time soon. Prices are always described as “sticky” – once they do go up, they tend to stay there rather than coming back down, when we are talking about goods, and particularly food. Profits will “never have looked so big” – although in real terms, a different story is likely to be painted.


US inflation does at least look to have peaked in June 2022. It would be a surprise to see this peak beaten – although it is by no means impossible. The UK is trappier by far – we are only 0.7% off what looked like an October peak, with a decent sized number coming for April if I’ve got this right. The US has shown us that the transitory inflation simply wasn’t enough of the total, especially by the time it DID finally pass – US core PCE (the preferred measure of dangerous inflation) is still sitting above 4.5% – its peak of 5.3% in March 2022 was nearly “bettered” later in 2022 as it touched 5.2% again, and there has been 16 months in a row now above 4.5%. This isn’t transitory stuff – the inflation is well entrenched in the system.


The core inflation in the UK touched 6.5% instead last year in September and October – and is still sitting at 6.2%. This horse is a fair bit further out of the gate than in the US – which is not unusual. The strength of the dollar and the comparative weakness of sterling in its unique position as the former global reserve currency has always seen the UK running hotter than the US – but this is quite a departure. 


This, in a nutshell, is why this quote feels most accurate this week. There’s lots and lots to play out yet in this cycle – but this really should be the end of the beginning. 


Meanwhile, the economy lumbers on. Nationwide are recording a 7th consecutive month of house price falls as they see it, with a -0.8% number being returned for March. The other indices are yet to report; Halifax disagreed quite strongly with Nationwide last month as it appeared the decline might have been arrested. The jury is out here.


However, sterling continues to appreciate. The current probabilities of further interest rate rises as things stand see a 75% chance of another 0.25% interest rate rise in May, and a 52% chance of yet another one in June. Terminal rate is certainly looking closer to 4.75% than 4.25%, although how long it can hold up around 5% is anyone’s guess, to be honest. 


It needs to be there to do what it can to address this inflation fire, but the higher we do go, the more pressure it puts on those house prices. The 5 year swap is back to 3.75% territory, meaning costs of finance around 6.25% are reasonable; this would include amortised arrangement fees but puts pay rates squarely in the 5.5% region unless we are talking 4%+ on arrangement fees.


This really represents the fact that those who bet quite aggressively on a rate cut later this year have been proven wrong – for the moment. It was a dip and a wobble as the speculators loaded up on the chances of a very large rate cut – a bit like betting against the very “best” securities to go broke as some did in my favourite docu-movie, the Big Short. The AA rated and above, which did wobble and default, was the source of returns of tens of thousands of percent for those who bet on it. You can see the attraction, but for the moment, the market has extinguished those sellers. I doubt we’ve seen the last of the chance of a bet on similar outcomes this year, though – although I think inflation still conquers all for the moment and drives rates upwards (and keeps them up) even if we do hit recession, which gets more likely the more base rate is likely to rise.


Every household is £67 a month worse off as we go into April as well. The energy price help has stopped. Of course, every household is likely to spend on average £67 less on gas than they would in a winter month, so this might not bite until October. It is also disinflationary, in a significant way – but likely only papers over that difference between winter and spring as far as the heating bill goes.


Still – April 1 2023, for me, marks the end of the beginning.


Further rate rises are going to keep turning the screw on landlords who are on the old variable rate trackers. “Just one more rise” – if it is two more, without relative incident (and that’s a big old assumption right there) – will push a few more over the side of the ship. Deals still appear to be more and more available, from what I am seeing. Rates are unkind and mean tight management is needed to get new purchases “in the book” – and this week I wanted more to dive into this dichotomy, since Covid, and really spell it out in a way I haven’t before.


On the one hand, having been already significantly exposed (250+ units) to the market before the pandemic, the vast majority of which was residential, my group and I were really significant beneficiaries of the Covid boom, stimulus driven of course. Nationwide would argue we are nearly 5% off the top from the “pre-Truss” days, which hurts, but valuations never seemed to get too carried away on the remortgages that we were doing.


This took our loan-to-value from a very expansionary one starting with a 6, and a high 6 at that, comfortable into the fifties, with no real skill being applied or pertinent here. Lovely jubbly – right?


Well, the sort of stock we are generally holding was always ripe for an inflationary period. I didn’t see it coming via the means that it did – but the affordability ceiling for rents on the majority of the portfolio has been very helpful indeed, and considerable headroom still exists. This wasn’t the only fruit either, though.


The dichotomy, certainly after 2020 played out, was just how hard it got to buy good value property. 2021 was really seriously testing – there was also the reasoning that the pandemic wasn’t done, and caution was paramount – but in reality, the writing was on the wall regarding house prices from Q2 2020, and the real (above-inflation, above-wage inflation) rise was very evident to me. I did fewer deals than any year since 2015, since when I have scaled my operation significantly. 2022 was better as some larger deals dropped – ones that took fairly significant time to put together, and the market seriously carried a couple of these forwards; luckily they were largely refinanced at the right sort of time.


However, the failure to scale in terms of quantum of deals versus other years hits the growth targets that I have set in a particularly hard way. Compounding in general truly is the eighth wonder of the world, but when the numbers don’t come in earlier in the model, the cost at the end is eye-watering. 


There was another factor too. I decided to opt out of the “chasing prices upwards” game for refurbishments. We had a few projects already on the table (of course) which we have seen through, but I insisted on a bearish approach very early on when I saw commodity prices moving – thus, we priced ourselves out of a lot of heavy refurbs which pre-covid were a large part of our bread and butter. 

As the saying goes, “he giveth and he taketh away”. That was very much Covid through my lens as an investment group operator. It was definitely testing.


The other saying that springs to mind here though is “you don’t know what you’ve got till its gone.” That’s for the ultra-low interest rates we were all paying for loans underwritten in 2021 and early 2022. Those regular readers who took action when the inflation scenario went from the theoretical to the very real, and the interest rates started to follow should have secured some very nice cash flows through to 2027 or so; in the interim however, the 80%+ who didn’t take action will be facing dropoffs onto some significantly punitive rates; their solution may well be to sell, of course, but with far fewer mortgage approvals, buyers who are semi-willing and mostly able are a stark contrast to those who were involved in every sealed bids process going a couple of years back.


So, at the moment, it all feels a bit like the wedding vows – for richer or for poorer, of course. In sickness and in health – the sickness is the market. Horrifically low rental availability, which gets worse before it gets better, for sure. For better or for worse? Well, there’s been both, but the cost of debt is most definitely for the worse. To love and to cherish? There’s few landlords that feel like that anymore, if you listen to the anecdotal evidence and the word on the street. ‘Till death do us part – instead, it can simply be a sale or staggered exit on a portfolio. No mad rush – and if things indeed are 5% or even 10% lower, that’s only giving back some of the previous 30 months’ worth of gains. Not ideal – and everyone wants to sell at the top, of course, but still, a late-in-the-day boon in terms of the capital growth element which should mean plenty can still exit at a very reasonable price.


Exit they will, I thought this week, when I heard the news about the likely legislative path for EPCs being pushed to 2028. Many celebrated, although all I heard was the sound of one more can being kicked down the road. Good for the sector? Yes, very likely – although some more will no doubt still use this chance to exit rather than spend £10k on a property that will add perhaps 1-2k to its value – the commercial argument, with no promise of grant schemes or similar, will definitely still lead some to sell up. 


Back to the vows for the denouement; to have and to hold. Perhaps the greatest of them all; in any recessionary environment, our number one objective should be to hold. We may have to have a fair bit less in order to hold; but it is far, far better than the alternative. With that in mind……make sure to keep calm and carry on!