Supplement 170923 – The Most Important One So Far

Sep 16, 2023

“Tough times never last, but tough people do” – Robert Schuller, American televangelist.


Welcome to the Supplement everyone. This week’s title – the Most Important One So Far – could easily be reframed as “the most important one since the last one, which was also quite important. As was the one before”. That would hardly have tripped off the tongue, thought, would it? What I’m referring to is the Bank of England meeting, next Thursday 21st September – and we’ve got almost all of the pieces of the jigsaw now, enough to take a firmer view on what is going to happen rather than sitting on the fence. After the macro roundup, I also wanted to dive into two reports in a level of detail, both of which have been released this week – helping to continue building the picture about what’s REALLY going on in the UK property market. 


So – a slew of data this week and here come the highlights. Unemployment is up again, for the third month in a row – from 4.2% to 4.3%. That’s now an official trend, and will factor into the discussions at the Bank’s Monetary Policy Committee meeting next week. Whilst unemployment is not in the official Bank mandate, the two factors that it looks at beyond the m. Monetary policy levers (primarily interest rates, of course, but also quantitative easing) are unemployment and Gross Domestic Product (GDP), so it will have to be in the mixer. 


We need to dive a little deeper. Keeping political ideology to the side, inactivity ALSO grew last month by 0.1% (some of this is time of year – university term starting, so mature/masters students will be coming out of the labour force) – the major driver behind this is long-term sickness which is at an all-time high. Why? Well, blame Covid, some would say – the better analysis though would be to blame the response to Covid. The NHS waiting list backlog is moving beyond Mr Sunak’s target of “getting it down by the end of the year” as it has continued to increase, and it is self-evident that there is a large correlation between people getting healthcare that they have come to expect and have even taken for granted in the UK, and their ability to work (or inability). Ironically, of course, when the waiting lists DO start to come down, this will actually increase unemployment (all else being equal) because those on long-term sick leave will be able to work again, but may well need to find a new job as they have been laid off. 


So – employment really did shrink, by 0.2% (since there are only 3 statuses – employed, unemployed, and economically inactive – as far as the figures are concerned). Right – next is pay growth. That figure was also released last week and held the same (at 7.8% excluding bonuses) and right away you can see the mismatch. A clear trend upwards on unemployment but wages still pushing upwards – and this cannot continue. The job market has certainly turned where the premium for switching jobs has started to evaporate, and vacancies fell under 1 million for the first time in the post-pandemic era. Carry on at 0.5% per quarter increase in unemployment and the latest Bank of England unemployment predictions will be proven wrong before Christmas is here! 


Next up of significance was the mid-week news on the economy. A fairly significant 0.5% was blown off in July – expectations were poor at -0.2% but it missed to the downside by some way. The second metric of the Bank of England also wobbling. The actual number, there, is equivalent to being more than £10 billion, in real terms, smaller than the month before. The 3-month is still 0.2% larger, and the 12-month is a big, fat, zero in terms of growth. Stagflation has most definitely been here – somehow, the economy has kept pace with inflation although almost any worker will tell you that their wage rises haven’t! This 0.5% fall means that when we get to July-September’s figures, which will be released in November, there’s an overwhelming likelihood of a negative print, which is halfway towards a technical recession. Fourth quarter is usually strong, though, although weather dependent – so we may well still just about dodge that recession bullet one more time. NIESR (the National Institute for Economic and Social Research) produce a more real-time GDP estimate and they suggest that August was positive with a 0.2% growth – surprising, but June was strong and July was particularly weak, much of which is blamed on rainfall and poor weather for the season in general, so perhaps July is a blip. It is a blip right around break-even, though, as I have said before – and this is a fairly significant problem.


One more macro metric that needs throwing into the mixer this week – the RICS house price balance. It never looked as though it was going to be good; the consensus was -56% (so, as a reminder, that would mean of the surveyors who responded to the monthly survey, 22% would have seen growth and 78% would have seen prices retreating) – this loose rule of thumb of between one in 4 and one in 5 areas growing is worth bearing in mind for new purchases if you are somewhat area agnostic (as I am); for your existing stock, since you can’t pick it up brick by brick, it might not be so helpful! Overwhelmingly, though, expect bearish valuations and if we DO accept the Nationwide/Halifax hybrid figure of around 5% drop in house prices year-on-year it seems prudent to suggest that the real-time market hasn’t yet found its bottom.


So – where does that leave the Bank of England? Well, Thursday’s ECB rate decision had a significant bearing on what the markets thought. I’m a believer that what the ECB and the Fed do is much less significant than the market seems to think – however, all of those central banks have been facing similar challenges (inflation) at different paces. The UK is behind all of them, and has the highest inflation still. The ECB raised rates again and went to 4% (they were negative, not so long back – but then we were at 0.1% of course just under 2 years ago). This was enough to influence the swap markets and at the close on Thursday the 5-year SONIA swap, a proxy from which the 5-year fixed rate of debt can be interpolated, was at 4.5% – it’s lowest figure for several months, and 0.75% below it’s 5.25% high around 7 weeks ago. 


The market has made up their mind, almost. The UK WILL raise rates again. I am inclined to agree because in spite of the unemployment and GDP issues, the economy is stumbling on and the Bank will want to see wage rises coming down significantly before it stops the pressure. The likely path for the rest of this year as I write this looks to me like “rise, pause, rise” to see us end the year at 5.75%. Obviously the further out we are the weaker any predictions will be – but I see the last rise having to come in because oil has now crept over $95 a barrel, and this is coming at a terrible time just as CPI inflation really did look set to tumble down. Oil looks like it is in a breakout pattern and price really could go higher – we will be helped by the probable mild winter as discussed, but you still need the same amount of fuel to get food on the supermarket shelves, for example.


Whilst the unemployment trend should and will concern them, no number below 5% will worry the Bank too much (it WILL worry the incumbent government, however – giving them one more problem before setting election strategy for 2024). The Bank has predicted 3 of the last 0 recessions over the past couple of years, and since they are now NOT predicting one, it seems, ironically, that it looks more likely than it has done in that period, as the weight of keeping up with such significant inflation finally bites.


Off the fence then – expecting 0.25% rise on Thursday. Good or bad, though? If, like me, you are in contact with a number of landlords exposed to the base rate on some older loans that they’ve got – probably good. The swap rate is unlikely to react much (unless there IS what would now be a relative surprise of a pause), but the gap between “base + margin” and the swap rate will widen even further, from currently 7.25% (5.25 + 2) vs 6.5% (4.5% 5y swap + 2) to 7.5% vs 6.4% (maybe) – that’s a fairly significant amount of blue water. A quarter of a percent should never be much – but VERY few with significant leverage can afford 7.5% after considering all operational costs – that sees 10% yield or more be needed if they are using agents and doing even the most basic of maintenance and keeping properties compliant.


If you are personally exposed to a lot of base rate related loans – then self-evidently, probably bad. For existing stock exposed to that, the challenge continues – but as the swap rate inches down, that’s what you need to be controlled for your next 5-year (other durations are available, of course) mortgage cycle. This is not an overnight game, this is merely a battle within the fog of war – remember that!


I wanted to also highlight what’s being seen in the auction market – more stock, and more withdrawals before the auction to desperately attempt to keep the veil of successful auctioning up, whilst the market struggles roughly as much as it did 12 months ago, when we all had a lettuce to blame. My swap rate analysis is all well and good but people don’t react to it in real terms, so we are still seeing the effect of a 5.25% swap rate (and the mortgage products that have come out on the back of it) rather than the 4.5% print from this week. It takes weeks to filter through – and September’s auctions, historically buoyant, are not performing as I write this.


So – onto the two reports I wanted to get into this week. I think you know by now that there are too many reports, and too little time – but both of these need consideration “in the now”. Firstly – the FCA published their quarterly mortgage lending statistics report this week. This is the best data in the game, and is under-highlighted in the financial press. The whistle stop summary of that excellent report:


  1. All loans outstanding remain at about 20% LTV compared to the value of UK residential property. That’s historically very low
  2. There is 0.4% more debt outstanding than last year. That’s a very slow credit expansion – and after factoring in inflation, a big real-terms fall in secured debt
  3. The value of gross mortgage advances was down 32.8% on last year’s figures for the same period (Q2) – a massive decrease in that volume
  4. The split of the new loans was only 8.1%, which is the lowest since Q4 2010. This was significant in the last report, which I recently analysed, when it was down at 9.8% – the 10 year average is over 13.5% of leverage being used for BTL, so a 40% drop below the 10 year average. This, also, is before we factor in the particularly high swap rates observed in July and August this year of course!
  5. Arrears also moved up significantly and although they didn’t say as much, the pace of this will be of concern to the FCA. We are talking 1.02% of all balances compared to 2.5%+ in crisis times – so no need to sound the klaxons yet – but this has been bumping around 0.6% – 0.7%. This 1.02% is the highest figure since Q1 2018


These numbers, as always, are useful for putting everything into context, including historical context. Economic history solves many of these puzzles, or at least makes them make sense – that’s exactly what’s allowed me to forecast and chart the inflation path through these recent years with a solid level of accuracy.


They are even more powerful when put side-by-side with further insightful data. I’ve found a new respect for Zoopla’s research this year, and will be featuring more of their analysis and my take on it going forward. The data quality is really quite impressive. They provide a lot of regular reporting including a monthly rental market update, which is worthy of note. Their number for year-on-year rent increases for new lets is 10.5%, which is very close to the Homelet index (my other preferred source for this data) of 10.3%. I’d be inclined to choose Homelet over the two because it is scraping from all the portals, and portal dominance on rentals is far less emphasized on one portal than it is in the sale market, where Rightmove have such a large percentage of the market share. 


The other bullets from the Zoopla September rental market report though:


  1. Scotland rental growth at 12.7%. If you want proof that rent controls distort a market and disadvantage the market overall – THIS IS IT. The hard left’s response to these facts and figures is to push for MORE rent control, describing in an article this week the ability for the market to set new rents for new tenancies as a “loophole”. Insanity beckons for the parts of the UK controlled by idiotic ideologues, I’m afraid – and who loses most of all? The tenant. Tragic
  2. Rent is currently 28.4% of earnings – highest in a decade. This is interesting, because as per my analysis a couple of months back, we are still not at the affordability pressure of pre-2008, when rent took up a larger percentage of earnings. It is hard to swallow for tenants – just as higher mortgage payments are hard to swallow for homeowners – but this 28.4% still has room above it before affordability chokes off rent rises altogether, in my view. Affordability is the next key metric that Zoopla sees really influencing pricing, and I am inclined to agree – the story is simply that supply is so broken, and demand so significant, that these are not the main economic factors at play in setting rents and rents are only limited by affordability. We aren’t there yet – but there’s no doubt affordability needs to be closely monitored
  3. Zoopla sees a 9% rent rise by the end of 2023 being the annual figure and is punting at 5-6% in 2024. Personally I think about 7% more in the next 12 months is a good stab, so we are not far apart on that one. Expect it to die away but only to 4% (or so) in the 12 months following that.
  4. 12 months ago, rental inflation was 12.1% over that period – so we’ve seen 23.9% rental increase in just two years. This is a realistic looking figure (for new lets) from what we’ve seen in our own business.
  5. The average agent at the moment has fewer than 10 voids on their books compared to a pre-pandemic average of 16.5 – a near 50% “adjustment”
  6. Buying is now more expensive than renting whilst mortgages are at a 5.5% level for owner occupiers. One more reason to stay in rental…
  7. The 10 year average for affordability of rent is 27.2%, so the 28.4% is outside of it but only by around 5% or so
  8. Zoopla expect higher levels of sharing and this makes perfect sense, as prices rise for renters
  9. Rental growth is being somewhat concentrated on comparatively cheaper areas, although Edinburgh is an outlier. Inner London rents are losing steam as affordability and also space is already squeezed to its near-limit – whereas outer London rents are performing strongly


I don’t want to leave Zoopla alone until I’ve also thrown into the mixer their own analysis on the sales market – given that that report leaves us in no doubt that rent rises have further to go, and gives us some key hints (focus on areas where there is affordability – something I’ve used as a cornerstone of my purchasing strategy since the beginning, without really having a clue as to when I would need that level of rope to be there or as to what would prompt rents to really start moving upwards). Thus, there’s a little bonus third summary on their most recent house price report from August:


  1. Prices up 0.1% year-on-year. This is significantly different from Nationwide and Halifax, who between them show a 5% drop, on average, year-on-year
  2. There have been 21% fewer completions than 2022, which was a very healthy sales market as you will remember!
  3. Affordability is up 9% in the past year, due to earnings increases
  4. There will be 1 million completions in 2023. I personally had forecasted lower as I expected the market to slow more, but there’s a reason why I was too bearish and that will become clear
  5. Mortgage-backed sales are down 28%, cash-backed sales are basically unchanged. The amount of cash business still going on (simply split into “downsizers” and “investors” in any bulk) is steady, so cash buyers are not sitting on the sidelines in general. If you downsize and want to move, there is such significant equity if you have been in a property for 30+ years that any concerns on the values in the market are clearly not stopping you – and rightly so, you’d think
  6. There’s 16% more stock than the 5-year average in a real pivot for the market – but still 9% lower in terms of supply, and significant drops in sales agreed (down 20% compared to 5y average) and demand (34% below 5y average). It’s tough selling houses at the moment, and we are seeing the same in the disposals we are doing (on a small scale) in several areas
  7. The distribution of the price changes is really telling – the basics are that the more expensive London, and the South, have fallen compared to the Midlands and the North, which have continued to rise (albeit very slowly) according to Zoopla
  8. The price change pattern is simply the incidence of the price differentials in those areas. Houses have always been affordable in Northern markets – deposits have been the biggest factor holding people back. With much larger loans, the more expensive houses have proven to be the most sensitive to that change in credit pricing – we should not be surprised
  9. The average monthly mortgage payment in London is now 24% above the average rent, even in the face of such large rent rises. Whilst it is hard to make southern rentals stack on a yield basis, there is a massive and significant market that is simply not going away anytime soon, and Outer London/suburban is definitely worthy of consideration
  10. Southern England BTL investors are now needing to put 40-50% deposits down on average to get lending. This obviously massively restricts new BTL loans in those areas and has a knock-on impact on supply
  11. Zoopla sees sales volumes having to come back before house price growth is back in a meaningful way. This is a significant comment and I do wonder whether they have truly factored in the effect of inflation here – but time will tell


So – the real skill of course is weaving all of this together, and also stitching in the other credible sources of data and analysis that are out there. Not easy, but I’ve got to try, right? Some brief conclusions from today’s efforts, and knowledge of some of the rest that is out there:


  • Cash buyers aren’t really on the sidelines here. This makes some sense – they are not troubled by the interest rate, although it does increase the risk-free rate of return of course. They aren’t expecting a big drop in prices, though, it would be fair to say
  • Pricing could well be relatively sticky for the next couple of years, whilst inflation continues to send affordability in the right direction. I’d suggest 2 year mortgages, particularly with big fees like 5%, are potentially quite risky if you are expecting to pull more money out in 2 years’ time
  • Rates are here to stay, like this – unless they aren’t. A fairly orderly but rapid path back down to 2% or thereabouts, in chunks of 0.25, 0.5 and perhaps 0.75 looks unlikely. More likely is a sustained period at the top (which might still be above 5.75% – the USA are still struggling with inflation even though they have got it under 4% now, and are more than 12 months ahead of us in their latest cycle) – the other, slimmer chance probability is a fast drop due to some form of economic collapse which we haven’t seen the signs of as yet – PERHAPS itself triggered by the interest rate hikes
  • Money flowing North is inevitable, and sensible – and likely to be sustained. The rates are making this a self-fulfilling prophecy. If you need 8%+ yield to talk “investment grade” – i.e. you are using leverage – that takes you to the outer Midlands and beyond – or into some aggressive active asset management strategies such as HMO/STR if you are not already there
  • Houses around 300k+ are the sticky ones. These are potentially HMO style deals if you do not want to venture North
  • Now is a time to explore equity partnerships rather than rely on debt, in case I’m wrong and we haven’t seen the high in the swap rate market – or we just spend the next 12 months bumping around between 4.25% and 5.25% in the swaps market meaning that today’s rates will persist
  • Equity release was due an absolute renaissance in my view – look at all that latent equity and the difficulty of saving the deposits – but these high rates will postpone some of that. Indeed, years of low transactions (and we better look at the average transactions across 2020-2023 before we make too many conclusions) – but if it IS years of low transactions now, will create a bottleneck in the system
  • Economic growth looks unlikely in any meaningful way over the next 12-18 months
  • Remember markets hate uncertainty and the upcoming election definitely means uncertainty – uncertainty that either of the main players are competent or good enough
  • The overall chat around a “soft landing” – that all the stimulus will be ironed out by this rate hike period and that we are nearly at the end of it, relatively without incident, is simply not backed up by history
  • Large US corporates and I look like we are on the same page that rates have peaked (NOT base rates, but swap rates) – The FT reported this week that the years to maturity of new debt issued this year are the lowest they’ve been for over a decade, and that speaks volumes – sadly, we do not have the same variety of tools at our disposal at the SME end of the investment and development markets, more’s the pity! That’s this week’s image


Once more we are at the end for this week – well done for getting through that sea of analysis. Be sure to tune into the 9am live on YouTube if you can (or watch on repeat) – if you don’t already know about it, just search up “Propenomix” – please subscribe to the channel if you enjoy the weekly content (or even if you don’t, but if you don’t, how have you got this far!) – and Keep Calm and Carry On, of course