Britain’s New PM: How the Property Market Might Change
A little while ago, we published an article looking at the two Conservative party leadership candidates – Liz Truss and Rishi Sunak – and how their policies might affect market conditions for investors. With that contest now resolved, it’s time to revisit those issues and to examine how more recent policy changes could change the UK property market.
New Support for Domestic Energy Bill-Payers
On 8th September, the government announced a decision that neither candidate had floated at the time of our last article. Nevertheless, it was an important one. On the Gov.UK website, the Department for Business, Energy and Industrial Strategy (BEIS) announced that it would replace the price cap with a new ‘energy price guarantee’. Explaining it, BEIS wrote:
“The Energy Price Guarantee will ensure that a typical household in Great Britain pays an average £2,500 a year on their energy bill, for the next 2 years, from 1 October 2022. The consumer saving will be based on usage, but a typical household will save at least £1,000 a year (based on current prices from October). Energy suppliers will be fully compensated for the cost of the Energy Price Guarantee.”
For property investors, and for the economy in general, this is a fairly momentous step. Energy costs feature heavily in the calculations that produce official inflation figures. Consequently, recent gas and electricity price-rises played a large part in the rapid rise of the Consumer Price Index. Now, however, the policy places a strict limit on how high domestic energy prices can go – over the next two years at least – so economists will now be revising their inflationary forecasts.
The consequences are hard to overstate. It’s worth noting that some sources, such as Citibank, had predicted that inflation could exceed 18% next year. Even the Bank of England’s figure were alarming: suggesting a rate of around 13% before the end of 2022. If that had happened, then ordinary families would have been facing the direst of financial challenges. Millions of Britons are already classed as living in fuel poverty, but if annual energy costs were to have risen to over £5,000 as some sources had predicted, then conditions would have grown very substantially worse.
Energy Costs, Disposable Incomes and Rental Payments
In that sort of nightmare scenario – which was still a very real possibility until this month – such extra pressure on household budgets could have had numerous negative consequences. Most obviously, it would have forced millions more into poverty and truly miserable living conditions. As various charities and newspapers have remarked, families would have to make hard choices between heating and eating. For that reason alone, this policy must be welcomed.
For investors, too, the outlook was worrying. Landlords rely on tenants to be able to pay their rents, but faced with escalating living costs, many households (and here we’re potentially talking about millions of people) would have been at serious risk of falling into arrears.
That risk is lower now but it still exists. Even back in 2020 official government figures showed that 3.16 million households (over 13% of the population) lived in fuel poverty, and that was in England alone. Since then, real-terms average earnings have fallen further and, at the same time, fuel costs have risen sharply. Consequently, average disposable incomes are falling and many people will inevitably find themselves with less to spend on housing, food and other essentials.
In 2021, the average domestic energy bill was around £1,339 per year and even taking account of the new energy price guarantee, that will reach £2,500 by October. Thus, the average ordinary family will somehow have to find an extra £1,161 every year. Average real-terms earnings are reportedly falling at 2.8% per annum so finding any spare money at all will be a challenge for many tenants right now.
All this, of course, will tend to limit the potential of average rental values to rise in the coming months, and it could see landlords in some lower-income rental markets contending with late payments and cashflow concerns.
Nevertheless, things could certainly have been much worse. According to research published by the University of York in August 2022 (i.e. before the price guarantee announcement), “more than three-quarters of households in the UK, or 53 million people, will have been pushed into fuel poverty by January 2023.”
It should be noted, incidentally, that the above findings already took account of the £400 energy rebate. The forecast is based on the standard definition of a household in fuel poverty – i.e. one that spends more than 10% of its net income on fuel. This gives a sense of the scale of the problem that the new price guarantee is seeking to prevent and helps to explain why the cost to the public purse is set to be so enormous.
The intervention is very much about damage-limitation rather than actively improving economic conditions, so investors should now be re-examining their strategies and looking for opportunities to mitigate their risks.
Two of the more obvious ways to do that are 1) to shift investment choices towards higher-earning tenants who should remain better able to pay, and 2) to think about investing in more modern, energy-efficient properties that will help protect tenants against the worst effects of rising energy costs.
Inflation and the Base Rate
As we noted earlier, energy and other utilities are part of the hypothetical ‘basket’ of goods and services used to calculate official inflation data. Consequently rising energy costs will tend to push those official figures upward. For exactly the same reason, the new energy price controls should help to prevent inflation from rising as fast or as high as economists had previously feared. As a result, the Bank of England may not feel quite so much pressure to keep the base rate elevated for so long.
Given that CPI inflation is currently running at +9.9% (as of 14 September 2022), there’s little doubt that the Bank’s Monetary Policy Committee (MPC) will seek to raise the base rate again this year, but how often and by how much is very difficult to predict. What is more certain is that if energy costs plateau rather than continue to skyrocket, the base-rate graph should stay flatter and any peak should be shorter-lived.
That would be reassuring news for any investors who might be looking to take out a new buy-to-let mortgage in the next few months, as well as anyone with a variable rate mortgage and, of course, first-time buyers. As the base rate rises, so too do the interest rates on mortgages, so the lower it stays, the more affordable such purchases stend to be.
Numerous sources have suggested that higher mortgage rates will be one of the most powerful forces working against capital growth in the final months of this year and beyond. So anything that might help to keep those rates lower should not only help with initial affordability; it should also help to permit faster capital growth in the longer term.
Energy Costs, Business and Employment
As part of its statement on 8th September, BEIS promised that businesses and charities would receive their own package of support on energy costs. It would, it said, be broadly similar to the one aimed at households. However, unlike householders, businesses will only be offered six months of support, after which government would only “provide further support to vulnerable sectors such as hospitality, including our local pubs.”
This has alarmed business owners, first because it suggests that many of them will receive little or no support after that initial period and, second, because the government has also warned that it will struggle to launch the initiative until at least November.
The consequences for investors are indirect but important. Many companies have said that they risk bankruptcy without similar and continuing support. Higher fuel and energy costs have far-reaching effects, influencing costs and profitability in virtually every industry, so insolvency could be a very real prospect for a broad swathe of employers. And if that happens, large numbers of jobs could also then be lost, leaving more ordinary Britons with lower incomes and greater difficulties in paying their rents.
Energy Efficiency Policies
It is important to note that, at the time of writing, the new prime minister has only been in post for a few days. It has been a period marred by the sad death of Queen Elizabeth II and complicated by arrangements for a state funeral and a national day of mourning. Consequently, Ms Truss has not had the opportunities she would likely have wished to make rapid progress on important changes in policy.
Nevertheless, it seems clear that she intends to support the continuation of policies aimed at improving the energy efficiency of Britain’s housing stock. This includes a number of energy efficiency support grants and legislation that will oblige landlords to maintain EPC ratings of ‘C’ and above on lettable properties. Both issues remain important to investors, especially since the sharp upturn in energy costs, which has created a fast-growing preference for more modern, better-insulated homes.
New Policies and Inflation Risks
Critics of some of the prime minister’s tax-cutting plans suggest that in addition to being unaffordable in terms of government borrowing, they could also exacerbate inflation. A reduction in VAT, for example, would lower the apparent cost of certain goods and services, potentially creating more room for vendors to increase their prices.
There isn’t a straight causal connection here – a VAT cut wouldn’t necessarily result in higher prices – but it is a risk and some economists have suggested that it could force the Bank of England to raise the base rate further, driving interest rates at high as 7% before the end of the year. That might benefit savers – reducing the real-terms losses on any money held in savings accounts – but it would be decidedly unwelcome for anyone with a mortgage to pay.
Housing and Planning Policy
Before the election, Liz Truss declared herself in favour of building on greenbelt land, particularly in areas close to major transport hubs. She had also spoken of changing planning rules more generally and disregarding what she termed ‘Stalinist’ housing targets.
Instead, she said she planned to “rip up red tape that’s holding back housebuilding and give more power to local communities” by creating new ‘opportunity zones’. In these zones, planning regulations would be less stringent, permitting more and faster housing development.
It’s impossible to say how quickly such proposals could be enacted, nor how much legal opposition they would face. However, if they were to make it onto the statute book, the effect would presumably be to boost housing supply in certain regions and local areas. If that were the case, then the gap between supply and demand might narrow and that could act to reduce asking prices overall – at least in the areas in question.
However, planning regulations are not the only constraint on housebuilding rates. Other factors include the availability of skilled labour and suitable materials, and of course the will and capacity of housebuilding contractors themselves. In the past, some builders have been accused of ‘land-banking’ during times of relatively low house prices – i.e. securing planning consents but delaying construction until such time as average values rise more sharply, thereby producing more profit.
Ultimately, only time will tell what, if any effect the new planning proposals will have on housing supply and whether they will change supply/demand dynamics enough to bring average values down. For the time being, given the scale of demand for accommodation, it seems unlikely.
Policy, Spending and Debt
During the leadership contest, Rishi Sunak argued strongly against Liz Truss’ proposals to use government borrowing to fund tax-cuts and additional spending. He argued that such measures could be inflationary and that they would add to an already mountainous pile of public sector debt that would store up problems for the future.
The UK already has a high ratio of debt to GDP. In August 2022, the House of Commons Library reported that “at the end of July 2022, government debt was 95.5% of GDP.” Since then, it has risen further and is expected to exceed 100% in September. Given the likely cost of the energy price guarantee, which the PM intends to fund via borrowing rather than via any windfall tax on the gas and oil companies themselves, that seems more than likely.
This matters to the economy because the cost of servicing public sector debt is already very high. Like any other organisation, the UK government must pay interest on any borrowing and, in August, ONS reported that “debt has reached levels last seen in the early 1960s.” It goes on to say: “Central government debt interest payable was £5.8 billion in July 2022, +£2.3 billion more than in July 2021 but -£13.9 billion less than the record £19.7 billion payable in June 2022.”
For investors, the effect is again indirect. A government that is spending more of its funds on servicing debt is able to spend less on other things; valuable and important public services such as education, healthcare and support for businesses. This could well have a depressive effect on national economic growth and employment figures, so – again – ordinary families might find themselves worse off and less able to afford their rents.
Moreover, the problem worsens in times of high inflation because of the way that interest on government debt payments is calculated. It is linked to the Retail Price Index, and because that is currently running unusually high, at +12.5%, government spending on debt has also risen sharply. ONS writes:
“Since mid-2021, the cost of servicing central government debt has increased considerably. These rising costs do not principally reflect recent increases in the level of government debt... Instead, the recent high levels of debt interest payable are largely a result of higher inflation, with the interest payable on index-linked gilts rising in line with the Retail Prices Index (RPI). This month the interest payable on central government debt was £5.8 billion, with £4.0 billion of this £5.8 billion cost reflecting the impact of the RPI.”
In short, there are many good reasons why it will be important for the government to reduce the current rate of inflation – not least the need to improve its own capacity to spend tax revenues on vital services rather than merely on servicing debt.
The Value of Sterling
The value of sterling (i.e. the pound) has declined markedly since 2016 when the result of the EU (‘Brexit’) Referendum was announced. At the time, many investors lost confidence in Britain’s economic prospects and, broadly speaking, the pound has remained on a downward trend since that time. In 2015, £1 bought $1.53. Today, in 2022, that same pound will buy only $1.27. The biggest falls in the exchange rate occurred in 2016 (when the pound’s value fell by 16.05%) and then again in 2022. This year, as of September 2022, its value has fallen by 14.82%.
The situation has not been improved by the country’s high rate of inflation and lower-than expected productivity. Nor will it be improved if international markets believe that the new PM’s spending commitments and borrowing intentions are unsustainable.
For investors, the most important consequence of a poor exchange rate is that it is another inflationary factor. That’s because it makes imports more expensive. When sterling devalues, British retailers and other businesses must pay more pounds to buy foreign goods and services – everything from food and fuel to financial services. That raises prices in shops and elsewhere and therefore tends to make ordinary Britons poorer in real terms – i.e. because their buying power is reduced. Once again, that tends to leave them with less to spend on rent.
Key challenge for the new cabinet will therefore be to reduce the rate of inflation and to restore some measure of faith in the UK economy. If international markets are confident about its prospects, market sentiment should improve and the value of sterling should begin to rise. That has not yet happened – the pound is still very low against both the dollar and the euro. However, it will be interesting to keep an eye on exchange rates, which can often be regarded as a crude barometer of Britain’s economic credibility in the eyes of others.
Other Policies
Two important commitments in Liz Truss’ campaign were to:
· Reverse the 1.5p increase in National Insurance (in force since April 2022)
· Scrap plans to raise Corporation Tax from 19% to 25% in April 2023
The first of these should help to give ordinary working families slightly more spending power in the months ahead, though this will of course be eroded by inflation. Nevertheless, it would represent an improvement upon the status quo. That could help to offset some of the negative effects previously mentioned and, for some tenants, it could make the difference between being able to continue to pay rent or going into arrears.
The plan not to raise Corporation Tax will not actively improve conditions but for those companies facing fast-rising energy costs and possible insolvency, it will at least not make things any worse. Again, this could make a crucial difference and keep people in jobs when they might otherwise have lost them. However, at an estimated cost of £17bn per annum, it’s a commitment that will inevitably add to government debt.
Policy and Capital Values
In the previous sections, we have considered the implications for investors mainly in terms of average incomes and the ability of ordinary people to pay rent. This is because it’s here that the impacts of policy changes will most probably – and most immediately – be felt.
However, average incomes also have a bearing on capital values, and for essentially the same reasons. If prospective home-buyers have less income available, then they will be less willing to commit to larger mortgages and they may well be more hesitant to make their first purchase or to move up the property ladder. As a result, house price growth could gradually slow.
Similarly, capital appreciation could slow if the base rate continues to rise – i.e. because people will be wary of the rising costs of interest payments on new mortgages. And such concerns seem perfectly justified; in the face of exceptionally high rates of inflation, the Bank of England seems very likely to raise the base rate further.
Affordability and the spectre of rising mortgage costs are two reasons why most industry commentators expect house price growth to moderate over the next few years.
Crucially however, the imbalance between supply and demand is unlikely to change substantially, so 5-year forecasts still indicate steady growth in average property prices. These expected rates are much lower than at present but, by 2024, the rate of inflation is also expected to be much lower. On balance, then, taking account of both capital growth and rental returns, property should still deliver real-terms growth in value.
Summary
At the time of writing, the new PM has only been in Downing Street for a few days. Consequently, while there is much speculation about policy, little has yet changed on the ground. We are seeing indications of intent, and we can refer back to previous campaign pledges, but what we haven’t seen is political commitments coming up against real-world constraints. What the new cabinet can really achieve in these fast-evolving conditions remains to be seen.
What is more certain is that conditions will be very challenging in the coming months. High inflation, low productivity, falling real incomes and a rising base rate are all forces that, in their various ways, will work against investors and the economy in general.
As a counter to that, however, investors can take some comfort in the underlying strength of the residential market, which is rooted in very high demand. Unlike other asset classes, property is underpinned by that unchanging demand, so it’s much less susceptible to rapid fluctuations in performance and value.
Similarly, despite the PM’s aspirations to change planning rules, it’s likely to take years for such policies to make a material difference on the ground. The supply of good residential property – particularly the more sought-after energy-efficient types – will remain very limited. As a result, capital values should hold strong in the medium and long terms, and competition amongst prospective tenants should also support a steady increase in average rents.
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To find out more about investment opportunities in residential markets across the UK, please call our advisory team on 01244 343 355.