The Leadership Election: How It Could Affect Investors
The Conservative Party’s leadership election is making headlines this month as the final two contenders battle it out to become the country’s next prime minister. While we certainly don’t wish to take sides in the contest, we feel it might be helpful to offer some thoughts on how the two candidates’ proposed policies might affect the property investment market.
Taxation
Perhaps the single most dominant topic for debate has been taxation. British citizens are currently facing the highest tax burden since the 1940s so it’s a political hot potato that both Rishi Sunak and Liz Truss have been anxious to address.
The two candidates’ positions have perhaps been over-simplified in the media. Truss is generally characterised as a voice for cutting taxes sooner and faster, while Sunak is seen by his supporters as an advocate of prudence, of reducing taxes only when the country can afford to do so. The reality, of course, is rather more nuanced, but a brief summary of their respective proposals shows that Liz Truss has set the more radical goals.
Truss Proposals:
· 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
· Suspend green levies on energy bills for at least one year
The BBC calculates that these measures would cost an extra +£38.5bn in 2023 and around +£30bn per annum thereafter, depending upon whether or not the green levy is reintroduced in subsequent years.
Tax cuts are obviously attractive to grass-roots Tory Party members – i.e. the people who will actually determine who gets the job of Britain’s next PM – and this may have been reflected in recent popularity polls. By the end of July, the former Chancellor had revised his stance somewhat, announcing that he would introduce one tax-cut of his own.
Sunak Proposal:
· Remove VAT on domestic energy bills for one year (if average bills exceed £3,000)
It’s important to note that VAT on household energy is not currently set at the standard 20% rate but at a much-reduced 5%, so cutting it to zero would not be as radical as perhaps it sounds. The total cost to the Treasury is estimated to be around £4.3bn.
Each candidate has asserted that their respective proposals are affordable and sustainable but the BBC Fact-Checker offers an independent analysis. For example, although Liz Truss had claimed that the government could spend an extra £30bn without breaking its own rules on borrowing, the BBC notes: “the Institute for Fiscal Studies has pointed out that inflation will eat into that figure. For example, the government's increases to public sector pay will cost billions. Meanwhile, surging inflation led interest payments on UK government debt to hit £19.1bn in June, the highest amount on record.”
Tax-Changes, Incomes and Inflation
There are very few simple calculations in economics because every variable typically affects several others. As a result, tax changes can have a mix of deliberate and unintended consequences.
For example, reversing last April’s 1.5p National Insurance increase would mean that ordinary British workers would see fewer of their earnings lost to tax. That could help to reduce pressure on household finances at a time when rising energy costs and inflation have been eating away at real disposable incomes.
To that extent, Truss’ proposal could reduce the severity of diminishing real incomes and could potentially reduce the risk of declining market sentiment. Average earnings and consumer sentiment are both factors that can affect the rate of property price-growth, so the policy could ultimately mean a more resilient property market with better prospects for capital appreciation.
Protecting household spending power is one intended consequence of such a measure. However, there could be side-effects, too. Critics argue that reducing the tax burden during a time of exceptionally high inflation could exacerbate the problem and lead to people paying higher prices for longer.
Higher inflation would erode spending power over time – erasing the shorter-term benefits of the NI contributions policy – and might force the Bank of England to attempt to control it by raising the base rate of lending. In the longer term, then, the policy could have a very limited effect on spending power and property values, and it could also precipitate a rise in annual mortgage costs. What’s more, higher interest rates could also act as a disincentive to business investment, thereby acting as a brake on the pace of any future economic recovery.
This is certainly the argument that Rishi Sunak has advanced. Speaking during a Channel 4 debate, he said: “We must not make it worse; inflation is the enemy that makes everyone poorer. It erodes your savings, it erodes your living standards, it means that those of you who have mortgages will see your interest rates go up higher and higher.”
However, the influence of relatively small tax cuts upon the rate of inflation is questionable. With the Consumer Price Index currently running at +9.4% and RPI running at +11.8%, household costs are rising quickly and, in most cases, such increases will far outweigh any savings from tax cuts and any increase in average wages. Real earnings have been lagging well behind the cost of living for some time now, and as people continue to feel materially poorer, they will almost certainly scale back their spending. In consequence, inflation should gradually slow.
Energy Costs
Despite his warnings about inflation, Rishi Sunak is also proposing a modest tax-cut: reducing VAT on domestic energy bills from 5% to zero. The actual cost payable varies according to a customer’s energy usage and, because VAT is a percentage calculation, its impact in terms of ‘pounds and pence’ will increase each time the price cap is raised. Consequently, there is no definitive figure that a typical household will save. Presently, however, the Sunak camp claims an approximate saving of £160 per home per annum.
On the other hand, one must recognise that average energy bills will be rising by far more than £160 a year, so – again – this is more about ‘damage limitation’ than it is about putting more money in people’s pockets. Even after such a cut on VAT, households will still find themselves considerably worse off. In real and absolute terms, energy costs will be higher, people will feel poorer and, over time, the combined effects should actually be deflationary.
Like Sunak, Truss has also targeted energy costs, but in her case via a proposed cut on the green levy. This has been something of a political football lately, with different MPs making contradictory claims about its true cost. However, FullFact.org has provided a helpful analysis that estimates the cost at around £153 per household per annum. In terms of value, then, it is not dissimilar to the former Chancellor’s VAT-reduction estimate.
Householders will welcome any help at all at a time like this but the effects of either policy will be dwarfed by the likely scale of forthcoming energy price rises.
Writing on his Money Saving Expert website, Martin Lewis notes that “The UK energy market is broken. The theory is we're meant to gain from competition, but there hasn't been any – instead we have effectively regulatory-enforced high prices… The new prediction is the energy price cap will rise by +65% in October (to £3,244/year on typical use).”
Looking ahead, the article estimates average costs in 2022 and 2023. Its predictions are:
· April to September 2022: Up +54% to an average of £1,971/year
· October to December 2022: Up a further +65% to an average of £3,244/year
· January to March 2023: Up a further +4% to an average of £3,363/year
With people already paying around twice the usual price for their energy, a VAT reduction of around £160 would not deliver any absolute saving, and nor would a suspension of green levies. To be blunt, affordability is only going to worsen when energy caps are raised again.
For investors, this means that potential buyers and tenants could see their incomes squeezed and find themselves with less disposable income overall. Many will start to worry more about their ability to make their rent or mortgage payments, and the collective effect could limit headroom for price growth in the wider market. Small tax-cuts may reduce the severity of the impacts but these are really only ‘sticking plaster’ measures.
Broader Economic Factors
Falling household incomes and high inflation are serious in themselves but they are symptomatic of even bigger problems. Some of the country’s most significant inflationary pressures are the result of global economic conditions and cannot be controlled by unilateral domestic measures alone. For example, while the Bank of England could raise the base rate to discourage ‘cheap’ access to cash, that would have little or no direct influence on the costs of materials imported from abroad.
Globally, commodity prices are high mainly because of shortfalls that accumulated in 2020 and 2021 during the Covid pandemic. Short supply combined with fast-returning demand drove prices higher and we are only now beginning to see international markets beginning to normalise.
Other important factors include the war in Ukraine – which has affected the price of fuel, energy and certain foodstuffs – and Brexit, which added to the UK’s international trading costs and prompted a sharp reduction in the value of sterling.
When the result of the EU Referendum was announced in 2016, the pound saw its sharpest one-day fall in 31 years. On the day of the Referendum, £1 bought approximately $1.49 but it fell quickly to a low of $1.32 early the following morning. Today, £1 is worth even less; around $1.21. That equates to a devaluation of around -18.7% since 2016, and it’s a similar story against the euro. Consequently, sterling now buys much less than it did on international markets, which means that British businesses have to pay much more for imported products and services.
Inflation may gradually slow of its own accord as international markets find a new balance and as supplies catch up with demand. However, a serious challenge will remain for the UK: namely, how quickly it can return to healthy growth. Currently, we are in danger of ‘stagflation’ – in other words, low or stagnant growth combined with high inflation. That’s a poisonous combination that any future PM will want to avoid.
In late July, the International Monetary Fund published data showing that the UK was poised to achieve the slowest growth of any of the G7 economies next year. The BBC reports the IMF prediction that “UK growth will fall to just +0.5% in 2023, much lower than its forecast in April of +1.2%.” That figure compares against a global growth forecast of +3.2%.
Rishi Sunak is taking the view that inflation must be the priority when it comes to kickstarting any recovery, and with the UK government paying record sums to service public debt, it’s easy to see why. As inflation rises, so do the payments on government borrowing, and this is turning into a massive drain on the public purse. On 21 July, the Institute for Fiscal Studies wrote that “inflation combined with seasonal effects hugely increase(d) the government’s debt interest bill in June.”
It explains that “A quarter of the UK’s government debt is index-linked, which means that the cost of servicing it depends directly on inflation. Therefore, debt interest over the whole of this year will be much higher…” For June 2022, the Office for Budgetary Responsibility recorded that the monthly cost had risen to £19.4 billion.
IFS writes that “At £19.4 billion, today's debt interest figure for June is eye-wateringly high compared with the very low levels of debt interest we had become used to between the financial crisis and the pandemic. But this single month’s figure is driven by short-term and seasonal effects. Of greater importance is the size and any persistent increase in debt interest spending.”
Government Debt and Spending
Reducing the level of debt is therefore important but it relies on ensuring that tax revenues and government spending are kept more or less in balance. This is the heart of Rishi Sunak’s objection to Liz Truss’ proposal to cut taxes while also increasing defence spending – from its current 2.1% of GDP to 3% by 2030. The IFS calculates that the additional cost of such a decision would be +£23bn, a cost has led the former Chancellor to describe the plans as a “fantasy.”
Against that, the Truss campaign might argue that defence spending will support business growth and employment in UK supply chains, and that increasing productivity must, in any case, be another national priority. Increasing the supply of goods and services within an economy can be another way of tackling inflation, so there is a credible argument for stimulating such growth through public spending on key strategic industries. For property investors, any consequent growth in business and employment will generally be welcome since it helps to underpin the financial security of ordinary home-buyers and tenants.
In the same vein, Truss is also proposing to cancel the proposed increase in corporation tax, which is otherwise due to rise from 19% to 25% in April 2023. Such a decision would cost an estimated £17bn per annum. The rationale is that it would keep more money circulating amongst private sector businesses and, in this way, help to stave off the worst effects of a possible recession. Economists seem now to be regarding a world recession as an increasingly realistic prospect and, unfortunately, many of the counter-measures typically employed against inflation can also act as a deterrent to growth. Encouraging an investment-friendly economy is therefore yet another difficult but important objective for any future PM.
In response, Sunak argues that money always has to come from somewhere, and that additional spending on defence or on other economic stimulus must inevitably come at the cost of reduced public spending elsewhere. The Truss camp has conceded that spending cuts will have to be made, but it remains to be seen whether those ultimately manifest as public pay-cuts or as lower investment in services or infrastructure. Any of those will come with their own negative impacts, of course, and that could mean slower growth in certain regions, lower employment or a sharper fall in average incomes. The effects may be localised, either geographically or in terms of industry sector, but they would certainly affect market conditions in certain regions and communities.
Conservative Party members will ultimately have to decide which of these arguments is the more persuasive, but their decision is likely to have important consequences for property investors across the UK.
International Factors
The leadership election is taking place at a time of uncertainty and volatility. The UK economy has been hard hit by global inflationary factors, by the aftershocks of the pandemic and by a slower recovery than any other country in the G7.
In June, the FT explored some of the reasons for this. Citing data from the government’s Office for Budgetary Responsibility, it writes: “The OBR has seen no reason to change its prediction, first made in March 2020, that Brexit would ultimately reduce productivity and UK gross domestic product by 4 per cent compared with a world where the country remained inside the EU. That level of decline, worth about £100bn a year in lost output, would result in lost revenues for the Treasury of roughly £40bn a year. That is £40bn that might have been available to (fund tax cuts) – the equivalent of 6p in the pound off the basic rate of income tax.”
Speaking directly on behalf of OBR, its chairman Richard Hughes reported that “Trade as a share of GDP has fallen by around 12% since 2019, which is about two-and-a-half times more than in any other G7 country. Overall UK trade volumes are down by about 15% compared to what would have happened if we had stayed in the EU, because we have made it more expensive to trade with our single largest trading partner.” The OBR indicates that the fall in trade intensity could also translate into a 4% fall in national productivity.
These are big numbers that must be having a significant impact on trade volumes, tax revenues and international investment. Rekindling international trade and inward investment will therefore be vital for any sustained recovery in the British economy. Tax has been the principal bone of contention in the current leadership contest but the UK’s future relationship with Europe and other export markets will also have a critical bearing on the country’s economic fortunes.
This makes the vexed question of trade borders in Northern Ireland particularly important. As it stands, both candidates seem to be intent on scrapping the government’s previously agreed deal with the EU. Deciding to do so could potentially be a trigger for souring relations, legal action and perhaps even certain new restrictions on trade. It’s therefore an important issue but, as Sky News and other media have observed, neither candidate seems anxious to discuss it in televised debates. Nevertheless, whichever of them becomes PM, their decisions with respect to Northern Ireland and the EU could have important consequences for Britain’s ability to trade in international markets.
Other Issues
Both candidates have made other commitments with respect to issues such as law and policing, immigration, foreign policy, the expansion of freeports and Northern Powerhouse Rail. Amongst other steps, Liz Truss has pledged support for the creation of new investment zones, while Rishi Sunak has put his weight behind the proposed expansion of Britain’s offshore renewable energy industry.
These and other policies all have their own particular implications in terms of local populations, employment growth, average earnings and economic regeneration in specific UK regions. The creation of freeports, for example, could create new jobs in certain coastal communities – many of which have been property investment hotspots in recent years. Similarly, more investment in offshore wind could boost employment prospects and average earnings in regions such as Merseyside or the Yorkshire coast – areas that have begin to establish themselves as international centres of excellence for sustainable energy.
It's beyond the scope of an article like this to explore all the many implications of the candidates’ various campaign pledges. However, the possible impacts of their respective policies on particular regions or industries may give property investors an added reason to maintain a keen interest in the contest’s eventual outcome.
Summary
This overview of policies and their potential impacts on the property market could give the impression that the leadership election is a critical ‘make-or-break’ issue for investors. In reality, it’s probably much less influential than that. The two contenders aren’t so far apart in many important respects and, moreover, there are certain market drivers that they can do little or nothing to affect.
It’s becoming a very well-worn argument but it’s nevertheless true to say that demand for residential property will still greatly exceed supply, whichever MP finally takes the top job. Neither has set out radical proposals for changing the housing market. Construction rates are unlikely to change very much and, to judge by all recent market reports, there are still far more potential buyers and tenants than there are homes available.
In short, many facets of the property market remain robustly independent of government policy. For so long as the market continues to be characterised by high demand, restricted supply and extremely low borrowing costs, property investment should remain a rewarding and reliable choice.
* * *
To find out more about investment opportunities in residential markets across the UK, please call our advisory team on 01244 343 355 or email sales@residential-estates.co.uk