With food prices increasing, prices at the pump surging, worker shortages in key sectors, strikes causing travel chaos, mortgage rates rising and weakening economic indicators, it’s difficult to pick up a newspaper these days without reading about the prospect of a summer of discontent.
It’s no wonder many investors are pausing to take stock, thinking about how the coming months will unfold and how they should allocate their capital given the series of predictions of doom and gloom ever present in the press.
In this blog, I’ll set to cut through this media hype and discuss what we know and don’t know and what I think is possibly in store for house prices in the UK.
To begin, here are some observations and comments:-
- Predictions are just guesses (ours included). Even so called ‘experts’ do not know what is actually going to happen
- Consumer Price inflation hit 9.1% in May
- The economy is incredibly self stabilising
- Unemployment is at its lowest level in nearly 50 years
- Household savings rose significantly during the pandemic
- Everyone needs somewhere to live
- There is a shortage of housing stock in this country meaning there is a persistent surplus of demand over supply
- There is too much focus on whether the UK moves into a technical recession or not
- It’s not the 1980’s (even if Kate Bush is number 1, Top Gun is in the cinemas and Russia is taking on the West)
I will expand on some of these points below.
Recession
Of course it matters if the economy tanks, it really matters. The problem with the UK media in my experience is that there is a huge amount of focus over whether the UK tips into a technical recession and not the size or depth of any fall in economic activity.
A recession is defined as two consecutive quarters of negative growth, so two consecutive quarters with GDP falling 0.1% would be classified a recession whereas a 10% fall followed by 0% growth would not be. It is clear to us which is the worst outcome for the economy.
Investors should cut through the noise and media analysis (where a difference of 0.1% can be the difference between doom and boom) and focus on the bigger picture.
Inflation
While there is plenty of bad news, the key factor to focus on is the level of inflation. It’s inflation that is causing real wages to fall (see below) and the cost of living to rise. I’m of the opinion that there is a strong possibility that the self stabilising attributes of the economy will ultimately kick in causing a moderation in inflation back closer towards more manageable levels.
What do I mean by self stabilisation? I mean that surging prices driven by too much demand for limited resources will lead to less demand for these resources which in turn will lead to lower prices. In addition, market forces will lead to more supply coming online to take advantage of these high prices which in turn will depress prices (for example if copper prices are high then mining companies will put resources into mining more copper).
There is, however, a key risk to this opinion:-
Key risk: wage/price spiral
What governments and central banks most fear is a wage/price spiral. This is where workers see prices rising and demand higher wages in response to protect their standard of living. Companies with higher wage costs are then forced to raise their prices in response which sends prices higher in the shops meaning workers demand higher wages to compensate. This cycle continues causing instability and a lack of confidence damaging growth and livelihoods.
Nominal v real growth
There are many stories in the press right now about ‘wage cuts’ or more specifically ‘real wage cuts’. What is important to understand here is that when people say this they do not mean the actual amount they are paid has been cut but that their pay in real terms (i.e. the value of their wages adjusted for the effects of inflation) has decreased.
This is an important concept and the same applies to savings/investments. Investors need to think carefully about this and be aware that the purchasing power of their cash savings is being significantly eroded by high inflation. This is something we discussed in a recent blog along with ways to mitigate this risk by investing in investments linked to a real asset.
Now the positives
It’s not all doom and gloom. The UK has record levels of employment, the lowest unemployment rate in a generation, household savings were bolstered during the pandemic, the war in Ukraine hasn’t escalated as once feared, markets are severely pessimistic and there always remains a large supply/demand imbalance of residential property.
I’m of the belief that, provided we do not get into a perpetual spiral of higher wages leading to ever higher inflation, then the economy’s self stabilising attributes will cause inflation to moderate to more manageable levels (albeit likely at higher levels than in recent decades).
House prices
So, what does all this do for the outlook for UK house prices?
In an inflationary environment, with the price of everything (including wages) increasing we would expect house prices to continue to increase, certainly in nominal terms.
This, however, is not the same as saying we expect house prices in real terms will increase. If the economy is weak and headline inflation running at around 10%, then we would anticipate house price inflation will run at a lower level but still see nominal prices rise.
I’d expect nominal house price inflation to moderate to a low single digit rate of growth while the economy is weak, supported by high employment, the excess of demand over supply for housing and increased household savings. Even in a nightmare scenario of inflation soaring even higher and for an extended period we expect house prices to keep increasing in nominal terms.
In the long run we expect real house prices to continue to rise as the population continues to grow and housebuilding does not keep up.
The markets and the economy
Finally, a wider look at what’s happening to markets and the economy puts property investment decisions in further context.
Many traditional investments are having a rough ride at the moment, buffeted by high inflation, weakening growth and rising interest rates. This raises one aspect of our type of investment that we are particularly keen on. We believe that with much of the income for our investments ultimately coming from the government, we are substantially insulated from economic cycles, and particularly from short term wobbles that are presently talked about. Trading businesses and individuals are being bounced around quite a bit at the moment but we look to create longer term secure, stable income from the investments that we seek out and list on the platform.
We also build inflation into most of the leases that produce your income. Interest rates may go up a bit for now, with some part of that passed on to savers, but inevitably if there is a subsequent economic slow down , rates could well be lowered again in response. Meanwhile, our investments generate income that moves upwards in line with inflation but does not fall back when interest rates fall. Having investments that do not just go up and down in synchronisation with other markets is fundamental to a diversified investment portfolio. This is partly what we sought to achieve when we founded the company and we are now seeing a period where those benefits are coming into sharp relief.
You can read more about making an investment that benefits as prices rise while also helping house vulnerable people in the UK by clicking here.