Supplement 17 Mar 24 - Context is everything!

“Separate text from context and all that remains is a con.” - Stewart Stafford, author

Before we begin - Rod Turner and I ran a Property Business Workshop in January in London. We covered a wide range of topics - all the way from what a great investment looks like, to how to operate more than one company, why you would do that, how you might structure it, all the way down to a whole host of productivity hacks and general “January fitness” activities for your business(es). We enjoyed it, got some great feedback, and met some great people too. We are going to run another one with fresh content including due diligence (both on business partners and with a view to lending money), joint ventures, mergers and acquisitions and some accompanying case studies on some easy (and more complex) deals that we’ve done. The tickets for the next one are here https://bit.ly/pbwtwo - the date for that one is Wednesday 24th April, and there’s a discount for the early birds that’s only got a few days left so don’t be shy………

Welcome to the Supplement proper, everyone. This was one of those weeks where, for whatever reason, I saw more out of context stats and social media posts than the norm. I get it - the algorithm knows that I go hunting for stats, but does it not realise that I go hunting for stats that are meaningful!? Instead of getting annoyed, foaming at the mouth at a screen somewhere…….

It was a time to look behind some of the typical cycle of clickbait headlines and attempt to add some value. Before we get into the intergalactic arrears situation (which, spoiler alert, is barely raising the needle, let alone creating content for the next “Big Short”), however, it is customary to kick off with the macro roundup on what’s been an eventful week.

The big four this week largely pick themselves - (un)Employment, GDP growth, the RICS house price balance, and the bond and swap yields.?

You’ll know by now that I am cautious of the headlines and have a bit of a bee in my bonnet about us focusing on, and reporting on, the wrong metrics - or, that instead of hitting the bullseye, we have a tendency to spray the darts somewhere near the right target, as a nation, but rarely hitting it. The employment report is always the one. This week’s release - January’s unemployment rate - was an increase to 3.9%. Economic consensus was that we would hold at 3.8% - the figure for December - even though only a few months ago, consensus was that unemployment would be more like 4.3% and rising at this point.

The bears get a free shot at a miserable headline about unemployment “on the rise”. Only those truly committed to the truth and the detail prefer to note the following, which is relevant:

i) 15k more people were on payrolls in January compared to December

ii) 1.3% more people were employed compared to January 2023

iii) Estimates for February are that another 20k net were added to payrolls

iv) The estimated year-on-year growth in the workforce for February is 1.2%

v) Employment remained steady at 75% exactly of 16-64s, and therefore:

vi) Economic inactivity was 21.1%

vi) comes from some simple maths. 100% minus 75% employed minus 3.9% unemployed is 21.1%, right??

Except it wasn’t. Economic inactivity is actually recorded at 21.8%. The ONS do this sometimes - and there is method to it - but to mathematical pedants like me, it just looks wrong. Why does this happen? Because unemployment instead measures everyone 16+ who is seeking work (the other two measures cap people at 64 years and 364 days). Put another way - there are 0.7% of the broader sample who are 65+ and still looking for work - more than a couple of hundred thousand people.

Anyway - undeterred, the deeper labour market dive goes on. Unemployment benefit claimants were also up - 16.8k on the month and 85.8k on the year. Around 20% of that year on year growth was last month alone. Claimants number 1.585 million.?

Job vacancies also continued their 20-month journey downwards, down 43k on the quarter to 908k. Still above the pre-pandemic highs.

And then the big piece of the puzzle for inflation and interest rate setting. Wage rises (ex-bonus) stayed higher than wage rises with bonus, as the pandemic one-off bonuses that were used by many companies including the public sector to factor in some of the herculean efforts made during Covid, continue to drop out of the figures. Including bonus a slightly more manageable 5.6% was the print for January - ex-bonus, the figure is still above that daunting 6% number, at 6.1%. 2% inflation any minute now though apparently, promise……tell me another one.

Annual real growth in regular pay (another much more suitable metric, again under-reported) was 1.8% when adjusted for CPIH (the measure of inflation that includes housing costs - darling of the ONS, but controversial for the “synthetic” component of it that effectively imagines all owner occupiers are paying rent - also, the ONS has absolutely no handle at all on what property upkeep costs are like in my view). Still - that’s a very healthy print.

Enough on unemployment. Getting concerned when the figure is still under 4% is just silly. Not many years ago below 6% was seen as very healthy indeed and under 5% a significant rarity. Get that 21.8% inactivity rate down - primarily by sorting out NHS waiting lists (easier said than done, I get that) - and perversely that figure would go up, but there will be plenty of talent on the sidelines, involuntarily, at the moment.

Growth next. You will have seen the headlines, all is forgiven, UK economy returns to growth, etc. etc. Again - context, and detail please! The economy grew more in November (0.21%) than it did in January just gone (0.2%), and November was during what’s currently being labelled as a technical recession (the history books will change this, I become more and more convinced of this as time goes along - it will just take a few years).

Of course - we’d rather growth than not. The nail in the technical recession coffin - it is wrong to call that from January’s data, but we know from tracking the PMIs closely that February was a good month for services, and thus it is unlikely, unless it was a particularly poor month for consumption and that wasn’t picked up in the real time metrics, that February was a contraction. The National Institute for Economic and Social Research (NIESR) is forecasting a +0.3% for Q1 2024, but I actually think it could be a shade higher. There have been a few wobbles, as the cost of debt has pretty much flatlined after trending upwards from the Xmas lows, for example - but there’s been positivity and spending, and activity in the construction and property sectors for sure.

Construction output was up 1.1% for the month, but is down on the quarter, and just about ahead for the year. The improvements are very recent - on the quarter, new work was down 4.5% (but typical for a quarter spanning Christmas) - and maintenance and repair was up 4% (typical for a winter season, of course!). Normality has started to return to seasonality, and we are only a year away from being able to trust year-on-year comparisons again - subject to there being no crises in the interim.

The better comparable is to 2019 in general, still. New work is down over 10% in output terms. Repair and maintenance is up 32.4% since then. This makes lots of sense on multiple levels when you break it down. Rates mean that new work is less attractive, and construction inflation means that fewer projects stack up than they used to before the pandemic. Fewer new projects mean more repairs and maintenance, and inflation has completely taken hold on that front. None of this lines up to a new administration building 300,000 houses a year, of course, and everyone also forgets that the 240k units delivered in 2023 (not bad, given our capacity constraints) were planned in good times - the housing starts dropped off a cliff in Q3 2023, although the figures are difficult to trust because of building regulation changes implemented in June 2023 which made Q2 2023 look very good indeed. In 9 months (new figures will be out next week for the whole of 2023) there were 126,600 starts - compared to 138,000 starts in the first 9 months of 2022, so a drop of 8.2%. I doubt Q4 2023 looked particularly good for starts either but we will find out!

To the RICS house price balance then. The best semi-real time temperature taker of what a valuation might look like. Anecdotally I can only say that I have seen half a dozen posts this week about disappointing valuations from people who are particularly active. This does seem strange in terms of the timing, because the house price balance is better than it has been since October 2022. It is still negative, but a print of -10 is indicative of a 45/55 split between prices going up and down in surveyors. It is also - if you trust the Zoopla and other analysis that has been broken down in the Supplement in the recent past - highly likely to be a North/South divide with the cheaper, more northern markets performing well and the more expensive southern markets struggling or still shrinking in price - simply on a rates and yield basis. For more expensive houses you need to borrow more at higher rates and affordability (whilst wages are higher in the south) gets squeezed.

On the flip side, let us imagine the four possible paths there are to lower interest rates. My expected one, which is unpopular (mostly because it isn’t great for business, but I am renowned for saying what I think, of course) - a slow dribble downwards. 0.5% off the current mortgage rates by the end of 2024 - that’s where I think we will be at. So that’s 0.5% off the bond yields, basically - or a shade more, since the swap rates are trading at or below the gilt yields at the moment - there is no “spread” to speak of. The more hopeful one, where the rate moves down in an orderly and speedy fashion to 2.25% coming off the base rate in under 2 years, with an associated drop (not all of that, because the gilts are already trading 1.25%+ below the base rate) in mortgage rates. Back to 4% or under on 5-year limited company buy-to-let by the end of 2025, basically. The shape of the yield curve needs to change once more for that to happen, although that shape shift has started to happen again and in a future article I’m sure to be taking on what animal the yield curve is shaped like at the moment!

The last two are both 10% (or lower) in probability. The “big drop” - another crisis event. Referendum, Covid, big crisis moment - bigger than a “prime minister is an idiot” crisis, because that can (and was) sorted relatively quickly. Back to lower rates. Fantastic - I hear you say - but that would take some monumental issue to make happen at the moment. Dropping rates significantly with inflation still at double the target, with so much inflationary fuel still on the fire, would be a real last ditch attempt in the face of something truly huge - which you’d expect us to see coming. An avalanche, pressure in the system somewhere of an unbelievable proportion - or a geopolitical event which truly dragged the UK in, in a big way - which is not yet on the cards, in spite of rumbles, uncertainty, and piecemeal involvement in overseas lands at this time.

Then the one no-one wants to talk about. More likely than the third. 10% or even 15% likely. Geopolitical tensions lead to inflationary events due to supply chain disruptions. Red Sea - but 10 or 20x the size of that problem (estimates are that currently CPI is around 0.2% higher thanks to the Red Sea situation). What happens then……rates go up. How do markets react? I’d expect stock markets to tank, at least at first - but bond yields would also rise. How much? Tough to say, but another 50 basis points puts a real blocker on business, which isn’t a huge rise. 100bps is as bad as it has been throughout this whole recent cycle. More would be really damaging to the housing market.?

The 50bps outcome is the one I would see with a double digit likelihood. But confidence-wise, it would be quite shattering. Back to the times where “we don’t know where the top is” - which is where we were at only 9 months ago, and calling that top (you heard it here first in the Supplement, naturally) was personally a big part of rotating tactics back around in my operation to be buying with some confidence in the term interest rate again (i.e. not having to offer so very low on everything that we lost 80%+ of our volume, although what we did buy was pretty darned cheap).?

Those would have significant impacts, although at least one is a Black Swan. I see the first outcome as a more than 50% likelihood - continuation of the “treacle” that I predicted at the beginning of 2023, but with the trend moving steadily downwards. Sideways markets (in mortgage rates), dropping an average of 0.05% per month, basically unnoticeable, but a property market with no reason not to keep up with CPI and wage inflation in general, hence my prediction for this year of 3-5% capital growth (all of that is “fake”, all of it is inflation inspired, basically). So - don’t worry, but do take some time to understand this is where we might get to - and if we did, work out what you would do.

Whilst nibbling at the gilt and swap yields, let me round those up to finish that segue. I regularly confess in public that I don’t understand the bond market sometimes - and this week was harder to understand. We opened the week at 3.877% yield on the 5-year and bottomed at about 3.82% when the unemployment data was out on Tuesday. Then the bears came out to play and we closed the week at 4.023%, back into my “expansion vessel” analogy. Nothing major - still trading around that 3.9 - 4% range as per the past few weeks. Sometimes you have to look overseas - mostly to the US - to explain our bond market - and there was an unexpected tick up in both CPI and core inflation, but only 0.1% ahead of the consensus forecasts. The low print in June 2023 for the US that I have cited, 3%, and the bounce off (which I am also predicting in the UK, with April 2024 likely to be our low print in my view), is continuing as their current CPI is 3.2% but core is still above that at 3.8%. I’m not sure that moves our gilts 20 basis points - but there you go. I did say I don’t purport to understand it all!

The Thursday night close on the SONIA 5-year swaps (the most recent it seems we can get, these days) was still under 4% at 3.912% yield. That’s a good 10bps below Thursday’s close on the 5-year gilt yield, and still simply shows you where supply of money is for 5-year mortgages and term loans, versus demand. Still more money than good homes for it, at the moment!

Perhaps the arrears data and FCA mortgage data will shed some further light on that situation - I love this data, but dislike the time lag involved. Nonetheless, it is critical to keep an eye on these things, if for no other reason than to make sense of the nonsense headlines that are spewed out after the release by the “clickbait mafia”.

Here’s the tale of the tape:

1. Mortgage balances overall kept falling - down 0.1% on the previous quarter and down 1.1% year on year. Clearly many people have still preferred to gear down. Not massive (although the absolute number is massive, of course, because outstanding debt is a shade over ￡1.65 trillion), but if you loaded inflation on top of all of that, that is some depreciation in the true value of that secured debt!
2. Gross mortgage advances were down 13.4% on Q3 2023, to ￡54 billion. You always expect a little less activity in Q4, but not to that extent. Pricing in Q3 - in honesty - where the peak in the rates was - is the true problem here.
3. “The value of new mortgage commitments (lending agreed to be advanced in the coming months) decreased by 6.6% from the previous quarter to ￡46.0 billion, and was 21.2% lower than a year earlier. If the onset of the Covid-19 pandemic is excluded, this was the lowest observed since 2013 Q1.” - those are the FCA’s words from the report. So, advances will be down again for Q1 2024’s data, you can pretty much guarantee, on that basis. Not surprising as the truly low rates around the end of the year and the very beginning of 2024 simply didn’t hang around for long.
4. Gross mortgage advances were 33.8% lower than one year earlier (so that’s Q4 of 2022 - but don’t think “Truss”, think “loans that were agreed before Truss was a lettuce”. Also remember, whilst the bond yields spiked, they actually climbed higher in the Summer of 2023, which is what is hurting this data so very much)
5. “The proportion of lending to borrowers with a high loan to income (LTI) ratio decreased by 2.6pp from the previous quarter to 42.7%, and was 6.6pp lower than a year earlier” - so, either banks have had less appetite to lend at higher LTVs, which is a natural response to higher risk - or people have been less willing to take bigger risks (which is a natural response on the consumer side, of course) - or a mixture of both.
6. “The share of gross mortgage advances for house purchase for owner occupation increased by 1.0pp from the previous quarter to 58.7%, and was 3.3pp higher than a year earlier” - so, the owner occupiers remained the most motivated segment of the market at the higher rates
7. (Here’s the biggie): “The share of gross mortgage advances for buy-to-let purposes (covering house purchase, remortgage and further advance) decreased by 0.5pp from the previous quarter to 7.0%, the lowest since 2010 Q3, and 4.9pp lower than a year earlier”. The average longer-term number in lower-rate days was nearly double this, at around 13.5%. In 2010 Q3, there were very few buy-to-let lenders in the market - it was completely different to today - and the 5 year gilt was around 2%, making 4% debt a possibility (it wasn’t there, because the risk premium was judged to be far, far higher at the time, but on today’s margins, it could have been. More like 4.5% cost of debt with a 1% fee - so, considerably cheaper than today).
8. (Here’s the point of reality left out from all of the reporting): “New arrears cases decreased by 2.6pp from the previous quarter, to 13.2% of the total outstanding balances with arrears, but remained 0.2pp higher than a year earlier” - so, basically, new arrears cases are not on the rise - but:
9. (Here’s the bit that made the headlines): “The value of outstanding mortgage balances with arrears increased by 9.2% from the previous quarter, to ￡20.3 billion, and was 50.3% higher than a year earlier. The proportion of the total loan balances with arrears, relative to all outstanding mortgage balances, increased on the quarter from 1.12% to 1.23%, the highest since 2016 Q4” - I’m not minimizing arrears being up 50% in one year. That’s a big rise. 9.2% QoQ doesn’t suggest something that’s trending the right way, or under control, either. However, note the most recent comparator - Q4 2016, not an abnormal or difficult time in the market at all, so what’s missing?

What’s missing is context. Context compared to true crisis times. I’ve taken a chance this week and gone data-heavy on the image, on the basis you might be interested! I apologise to those trying to read on mobile, as it won’t be easy to decipher, but it is worth a look on a laptop or desktop computer. Basically - for true context:

i) That 1.28% was 3.8% in Q1 2009, so we are at about one third of that level.?

ii) There are lots more new cases, and in new cases arrears are low (above 1.5%, below 2.5% as a rule)

iii) The number of cases in arrears is one fifth of the number of cases in arrears in Q1 2009 - and perhaps more importantly, around half of the 2016 numbers - this is just how much arrears have come down thanks to the cheaper money and Covid stimulus

iv) Nearly 93% have no formal arrangement or payment plan for these arrears. This compares to 75% or so in crisis times, and 80% or so in 2016. This tells me that lenders are not overly concerned and are not pushing formal arrangements at this time.

Conclusion - this is a market returning more to the norm. What’s been the big driver - interest rates returning to the norm of course, alongside cost of living being an issue that’s largely solved at this point.

Press conclusion, the sky is falling, arrears are up 50%, and house prices are going down on the back of it. Definitely. It's all a big meltdown.

Context isn’t just important. It is everything, as you can see from this. And with that, that will be my third mic drop of the week, after two presentations at Coventry Property & Poppadoms (check your local area for a meet - they are superb, and James Rogers is doing some wonderful things there) and also at Manni and Romey Chopra’s Titans, in Beaconsfield at a wonderful venue - another evening meeting that is well worth a look, very accessible, friendly, well attended and packed with great, active people in property!

Congratulations as always for getting to the end - don’t forget the Property Business Workshop on Wednesday 24th April - tickets for you, or anyone you know who might want one, here: https://bit.ly/pbwtwo . Onwards, upwards, as we lurch toward Easter - Keep Calm and Carry On!