For those amongst us fortunate enough to have sufficient capital reserves, rarely has there been a wider choice of investment vehicles so readily available. From the uber-safety of government bonds through the giddy risk of trading currencies to the current SPAC craze flooding the FTSE and NYSE, there is unlimited scope for achieving a personal utopia on the risk-reward scale. For many investors however, the search for yield is tempered by the fear of loss; when seeking appropriate returns on our hard-earned capital – considered reward for rejecting the dismal interest rates offered by high street deposit accounts – most of us are willing to risk a partial loss, but not a total loss of capital. But where do we find the optimum balance between risk and reward?
The answer requires a little more analysis than simply assuming the lotus position and getting all Zen about it, or indeed having philosophical love-ins with our IFA’s, or asking our accountants where lays the harmonious coexistence of surety and profit. Pirsig’s idea of the ‘romantic viewpoint versus rational analysis’ seems perfectly appropriate when it comes to the search for yield, and high risk strategies devoid of tangible assets – Forex, SPAC’s et al – fall at the first hurdle. Why not just head off to the Casino instead? You will probably still lose all your money, but the visceral thrill of the ride will at least provide some memorable entertainment.
Government Bonds? Remember, this exercise is supposed to be about seeking a reasonably healthy profit, and the UK’s long established safe-haven of 10-year gilts has been stuck in the circa 1% groove for years, even turning briefly negative on several occasions last year; and if earning a paltry 1% on our hard-earned investment capital is difficult enough to accept, then actually paying the government for doing us the great favour of taking our money off our hands is quite simply beyond the pale.
No wonder then that so many of us, when threading the needle between risk and reward, turn to property. Real estate, when including both residential and commercial properties, and property-backed investment vehicles, is the world’s largest investment sector. So, without further reference to the ‘Metaphysics of Quality’ (and with apologies to those of you unfamiliar with Pirsig’s seminal work), let’s examine why the Zen-like search for yield always returns to property and property-backed investments.
Risk versus Reward
Risk is mitigated by the underlying asset, so that even if the broader property market tanks, the asset, by definition, remains in place with a given value; which can be liquidated if necessary. However, experience tells us that property market declines are generally relatively short-lived, and the market always recovers given time, therefore a real-world loss is unlikely unless a forced sale is necessary.
Reward is usually two-fold, measured initially in terms of annual yield, and secondly in capital growth. And it’s here that the property sector really comes into its own, because we get two bites at the cherry, with the chance to profit from both short term income and long term gain. Its less a case of risk versus reward, more a case of low risk combined with high reward. In the search for yield, the final, rational analysis, tells us that property is the best combination of risk and reward available. The barrier to entry, for many, is the cost of getting up the ladder onto the yield curve in the first place; and it’s here that property-backed investment vehicles come into their own, as they afford the chance to reap the same, or similar, rewards at a fraction of the normal costs associated with buying property.
So, what of the immediate future? As we stand right here right now, in October 2021, when considering investment into property and property-backed investment vehicles, is now the right time to pull the trigger?
Two factors immediately come to the fore, which are, on 30th September:-
- The 15-month long SDLT incentives were finally culled
- The 18-month long furlough scheme came to a close
Undoubtedly, these twin factors will have a negative impact on the property market. The rush to buy property during the SDLT holiday eventually became nonsensical, as the taxes saved were far outstripped by the hyperbole-driven house price inflation. The unwelcome return of gazumping to the property market saw many buyers paying 10% or more over asking prices, in order to save a few percentage points in tax. To quote the great Alan Greenspan, it was a classic case of ‘Irrational Exuberance’.
The end of the furlough scheme will herald an uptick in the unemployment numbers, but all governmental and independent forecasts predict the peak to be capped somewhere around 8%, before gradually falling back to the 5% level over the medium term.
Another factor is interest rates. The historically low interest rates that have defined 21st Century economics are prey both to the factors above, and also to the inflationary pressures slowly coming to the fore. If there is indeed a ‘bubble’ in the House Prices Index, then this is exactly the kind of news that could sharpen the needle. However, all the available remaining data suggests the above is an unlikely scenario. Consider the following:-
- The BoE base rate currently sits at its record low of 0.1%. It’s a certainty that the BoE will raise the rate sooner rather than later, with the smart money on an imminent rise to 0.25% before the end of the year, followed by gradual increments during 2022. However most analysts expect the BoE to retain the status quo of the last decade, with the base rate at or below 1%. Which means mortgage interest rates will remain in the aforementioned historically low zone
- Most economists believe property prices are likely to be sustained in 2022 not only by continued low interest rates, but also due to constraints on supply from the lack of new housebuilding; the general consensus being that house price growth ‘will cool gradually rather than collapse’
- All expert forecasting remains obstinately bullish. Industry heavyweights Hampton’s and Knight Frank have forecast growth of circa 3% for 2022, 2023 and 2024, and predict that the boom in demand for second homes that began after the first lockdown in 2020 will continue, as the effects of the Covid pandemic have left many people wanting somewhere they can retreat to, away from the city bustle, without travelling abroad. Additionally, flexible and remote working and other Covid-induced changes mean households will move home more often than during pre-pandemic times, leading to increased activity across the sector
- Last but not least, the UK government is targeting construction of one million new homes by the mid-2020’s in order to correct the current housing crisis; highlighting the fact that demand for housing far exceeds supply, and will continue to do so for years to come. Economics 101 tells us that when demand exceeds supply, prices go up, not down
In conclusion, if we rewind 9 months to the start of this year, many UK housing market analysts were gloomy about the outlook for 2021, citing both Covid and trailing indicators as reasons to be fearful. Now that the world is managing the pandemic, lifting travel restrictions, and spending its disposable income again, the reasons to be positive far outweigh the reasons to be negative. Whilst growth in the property sector seems certain to cool down in the short to mid-term, expansion is still a far more likely scenario than contraction. As far as the search for yield is concerned, property, and property-backed investment vehicles, will retain their Zen-like status for the foreseeable future.
Steven Earlam.
© Griffin Property Group Ltd. 2021. All rights reserved.
