UK property – time to sell?
UK has been a good market for many HK investors, especially those who bought after the lows of GFC. Your writer has done even better by focusing on fringe markets which continued rising even when the prime central London sector crashed since its peak in 2014 – some popular development projects there having fallen by as much as 50% since:
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Chart 1: prime central London underperformed by 14% since 2014 peak vs Greater London…  |
But with a plethora of negative factors now taking centre stage politically, economically, climatically, and on valuation grounds, we think the prospect of future rises, let alone outperformance, of the UK property market, is now much dimmed. Below is an extract of a longer piece we sent to clients, some key reasons for our cautious views are as follows:
1) Energy / food / hyperinflation => drop in real income, rise in civil unrest
2) Debt explosion + Rate surge undermining returns
3) Taxes must rise to service the rising rates, unsustainable welfare, and military spending
4) International wars cause capital flights (to US/Asia) and disrupt business
5) Chasing out the rich – the selling has just begun? e.g. Superman Li. The Saudis, Russians, and Chinese may not return if the seizure of private assets continue
6) Regulations Overload is becoming unbearable – for property investors
7) Positive immigration inflows may reverse after Brexit
Below we will look at all these factors in more detail.
1) Massive energy/food inflation drains disposable income, may trigger civil unrest?
The UK/EU construct, being heavily manufacturing and trade dependent, cannot afford to lose reliable and cheap energy imports, which was badly hit by supply shortages following covid lockdowns. This is now worsened as geopolitical tensions explode.
Just about every essential commodity, manufactured good, and service (eg imported labour) is now at critically low levels, stoking massive price hikes sometimes in triple digits. For example: reserves of arabica coffee, the higher-quality bean loved by espresso aficionados, have fallen to their lowest level in 22 years… prices on the ICE futures exchange rallied as high as 2.55 in Q1, up 140 per cent from 2020 lows:
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Chart 2: Coffee inventory at multi-decade lows, and could worsen further as fertiliser/transport costs continue spiking  |
There has been widespread coverage of the energy shortage and price spikes so we will not go into detail here, one example being ominous The Telegraph warning on 18 Nov 2021 – well before even the Ukraine conflict broke out:
We are back to warnings of power rationing and industrial stoppage, a looming disaster for the European Commission and the British government alike
[Gas] Inventories are currently 52pc in Austria, 61pc in Holland, 69pc in Germany at a time of year when they should be near 100pc
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Chart 3: UK less affected by Russian imports, but still can’t escape rallying global prices  |
UK is not as safe as the chart above suggests, as cross-Channel prices move in near lockstep, and the fact that the government allowed storage sites to close means the country may be nakedly exposed with just days of stock.
Further, the Hinkley Point C nuclear power station will not come on stream for another five years at best, and have banned, since 2019, fracking to extract easy oil resources.
Edging private sector to invest in fossil fuels is now more difficult than ever: ten years ago, the "cost of capital" for developing oil and gas was similar to renewable – at between 8% and 10%. Now, the threshold of projected return that can financially justify a new oil project >20% for long-cycle developments, vs renewables falling to 3%-5%, according to Goldman Sachs.
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Chart 4: Cost of capital: very costly to start fossil fuels projects due to politics and ‘green imperative’ mentality 
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Why so high? Simple. Few want to lend to fossil fuel producers as stakeholder capitalism, ESG mandates, and identity politics infest corporate boards.
2) Debt explosion + Rate surge undermining returns
The West has sleep walked into a vicious cycle of:
(a) high welfare =>
(b) higher debt =>
(c) higher taxes when can’t borrow =>
(d) cut interest rates to -VE when can’t raise tax =>
(e) to buy political support, increase welfare (ie back (a))
This trick was easy to pull off from the early 80s when interest rates were as high as 15%, but now with EU at negative rates compounded by massive inflations every way you look, the game is OVER.
A slight increase in rates – when EM countries are now well equipped, after having gone through their own versions of debt crises (eg Asian Financial Crisis) – will cause the West into a painful reverse trade that threatens to rapidly unwind the past 40 years’ profligacy.
In the case of the UK, public debt has gone from 20% of GDP to 100% over 30 years (Chart 5), but all while interest payment fell from 10% of revenue to 3%. All of these are coming to a head now with collapse in confidence in public debt, triggered by govt mandated economic lockdowns, zealous push for green agenda, and now international wars:
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Chart 5: UK public debt as post-war highs |
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The optimistic forecasts of OBR are probably based on low rates, low inflations, and strong growths after coming out of the lockdowns, but all of these assumptions are severely challenged, which could mean a debt explosion from the highest level since the 1960s to much higher levels than forecast below:
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Chart 7: UK debt forecast likely too optimistic |
Coupled to this the economy destroying zero-carbon ideology feverishly pursued by most of bureaucrats and politicians, the UK could see as much as 60ppts more in debt load in the next 30 years:
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As international interest rates head higher, the ability of the slow growing OECD (mostly EU) to hold down their risk free rates will evaporate, as capital leaves seeking better returns elsewhere – all of this will lead to much higher finance costs for property very soon. The strong inflation backdrop (Chart 9) is also probably grossly under-estimated by the market, where low to mid single digit forecasts are still the norm, when we are already potentially looking at as high as 20%s levels (especially the 70s oil shock pattern repeats):
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Chart 9: with war added to the mix of energy + food crisis, we fear UK inflation could reach double digits soon  |
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Chart 10: Fed projected to hike 300+bps in next 1.5 years  |
If The Fed’s hike trajectory (300bps in 12 months) is anything to go by, given a weaker GBP (which means more imported inflation) plus higher energy uncertainties compared to continental USA, 400bps+ rate increases are a high probably outcome to us:
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Chart 11: yield gap analysis suggests possible price falls  |
As a result, even modestly assuming 300bps mortgage rate hike (Chart 11), the low property yields of today will feel a lot of pressure to catch up. Expanding yields mean higher rental growths are needed (69% in above scenario) just to keep prices from falling!
3) Taxes must rise to serve the rising rates, unsustainable welfare, and military spending
Part of the problem of high inflation and high interest rates is the erosion of profits at the corporate level and take-home pays at the individual level. It is no wonder that the government’s own forecast project the highest tax-to-GDP level since WW2 (Chart 12), adding insult to injury after the first two drags on people’s income:
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Chart 12: tax take as % of GDP up 8ppts from 80s lows  |
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Chart 13: 2019/20 to 26/27 tax increase by factor  |
All of this is in addition to the economic rebound nearing its peak, when corporate expansion intensions are starting to reverse:
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Chart 14: CFO expansion survey – growth may have
peaked |
As rates rise, and inflation and tax bite, people’s take-home pay will likely drop, leaving them less money to invest in property, and we expect the record high P/E ratio (home price to earnings) to also turn south (Chart 15), perhaps having first made a dash for new highs by as late as Q3 2022:
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Chart 15: Home price to income ratio also may peak by
Q3 22 |
Looking at the complex picture in one condensed chart, we factor in income growth and interest rises against real home prices (ie after inflation) below, we present two possible scenarios:
1) optimistic outcome where home prices stay unchanged (blue solid line, Chart 16) - the combined effect of inflation and income growth will make home prices a lot more affordable by 2026 (red sold line);
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Chart 16: yield gap analysis suggests possible price falls  |
2) but what if the cycle we see in the red line repeats itself, and the red dotted line plays out by 2024 at the 700 reading on the real home valuation index? Such an outcome would require a home price drop of 37%, as represented by the blue dotted line.
The only possibility for home price drops not to happen is if income rises more than inflation (unlikely) and rate hikes are much less forceful than we forecast (also not high chance)…
Although our forecast contains a lot of forward assumptions, what we know for sure also is that the market has been too blasé about how the govts and central banks will be able to keep everything on a steady straight line (very typical mandarin thinking).
In the next instalment
Our discussion will continue in a second piece shortly, in which we will go back to more descriptive mode and go
through some of the more real life examples of how and why owning and investing
in property in the UK is now much more an uphill struggle compared to the ease
it used to be barely 10 years ago... This aspect will very much weigh on the
global collective sentiment towards this asset class going forward.
The author would like to thank Benson Kong Yu Chin of The Hong Kong Polytechnic University for assisting in data collection, analysis, and drafting of this article.
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