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It’s a volatile time for the housing market and the country in general. No sooner than people have digested the mini-budget, all the key policies are repealed. Expected interest rates, with their corresponding 2-year mortgage rates, bounced as high as 6%, before falling back down over the past month. Every week brings a new ‘leaked’ headline about additional potential tax levies or regulatory changes. How are landlords and property investors meant to react?
For property investors, it’s easy to be perplexed about what, if anything, you should be doing at this time. We find ourselves in a state of zugzwang, as the Germans have helpfully labelled it. Zugzwang is a situation in chess where a move must be made, but each possible option appears to make the situation worse. If indeed we find ourselves in a position of zugzwang, it can be worth analyzing what decisions are available to property investors.
Should You Sell Up and Get Out of the Rental Market?
The last few years have seen landlords fleeing the private rental sector; driven out of the market by compressed margins and overbearing legislation. With spiralling mortgage costs and the repercussions of the housing white paper, it’s understandable that more landlords may consider following their erstwhile counterparts. Far from sunny skies, the closing horizon of the private rental sector seems to be full of dark storms and cloudy gales. Maybe you should forsake the boat and head back?
Whilst cashing up and getting out of the market may seem like a prudent decision, it could well be the costliest one. Selling your properties and withdrawing from the housing market will incur significant costs, with an agent and legal fees mounting up on top of a hefty tax bill for realized capital gains. The usual culprits will be sure to take their slice of your hard-gotten gains. Not only that, but house prices are also increasingly showing signs of wobbling. It seems inevitable that we will witness a house price correction, with prices falling by as much as 5% to 10%. You may argue that, if house prices are falling, now is the time to get out. However, it may well be too little too late. House price data always lags behind the actual market and the lengthy process of selling houses will undoubtedly mean that you will be selling your properties in a buyers’ market, with the resultant haircut to prices that will entail.
Let‘s assume for the moment that, despite the above, you are still happy to sell your properties. Perhaps you have accrued enough gains over the past 20 years to make a 5% to 10% fall in prices a more palatable prospect. The question is, what do you do when you have cashed out? Inflation is currently sitting in the double digits and the purchasing power of your bank balance will quickly start to fall. Financially, you will still be losing money, even if it doesn’t appear the case nominally. Even if you choose to reinvest, housing isn’t the only investment category with the prospect of negative returns. Bonds and shares have taken their own hammering this year, with many portfolios experiencing double digit falls, that don’t look to be levelling out any time soon.
Certainly, the option of selling up your properties falls in line with the concept of zugzwang. Doing so may avoid some pain, but it will certainly leave you worse off than your current position. Arguably, selling up may only appeal to landlords sitting at the higher end of the age spectrum, who may be able to cash in and use their cash to support family members or enrich their retirement. Otherwise, landlords still seeking to support their future may want to avoid divesting their portfolios.
Should You Double Down on your Property Investments?
If selling up and leaving the market is not your cup of tea and you concur that we are entering a buyer’s market, maybe now is the time to double down in the property market. Maybe it is worth funnelling more of your savings back into the property to help you to reap well-earned returns. For those landlords who ooze decisive bravery that others can only look on with awe, this may well be the logical path. However, this comes with its own problems.
Firstly, there is no guarantee that doubling down is the right path. For all but the most well-informed landlords, doubling down may wreak of blind optimism or reckless gambling more than it smells of astute investing. Admittedly, attempting to time the market has always been considered somewhat of a fool’s game. Yet house prices don’t look like levelling out anytime soon. House prices may continue to fall another 10% or more from this point, raising the prospect of negative equity and a precarious financial position if you were to purchase a property now. Not only that, but remember that a 10% fall and a 10% return are not the same thing. Mathematically, if prices were to fall by say 20%, it would subsequently require returns of 25% just to break even.
Arguably, from an affordability perspective, properties are yet to look attractive. Rising inflation and shooting mortgage rates have strangled net yields and butchered the potential positive returns of letting properties out. Not only that, even as house prices fall, they have yet to do so enough to support yields and return them to a potentially attractive level. Purchasing new properties now may result in negative carry – a condition where holding investments costs more than they bring in over a short-term time horizon. Your monthly mortgage payments will eat away at your profitability and increase the risk of further investment.
Investors should also be cautious that changes in the market value of properties and the population’s price expectations are two separate phenomena. Average house prices may well continue to fall to a point where they begin to start looking attractive. However, this does not mean that you will find a ready queue of willing sellers. As is often the case when house prices fall, homeowners opt to withdraw from the market and delay sales or moves until prices are closer to their expectations. Naturally, if you feel that your house was worth £300,000 a mere 12 months ago, but you are now being offered £270,000, you may choose to just sit on your hands and wait until things move back to where you want to be. Albeit there may be an increased supply of forced sellers. The question is whether there will be enough forced selling to outnumber buyers and shift the status quo.
Again, much like the prospect of selling up and leaving the housing market, doubling down comes with its own strategic problems. Are there any moves available to the brave landlord looking to continue purchasing properties, which leave them better off in the short term? Arguably, there may still be opportunities out there for the top 10% of investors; the hands-on, active landlords who are willing to operate in the niche markets and walk the paths that others don’t wish to. But for average landlords, doubling down does not appear to balance risk and rewards in an appetizing enough manner.
Should You Batten Down the Hatches?
Some more readers may have come to their own conclusion. Zugzwang describes a position where you must make a move. This is not chess; it is a property investment and I do not have to make a move.’ Feasibly, that may well be the right course of action. To do nothing. Landlords could seek to tighten their belts and hopefully build up their cash reserves, waiting until the market turbulence passes. However, by doing this you are still making a decision and plotting a course of action – albeit an inactive one. What is more, opting to do nothing comes with its own costs.
As we hypothesized earlier, nominal cash values may continue to build up in your bank account as rent continues to come in. However, unless you are sat on an especially high-yielding portfolio, it is unlikely that your yields are keeping pace with inflation. The purchasing power of your money will continue to degrade over time, making it less valuable whilst sitting in your bank account. Holding onto your money will certainly help to bolster the security of your financial position, but at best you may well be treading water. You will be continuing to put in the hours as a landlord, without seeing true growth in the income that you make.
Admittedly, of the options considered thus far, opting to play it cautiously and do nothing does appear to be the best option. It helps to provide financial security during a potentially hazardous period, whilst helping to retain some income and avoiding the nasty surprise of realizing capital gains in a declining market. But for some, inaction is not a palatable choice. It is a passive solution to an ever-evolving problem. When your future income is on the line, it is not easy to sit on the sidelines and watch the market go by, with your real returns woefully underperforming your expected returns.
What’s the Best Move for your Property Business?
So far, all the evidence suggests that landlords are in a zugzwang situation. Every option discussed appears to be uniquely disadvantageous in its own way. Conceivably, so far, the best route available is to cautiously hold onto your cash and sure up shop, even if this means that you are continuing to see the purchasing power of your money degrade. It begs the question, is there anything else that you can do?
One option that may be worth considering is the prospect of paying down your outstanding mortgages. If you have cash burning a hole in your bank account and a loan to value greater than 70%, paying down your mortgages may well be the best logical route. Most landlords will have leveraged their portfolios using interest-only mortgages. That means you are only paying the interest due on your mortgage instead of paying down the principal. The benefit of this structure is that it limits your monthly liabilities and supports your cash flow. However, when you have positive cash flow and nothing to spend your cash on, maybe it is time to consider making an overpayment.
The majority of mortgages will have overpayment allowances included in their terms and conditions. They will stipulate a maximum amount each year that landlords can optionally contribute to pay down the principal on their mortgage. Typically, this can be done through increased monthly repayments or in one lump sum. If you have the cash to spare, you can opt to pay down the principal on your mortgage and, in doing so, reduce your monthly premiums on your interest-only mortgage. Theoretically, by doing this, you will be earning the equivalent of your mortgage rate on the cash that you deploy. It may not be enough to keep up with inflation, but it can afford you the opportunity to reduce your liabilities and retain a financially stable position, whilst putting your money to work with a theoretically guaranteed return.
If you have enough cash to max out your mortgage overpayments and still have a war chest to spare, you have three choices. You could just opt to keep the remainder in your bank account and accept that its purchasing power will degrade. Otherwise, you could opt to purchase another property, with all the risks that this entails. However, the third option is to use your money to invest in your current portfolio. This could be the ideal opportunity to rationalize your properties and invest in them for the future.
Without a doubt, the first question you should be asking yourself is whether or not your properties have an EPC rating of C or higher. If they do not, then you will run the risk of facing a hefty bill in April 2025 when the government mandates that all new tenancies will need to have an EPC of C or higher. Assuming that energy-efficient items keep pace with inflation, it is certainly advisable to pre-invest into uprating your properties now whilst you have the chance. You can look at replacing heating systems or ensuring your properties are double-glazed. More affluent and adventurous landlords with significant roof space may even consider utilizing solar PV. There may be the opportunity to make your properties energy sufficient and include utilities within your rent, with the excess sold back to the grid.
Even if you are in the fortuitous position where you have reached your maximum overpayments on your entirely EPC C or above portfolio, there may still be the opportunity to put your cash to work through the use of permitted development or small-scale additions. You could add value to your properties and your tenancies by investing in tangible additions, such as garage conversions, conservatories, loft conversions or value-enhancing extensions. At the smaller end, you could use the current period as an opportunity to modernize properties with new kitchens or bathrooms to make them more desirable and valuable.
Admittedly, overpaying mortgages and improving the energy performance ratings of your properties may not be as intrinsically satisfying as adding new properties to your portfolio and they may come with slightly more risk than just holding onto your cash. However, taking this route is perhaps the only logical escape from being caught in a zugzwang situation. They allow you to add value and put your money to work, without running too much additional speculative risk or taking the decision to step away from the industry entirely. In fact, they could well be the only chess move which makes sense.
