David Jane
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Superficially attractive
Following on from our recent notes on why cash is a bad idea in the medium term, we also often hear of advisers with clients who want to liquidate their portfolios in order to pay down their buy to let mortgages.
This seems superficially quite attractive right now, mortgage rates are high, government interference in the letting market seems set to get worse, while markets have obviously been ropey recently.
A step back is required before making such a decision. One of the primary drivers of the success of buy to let as an investment was the combination of attractive yield with low funding costs. One of the few ways individuals have been able to borrow material sums of money is by securing it against property. Historically, rental income less costs has typically exceeded mortgage costs, if not initially, certainly after a few years of rental growth. The impact of leverage has meant that rental properties have turned a fairly average investment into a spectacularly successful one.
Change is a-foot
This has recently changed. House prices, although not rents, have been weak, while funding costs have increased materially. This has led many to consider selling the poorly performing investment portfolio to pay off the debt, while keeping the rental income.
All investment decisions are at the mercy of what happens in the future. Hence, a broad consideration of the kind of future we might be entering is merited. Our view is that we are in a period of higher inflation than we have seen in recent years. In that environment real assets, such as equities and property, may be amongst the best performing assets.
At the same time current interest rates are actually below the rate of inflation. Borrowing money is actually costless in real terms, while the assets that debt is financing are expected to grow at or above the rate of inflation.
Essentially, borrowing on a buy to let, while investing in other real assets such as equities, is the modern equivalent of the with profits policy that funded mortgages in the 1970s. These were hugely successful, rather than paying down the mortgage, borrowers had interest only mortgages and invested in an investment policy which invested largely in real assets. Despite what seem to modern eyes incredibly high mortgage rates the strategy was hugely successful, the house price rose, the real value of the debt fell and the investment policy was hugely profitable. All because we had a period of higher inflation combined with low ‘real’ interest rates.
The desire to pay down debt is the equivalent of the desire to go to cash at the moment, the current interest rates are giving investors a false signal, especially when considered alongside the higher rates of inflation expected. Actually, that money is really cheap, less inflation rates. Unfortunately for the buy to let landlord it may take a little while for rents to catch up with current mortgage rates, or more likely for values to fall such that yields are above funding costs. So long as landlords can weather that near term issue, owning leveraged real assets in an inflationary environment, whether property or equities, may make good sense in the long term.
A compounding of errors?
Rather than compounding the error of having bought buy to let at a near term peak with too much debt, holding on and accepting a year or two of negative rental returns after funding costs if possible, makes much more long term sense if you think inflation is here to stay.
At the end of the day many investors are suffering from a form of money illusion. Interest rates, whether on deposits or mortgages look superficially high until inflation is brought into consideration. Going to cash in a high inflation environment, is potentially one of the worst strategies in the long term.
