How can we win both ways?

9 November 2022 - 9:56 am
Any business in any industry is constantly striving to negate risk and maximise reward. It is very rare to establish opportunity from the demise of a staple part of everyday life. However, real estate and its cyclical nature offers exactly that. We all know the saying of ”food, water and shelter are basic needs”. Fundamentally, when the property market faces a period of decline in demand and thus values, what occurs on a macro level? Simply, more people rent as they shy away from buying property for all the obvious economic reasons and the basic decline in confidence or ability to purchase. What then is the opportunity?
For a fund like ours it becomes pretty obvious, and moreover, beneficial. When we develop real estate seeking profitability we often pigeon hole the profit into disposing of those assets with a positive bottom line in play. Yet that relies on demand, so how do you benefit from a decline in demand for one route to market? We balance the other route, tenanting, and feed off the demand by retaining assets and generating an income, and thus profit. There is also another beneficial component that many wealth creators miss, tax efficiency!
We of course pay tax on capital gain, yet only when we dispose of an asset. What happens in a tax environment when we retain an asset and utilise the path of gearing, to leverage out the capital value or ‘equity’? Zero tax exposure on that leveraged capital. When responsible gearing is deployed, it becomes rather attractive to the profit profile of the investment activity. Of course, we have to ensure occupancy to cover the cost of that gearing mechanism but in a market where demand soars for that route to market then the risk profile drops dramatically. Naturally, we still have exposure to tax through profitable income from a rental property, but the level of tax paid, especially within a corporate environment, is minimal compared to the hefty chunk of CGT you are exposed to through disposals.
Add in the need for a fund like ours to have responsible liquidity management, a cash flowing element to provide dividends to some shareholders who prefer a so-called ‘distribution share class’ and the results are wholly positive to the funds requirements and needs. I often hear people say how more millionaires are created in bear markets versus the same in bull markets and one rather common path is this strategic gain from a depressive real estate sector. It might not be for everyone as certain requirements come into play for this strategy to work, such as a healthy credit rating to access the equity at high street rates, a route to market to ensure high occupancy levels and capital to enter property developments on a commercial scale to increase the bottomline, through economies of scale. If you have this ability then the market turning south can see your profits head north and it’s exactly what we are ‘geared’ for if you excuse the pun.
So we face the future with huge confidence and when we see research like our team sourced for a recent press release, below, it only increases our belief that a depressed market will in fact conclude in higher profits for the fund and with it, our shareholders.
I felt it prudent to add the press release below, for some context, and with it the data compiled by Jessica – our Head of Research – and her team….

Rental market boom on the horizon as home buyers continue to struggle with rising mortgage costs

The latest research by Alliance Fund, the end to end real estate fund, suggests that should the property market continue to stutter, the nation’s rental market could be in for a boom, as historic housing market trends show that a decline in property sales also leads to a boost to private rental market stock.

Alliance Fund analysed both the sales and rental markets during the economic downturns seen during the Great Recession of the 2008/09 financial crisis and the more recent downturn spurred by the Covid pandemic.

The research shows that in 2008 when the Great Recession hit, property sales volumes across England fell by 49.3% on an annual basis. They then continued to fall by a further 3.1% the following year before rebounding by 6.4% in 2010.

At the same time, the level of privately rented stock available to tenants across England rose by 8.2% in 2008, an increase of 261,474 rental homes in a single year. This was followed by a further 7.6% annual increase in 2009, with the addition of a further 261,264 privately rented homes pushing the size of the PRS to a record 3.705m homes.

When the initial market uncertainty of the Covid-19 pandemic hit, the level of homes sold across the property market in England also took a hit, falling 15.9% in 2020, by far the largest annual rate of decline seen since the Great Recession.

In contrast, the growth rate of the private rental sector had been showing a steady decline since 2009 and, since 2017, had actually been reducing in size until 2020. However, when the Covid market downturn hit, the level of privately rented stock available across the market increased by 1.1% in a year, the first increase since 2016.

When analysing the market over the last two decades, the research by Alliance Fund shows that sales volumes have increased at a rate of 4.7% per year when the market hasn’t been blighted by an economic downturn, whilst the private rental market has increased by an average rate of 4.1%.

In contrast, during periods of economic instability, sales volumes have fallen by an average of 22.8% per year, while the rental market has grown at an average annual rate of 5.6%.

CEO of Alliance Fund, Iain Crawford, commented:

“The jury is still out with respect to the current turbulence plaguing the property market and just what impact this will have in the long-term on the ability of homebuyers to secure mortgage finance, as well as the knock on effect to house prices if they can’t.

However, historic market trends show that should the housing sector take a hit, the nation could be in for a rental market boom, as more and more of us remain reliant on the private rental sector in order to keep a roof over our heads.

This reduction in buyer demand will come as a worry to those investing and delivering new housing stock to the market, as they simply won’t be able to capitalise on the same level of opportunities available to them in a buoyant market.

At Alliance Fund, we’re firm believers that if opportunity fails to knock, it’s time to build a door and so in times of housing market hardship, we simply retain a larger proportion of our current portfolio and leverage it within the rental market.

This ensures that we aren’t adversely hit by a perceived deterioration in market health and allows us to maintain a strong and consistent cash flow, avoid a hefty capital gains tax bill, as well as giving us the ability to access funds to redeem shareholders where needed.

Not only does this approach allow us to be more tax efficient, but it means we are perfectly poised to pivot with the changing requirements of the housing market, which in turn boosts the yields we secure and the returns we can bring to our investors.”

Remaining at your service,

 

Iain Crawford, CEO.