Market Wrap #232: UK Inflation Rising AGAIN! Is Property a Good Hedge for Landlords?

Inflation in the UK is back on the rise, climbing to 2.3% in October after three months of decline. Higher energy bills are the primary culprit behind this increase, and the implications for the economy, your wallet, and property prices are worth exploring.

The Inflation Picture

Key Points:

• Inflation Increase: The UK inflation rate rose to 2.3% in October, up from 1.7% in September. This was largely driven by energy costs.

• Energy Prices: The quarterly energy price cap increased by 10%, raising average annual bills to £1,717, with a further rise to £1,736 expected in January.

• Consumer Prices: Households faced a £149 rise in typical gas and electricity costs. However, lower oil prices and cheaper live music tickets helped to moderate inflation.

• Core Inflation: Excluding energy, food, and alcohol, core inflation increased slightly from 3.2% to 3.3%, influenced by higher airfares and service costs such as hotels and air travel.

Looking Ahead:

Forecasts suggest inflation could exceed 3% in 2024, influenced by the Labour government’s budget and global trade tensions. It’s important to note that the Consumer Price Index (CPI) does not include housing costs. The more accurate CPIH, which factors in owner-occupier costs like rent and mortgages, showed a 7% monthly increase.

The UK’s energy market also stands out, with prices significantly higher than those in Germany, France, and the US due to the government’s “price fixing” practices. This disparity has a direct impact on inflationary pressures.

Bank of England's Stance

Despite a recent interest rate cut to 4.75%, the Bank of England is unlikely to lower rates further until February. Analysts expect just one rate cut per quarter in 2025, signalling that higher rates may persist longer than anticipated.

Impact on the Property Market

Higher inflation often leads to prolonged elevated interest rates, directly affecting mortgage costs. While inflation remains below crisis levels, rising household expenses and slower rate cuts could temporarily dampen property market momentum.

So Is property a reliable hedge against inflation? Let’s delve into the data.

The Long-Run Perspective:

Research by the Investment Property Forum (IPF) highlights that UK property delivers positive long-term real returns. However, as a strict hedge—where returns closely track inflation—property has been only partially successful.

Rental Income:

Analysis of the OECD’s rental index over 60 years shows that UK rental growth exceeded inflation 71% of the time, while in the US, this figure was 74%. While rental income isn’t a perfect hedge, it has often outpaced inflation.

Gross Yields:

The average real, inflation-adjusted gross yield for UK property over the past 60 years was 2.5%, with a nominal yield of 7.4%. In the US, these figures were slightly lower, with a real yield of 1.7% and nominal yield of 5.5%.

Decade-by-decade data for the UK reveals only one period—the inflation-heavy 1970s—where real yields were negative. Even in the 1980s, with inflation averaging 6.6%, nominal yields of 7.4% translated to positive real yields. By comparison, US real yields were negative during the 1970s, 1980s, and 2020s so far.

Conclusion:

Rental markets can act as a hedge when rental income grows in line with or outpaces inflation. Leveraged property investments with fixed-rate borrowing also offer protection, as the real value of debt decreases over time while property values typically rise. Capital appreciation over the holding period further enhances the inflation-adjusted gains for landlords.

While last week’s discussion centred on the UK’s supply-demand imbalance with 4.3 million missing homes, this week’s inflation developments underscore the enduring benefits of property ownership for landlords.