These are worrying times for Britain’s favourite investment, bricks and mortar. One of the biggest mistakes investors make is recency bias, where we attach too much importance to what has been happening over a number of years and assume things will carry on the same way into the future. The last decade has been a mixed one for private landlords. On the one hand, prices have continued to rise thanks to almost free money and a goody bag of government incentives from Help To Buy to Lifetime ISAs to Stamp Duty holidays.  On the other hand, since George Osborne’s section 24 changes in 2014 there’s been a steady stream of anti-landlord legislation that is driving more and more investors out of the buy to let sector. And guess what? The result of the war on landlords is that there’s a shortage of rental accommodation in the private sector so rents are going up! A government scheme that causes the exact opposite of its stated aim? Who’d ever have guessed? Don’t get me started on Biden’s Inflation Reduction Act.

For those doggedly persistent landlords who’ve remained in the game, the events of that last six months must be giving you cause to stop and reflect. Ever since central banks finally and belatedly admitted that the inflation they caused is not going to be transitory, they’ve been hiking interest rates further and faster than has ever happened before. This means that anyone investing in property through a mortgage is going to see the price they can afford to pay start to fall. Yes, there are many private buyers who don’t need a loan. And many investors are on fixed term loans at the old lower interest rates. But most of those fixes are for no more than two years so we will see a substantial number of properties coming up for refinance every month for the next two years. If you need to re-finance on a two year fix today you’re going to be paying something like 5.5% which is three times what you’d have paid just twelve months ago. Chances are that will turn many borderline properties into negative cashflow. You’d be amazed how many landlords have been outing up with negative cashflow for years just so they can enjoy the capital gains fueled by emergency interest rates held in place far too long by our incompetent governors of the Bank of England. Now they face the double whammy of negative cash flow and capital losses.

We have a number of canaries in the coal mine who can point us to what we are likely to see in the UK property market over the next two years. During the pandemic when people wanted to move out of cities into the countryside for more green space and a home study, prices in Sweden rose by 30% in eighteen months. It was the same story in communist dictator Justin Trudeau’s Canada, with prices soaring by 34%. Meanwhile in Britain the same phenomenon caused a 28% hike in average property prices. Now it’s time to pay the piper. Prices in Sweden are already down 17% from their peak and in Canada they’ve fallen by 16%. And no one is saying that we’ve reached the bottom yet. So is there any reason why the UK should be different? One reason for a time lag is that we have a much higher proportion of fixed rate mortgages than Sweden or Canada, with as many as 80% of loans coming into this category. But the signs are there if you care to look.

All the major analysers of the housing market like Halifax and the RICS confirm that the actual achieved sale prices of properties are falling yet at the same time Rightmove tells us that vendors are still increasing their asking prices! This is the classic market impasse stage where sellers are blinded by Recency Bias and refuse to accept the changing dynamics in the market. This causes a further time lag as properties stay on the market longer until people realise that they are going to have to compromise. Even if you find a buyer willing to pay the old, inflated price, they are likely to be stymied by their mortgage provider whose affordability tests will rule out a loan that would be big enough to pay the asking price.

So the question becomes, how far will prices fall as the impact of interest rates starts to bite? Well, the first thing to remember is that we have not yet reached the peak of the interest rate cycle. Central Banks have been caught with their trousers down as inflation has proved stickier than any of them predicted. That means they are likely to overshoot on the upside with interest rate rises even if that means forcing the economy into a recession. The second factor to consider is the alarming statistic that more than five million Brits have decided to become economically inactive. That means they are unlikely to be shelling out for new mortgages and may become forced sellers as they downsize to make ends meet. If ever increasing interest rates do cause the recession everyone seems to be forecasting, unemployment will rise further softening demand both in the sales and rentals sectors.

Those with a vested interest in the market are predicting a tiny correction of around 5%. That seems beyond optimistic to me, although there will always be significant regional variations that make it hard to quote a single number without it becoming a meaningless average. What may be more fruitful is to look at the extent of any price uplift during the 2020 to 2022 period and rank the likely fall as being the inverse of those gains. That will give a figure in the wide range of 10% to 30% so it’s a question of understanding your local market to see what the likely impact will be in the next few years.

Another dose of Recency Bias may be affecting the thinking of the property bulls who say there is nothing to worry about and any fall will be short lived. They point to the period after the Great Financial Crisis of 2008 which of course included the Northern Rock failure as if that is evidence to support a quick turnaround. It took at least four years for that crisis to work through the system and the Bank had the luxury of lowering interest rates to ease the burden. Today’s price falls are happening in an environment of rapidly rising interest rates, which means we should expect the situation to get a lot worse before we see some stabilization.

Whatever happens in the wider market, we need to focus on what we do as property investors. We need to snap out of any Recency Bias of our own and conduct an immediate audit of our Buy To Let portfolio. For each property we need to understand the current cash flow position then stress test it against the likely cost of any remortgage in the next two years. Can we increase the rent and what will the new net cashflow be once we complete the refinancing? We then need to look at its capital value and the equity we have in the property. If this was to fall by 20-30% would we still want to own this property? If we decide that the property is no longer viable, we need to look at the tax implications of selling it now. Is it in a company or in your personal name? Are there any capital losses elsewhere in your portfolio that can be set against the gain?

One option that Beaufort members are taking advantage of is the CGT deferral that is possible under the Enterprise Investment Scheme. We are not tax advisers so you will need to take qualified advice but our understanding is that you can reinvest the profits from a property sale into EIS shares and defer any capital gains tax liability for as long as you hang onto those shares. That way, you can play the politicians at their own game by letting inflation reduce the real value of the tax you owe and paying it in five years’ time when you have hopefully achieved a highly profitable exit from the company you invested in.

As I’ve said many times, successful investing in the 2020s is going to need a very different approach to the 2010s. That includes your approach to your property portfolio. With rising mortgage costs and falling prices, there’s never been a more important time to take a long, hard look at your portfolio and see if it’s time for some pruning.