Meet Deano: He's Got A Problem. Soon It Will Be Commercial Property's Too
Have you met Deano? A white-collar worker living a comfortable life somewhere outside of London, he is the new everyperson of the first quarter of the 21st century.
The creation of an economics-minded Substack author, Deano did well from 10 years of loose monetary policy and lowish taxes. He built a comfortable, normie suburban life on the strength of predictably cheap debt.
Low-interest-rate mortgage, Audi car leasing deal, regular holidays with his Fiat-driving partner and their kids — his needs are not great; he knows he won't change the world. He’s a regular guy. But he is far more exposed to a rising cost of living than some others.
And his situation is about to change. The end of a decade of cheap credit and low mortgage rates is about to radically alter the way huge swathes of people in Britain live their lives and spend their money — and change the demand for real estate they generate.
The shifting spending priorities of the middle class will mean some sectors of property will be hit hard — think discretionary retail, of course, build-for-sale housing and higher-end areas of rented residential.
But the change in the nature of consumer credit and consumer spending will see winners emerge too — budget hotels, family holiday parks, mid-market residential and casual dining are not going to fare badly in the new economic environment.
It was Deano’s spending that kept the mid-price restaurants busy for a decade, filled the cinemas, gyms and shops like Ikea. Low interest rates created for Deano, and his mates, an impression of wealth and ease. They voted Conservative to say thanks, according to The Economist.
Now Deano’s decade of debt-fuelled success could all be over as interest rates climb in an effort to curb inflation, an economic peril he has never seen before. His mortgage payments could already have doubled and will soon triple, and that car leasing deal will have to change — the Audi is likely to go, to be replaced by something less flashy. Instead of life getting better every year, it may go into reverse.
“Inflation is eroding purchasing power, disposable income is down, so consumers will postpone big decisions and concentrate on smaller purchases,” London School of Economics visiting fellow Orkan Saka told Bisnow. “The focus will be on buys that offer good value in consumer purchases, and on entertainment and leisure.”
It is almost impossible to say how much poorer Deano or the average UK middle-class household actually is, or will become. Even the keenest mortgage deals in the low-to-mid-price bracket are up substantially: Mortgage payments on a £240K house in the English Midlands are up about £200 a month, the equivalent of nearly 25%, according to some reports.
But deals this good may soon be unobtainable. Data from the Resolution Foundation suggested even households in the middle of the income distribution will see disposable incomes fall by 6% by 2023-24, and if Deano falls below this level, he could see household income down between 8% and 16%.
Less disposable income will alter spending choices. Affordable luxuries will be in, major spending and regular commitments will be out. One blogger pointed to a list of the kind of things consumers might buy — earbuds, air fryers, Nespresso machines — all moderately priced, they could now be off the list. Discretionary retail, already suffering, is going to be hit hard.
Casual dining, competitive socialising and budget hotels — all growth areas during the era of loose monetary policy — could also be winners in the new era of high interest rates and inflation, Saka said. That is partly because Deano — and everyone else — still remembers the early days of the coronavirus pandemic.
“You can’t discuss this without remembering the pandemic, which we still haven’t come out of economically — for instance, it is a contributor to inflation,” Saka said. "The issue here is that the basic lifestyles we had to lead during lockdown haven’t been forgotten: Demand for things we couldn’t have then, like air travel, continues to grow. And that appetite might counterbalance the dampening effect of inflation.”
The danger is that spending decisions become harder to predict. Academics agree that when people feel poor, their spending habits change. Research from the Joseph Rowntree Foundation shows that one of the most significant changes is that the normal inhibition mechanisms get scrambled and the focus of decision-making shifts to short-term wins rather than long-term aims. Leisure and entertainment that are equipped for spur-of-the-moment decisions look likely to fare best.
Deano and his partner have kids, and in times of trouble, this is what they will focus on. Spending on the children, whether in the form of entertainment, days out, education, clothes or teen must-haves, will still be high on Deano's list of priorities because he wants to be a good dad. Children's play centres, family restaurants, maybe cinemas and good-value holiday parks can expect to see good demand for some time to come.
Older children will be a focus for spending too. It is well-attested that the Great Financial Crisis of 2008-2012 had the effect of diverting more young people into higher education rather than joining the workforce.
Patron Capital founder Keith Breslauer is still buying purpose-built student housing, convinced it will ride out the storm.
“We’re involved in buying a good student block. The cost of 60% financing is 10% today," Breslauer said. "It was 6% to 7%, and so we have to take values down. The seller has to accept that. But values have dropped back to where they were three or four years ago, and we have to bet it won’t go further.”
But a sector of real estate that has expanded by focusing on the top end is going to have to change.
“In weak economic times, people are more likely to go to university, so demand for student housing is probably robust," Breslauer said. "But does it need to be mid-market or cheaper?”
The family needs of consumers will not be vanishing. They may, on the contrary, become more acute.
Breslauer said that is why he thinks the middle ground is the space to occupy. And he means middle ground in the sense of mid-market, but also middle ground in the sense of the small space overlapped by the three big imponderables in a changing market.
“We’ve got three problems," he said. "The first is the true nature of demand, and will it continue in this weak economic environment? So we know there’s not enough residential apartments, but can occupiers afford them? We know there is not enough warehousing space, but we don’t know if a slowdown in consumer spending will impact demand for it."
In terms of the residential market, the BTR sector should, in theory, be readying itself for a big influx in demand. The rising cost of mortgages will make home ownership, already out of reach for a large portion of particularly first-time buyers, even less affordable. Rightmove data showed rents outside London rising 3% in the past three months.
The demand for residential should rise, but the BTR sector in the UK has, thus far, focused on the higher end of the market. Affordable BTR should do well in the next few years.
“The second challenge is a harder one for investors, and it is: Will rising interest rates be compensated for my inflationary rental growth?" Breslauer said.
And since we don’t have any real clue what the Bank of England is planning, we don’t know, he said.
“The third is that public markets are in terrible shape," he said. "The opportunity, if you are smart, is to work out where these three things come together — refinancing, strong income and capital structure — and hope it can cope with interest rates moving. The opportunities in that space are not what they were in 2008.”
However, the opportunities are real enough for mid-market growth in student housing, senior care, build-to-rent and logistics. Breslauer also gave mid-market offices a nod. They are all areas in which the next three or four years are probably predictable, and some stability can be expected. So middle-ground, mid-market is the target. And that is where property investors will find Deano in the years to come.
"The trouble with high-end investments is the margin is good, and when they work, they work amazingly, but the volatility is so very high. It’s just not for us," Breslauer said. “We like to focus on stability — and generally that’s the middle ground."