In our final mini-blog for 2022, we continue our series of articles on market trends for 2023 and beyond, speculating where the P2P sector could go and the potential market trends that could unfold. For the second offering, we focus on how investment attitudes and appetites may change as we become accustomed to a higher-rate environment.
At the point of writing, the MPC had just announced 50 basis points onto the base rate, which most would argue was anticipated and already priced into the market. Still, after nine consecutive increases and rates at a 14-year high, we explore what that looks like from an investment perspective. Initially we want to look at the traditional positions investors take and then propose some of the comparative advantages the P2P asset class may offer.
When investors readjust their portfolios for rising rates, dozens of strategies are employed to capitalize; they may look at companies that derive their profits from the credit industry, consider floating rate bonds to minimize volatility, or focus on any investment where rates can be locked in. On the same note, certain assets become less attractive as rates begin to rise, and one of those historically is a REIT. A REIT, or a Real Estate Investment Trust, is a pre-packaged way to invest in a pool of real estate and profit from its rental returns, buying shares in a company with a sizable portfolio of mixed real estate and receiving the lion's share of the profits in the form of dividends.
Even though there is an argument to be made that higher rates equal higher yield, historically, investors will trade out of publicly traded REITs and back into the bond market or perhaps a fixed-interest government-backed position at a time when there is uncertainty in the property market. The main issue driving these decisions is the worry about non-performance; even though the trust is diversified, the returns diminish quickly if a proportion of the underlying assets acquire rental voids. Also, there are sizeable management fees for these types of products that remain in place, regardless of yield.
So, how does this relate to P2P? In the second of our assumptions and speculations for 2023 and beyond, we speculate that there will likely be an inflow of investors into the P2P market from many of these more established asset classes. The reasoning for this assumption is that savvy investors will see the broader picture regarding home building and how that differs from exposure to real estate yield.
The government has to stimulate the U.K. homebuilding market; houses have to be built, and essentially, in P2P backed by real estate, you're benefiting from that support. A downturn that affects the existing market may reduce prices, but it could also reduce costs in the development market; at the point of writing, build costs were down month on month, according to the BEIS. The increased cost of materials ultimately stagnated the market, and that situation is now starting to change. As they have begun to come down, construction levels are anticipated to increase, strengthening the value proposition of our asset class into 2023.
We often talk about headroom protection with P2P. What we mean by that is that the developer's profits, our profits, and your profits are all factored in, and you get priority; with a REIT, your earnings are reliant on the success of that one business. In addition, investors will see that the P2P asset class has a highly active resale market, so compared to non-traded REITs, it's liquid, and you're not tied to fees associated with non-performing assets should that situation arise.
One of the reasons REITs are attractive is the diversification of assets, but it's also one of the issues in a downturn. The very nature of the product is it has to generate enough yield to service all the shareholders & cover the fees, so many are made up of hotels, large commercial buildings, and office blocks, as they will have a high enough rental yield to service all the investors. Still, they are also all entities subject to serious rental voids in a downturn; you could argue people may use hotels less and work from home more. With P2P backed by the construction of the residential housing market, the projects included in the investment are more suited to weather a downturn as the production of residential homes isn't optional; it continues rain or shine to service the population's requirements.
To summarise, we have long believed that P2P has earned its place as an asset class alongside some of these traditional options, and as the rate situation unfolds into 2023, we believe will see a significant investment inflow into the sector to back up our assumptions.
Invest & Fund hope you have enjoyed our take on the market in 2022, and we would like to take this opportunity to wish you and your families a very Happy Christmas; we look forward to catching up with you in 2023.
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