Martyn Ingram of The Investors Partnership explains the consequences for three separate asset classes of August's rate rise by the Bank of England
In August, the Bank of England's Monetary Policy Committee (MPC) raised the bank base rate from 4.5% to 4.75% and, since then, many bank and building societies have been introducing some very attractive deals for new customers.
Presently, retail investors can easily secure rates of 5% gross - equivalent to 4% net of income tax at the lower rate - from some of the top bank and building society accounts, and they can find even more enticing deals if they are prepared to shop around.
Finding the best deal
Cash deposits offer investors inflation-beating returns and, with the prospect of further interest rate rises ahead, alternatives such as fixed income investments do not seem to be an appealing investment option.
Most fixed income investments, including investments in UK Government stocks or 'gilts', are unattractive investments to hold when short-term interest rates are rising and inflationary pressures are building. The approximate return from an investment in gilts is currently about 4.25%, irrespective of whether the investment matures in five or 30 years' time - the benchmark returns are higher or lower than this figure over other time periods.
Inflation will take its toll over the years so, as time passes, the real value of the income generated from fixed income gilt investments will diminish - as will the buying power of the capital at maturity. Retail investors always need to take account of inflationary risks when buying fixed income investments.
Only a few months ago, it was generally thought that interest rates would rise for a short period, in order to slow the rate of growth in the economy, and that the rates would soon be on a downward trend again. It was assumed that year-on-year inflation would soon start to fall, but now there is growing concern that inflationary pressures are worse than originally estimated.
The seemingly ever-increasing cost of fuel, rises in council tax bills and a host of other factors are all contributing to a rise in inflationary pressures. This is increasing the likelihood that UK interest rates will continue in an uptrend for much longer than many experts had predicted, and that interest rates may need to move higher than originally envisaged by the MPC.
If this happens, it could have a serious impact on economic growth and could lead to 'stagflation' - the combination of stagnation (low economic growth) and inflation (rising prices), where measures to address the former only serve to stimulate the latter.
A diamond in the rough
One asset class that appears to have been immune to all the negative news that has had a big impact on investment markets this year is commercial property. Retail investors have enjoyed strong and stable returns from this asset class, and many investors remain upbeat about the prospects for the UK commercial property market.
One of the attractions of commercial property is that the investment can produce a high level of income yield. Currently, the income yield from commercial property investment compares favourably with the income yield achievable from fixed income and cash deposit investment. The recent capital performance of commercial property has been strong and has underpinned investor confidence in the sector.
The capital performance of property investment is driven by the price at which transactions take place. The market value of a property is an estimated amount, whereas the price at which a property is sold is the only observable exchange price in the open market.
There could be a number of bids for a property, but the transaction occurs at the highest and best price. The majority of bidders may believe the property's worth is well below the high price paid, but the valuation of the property is not based on the spread of bids or even the consensus view - the valuation is based on the price at which a willing buyer and the willing seller complete the transaction.
The purpose of a market-price valuation is to determine the highest price at which a property will be sold as this is the price that would be achievable in the market at any given time. However, in order to know the price that the majority of potential investors would have paid, it is relevant to consider the market pricing of the other bidders. This is particularly relevant when the spread of bids is, on average, well below the price that was bid by the purchaser.
Retail money has been pouring into commercial property funds and commercial property managers have to conduct successful property transactions in order to invest the money into physical properties. The managers compete with each other when bidding on selected properties and, if a price paid for a property is higher than that paid for similar properties in the recent past, then those who did not secure the deal may well believe the successful bidder has paid too much for the acquisition.
However, the valuations of all properties need to take account of the fact that a transaction has been completed at a new, higher price. Therefore, managers and valuers need to take account of the change in market price when bidding in the future or when valuing properties in portfolios.
Winning bids are not necessarily good bids - it is easy to secure a purchase simply by offering to pay more than the other bidders. The winning bid will only prove to have been successful once the property asset is sold - at which point the true worth of the investment can be determined and comparisons can be made with alternative types of investment.
While the commercial property sector continues on an uptrend, retail investors will continue to make money by investing in the sector, just as in the residential property market. However, by the time winning bids start coming in at lower prices, many shrewd investors will have reduced their exposure to the asset class.
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