Marshall's Thoughts

The UK Property Market: Current Trends and Implications for the Economy

Aron Árnason

In February, house prices fell by 0.5% for the sixth month of negative growth. A report from building society Nationwide shows that median house prices have fallen to £257,400 from £273,800 in August 2022, reflecting falling demand as mortgage rates increase. Property is cyclical, meaning real house prices typically fall during recessions. While the UK did not officially enter a recession in 2022 and is currently the only G7 country to have recovered to pre-pandemic GDP, growth has flatlined. With high inflation, the effect of interest rate rises and hidden tax rises feeding through, the central bank forecasts a shallow five quarter recession, which suggests falling confidence and a drag on house prices.

The falling house prices follow a housing market boom during the pandemic as a result of low interest rates, a rise in demand for space with increased working from home, and a variety of government incentives including reduction of stamp duty land tax, the continuing Help to Buy equity loan, and a Help to Buy mortgage guarantee since 2021, designed to increase provision of 95% mortgages. These factors contributed to the dramatic 27% growth in average house prices between February 2020 and August 2022. Now some of these government incentives are being terminated, which will dampen demand. No new Help to Buy equity loans will be issued from the end of March, while the mortgage guarantee is scheduled to be removed at the end of 2023. This will help to return house prices to a more stable growth path. History suggests the recovery in house prices after a slump will be slow, so the 2022 peak may only be reached again after several years.

The housing market also received a shock following the mini budget of the Truss Government in September. Rates on mortgages jumped quickly to 6%, causing panic as mortgage approvals were withdrawn and deals fell through. After the policies were reversed, average rates on mortgages fell to around 4%, although this reflects a new higher rate. In December, mortgage approvals fell to their lowest level since January 2009. As interest rates rise, the higher cost of repayments reduces a borrower’s ability to afford a mortgage, so lenders adjust by reducing supply of credit. This in turn reduces demand for housing and reduces valuations.

Falling house prices will have several effects on the wider economy. Firstly, as homeowners become less wealthy, this reduces feeling of security which will affect consumption, in a process called the wealth effect. In 2001, Case, Shiller, and Quigley examined this link and suggest house prices have a strong effect on spending, and much more than stock prices. A second study suggested that a fall in housing wealth of the scale of the drop between 2005 and 2009 would cause a fall in spending of roughly 3.5%.

In addition, less affordable home ownership increases demand in the rental market. Real estate data provider Hometrack reports that private accommodation rents for new dwellers increased 12% last year. This also reflects cost pressures: higher interest rates on buy-to-let mortgages, higher taxes on landlords, and more costly energy efficiency regulations. The Resolution Foundation data shows that over 60% of private renters are struggling to meet housing costs. Indicators published by the Royal Institution of Chartered Surveyors (RICS) illustrates the rental property dynamic: tenant demand balance was positive at 32%, and rent price expectations were high at 45%. The statement from the RICS highlighted the need for more affordable housing, and suggested the Government increases the Local Housing Allowance to the 30th percentile to support private renters, as well as increase supply of housing through new builds and commercial property conversions. RICS also encouraged the Government to financially support landlords in the face of increasing cost and regulation challenges including expensive energy efficiency improvement targets.

Furthermore, there are several factors in the property market affecting existing homeowners. Firstly, there is fragmentation in the housing market. For example, prices for family homes have fallen less than flats. This reflects a fall in supply, as those who can afford to hold out on selling their homes would prefer to wait to sell at a higher valuation. The RICS reported that the stock of residential properties for sale was close to its lowest level since records began in 1978. Secondly, rising mortgage rates affect existing homeowners once fixed rate contracts end. According to the ONS, 1.4 million fixed rate contacts end this year, on rates generally below 2.5%. In contrast, new two-year fixed rate mortgages will be taken out at around 6% and could increase the cost of repayments. The Government anticipated this by removing an affordability test in August which prevented homeowners coming off fixed rate deals from switching to certain variable rate or interest only deals. This may provide borrowers with more flexibility and prevent defaults.

Higher mortgage rates may be a challenge after a long period of low rates, and there is also a housing affordability issue compounding the high cost of living, particularly in the rental sector. The Government should and has intervened to address some of these challenges. On the other hand, the house price move is clearly a correction. Despite prices not having fallen so sharply since November 2012, the current level is only 3.7% lower than its peak last year. James Sproule, UK chief economist at Handelsbanken, predicts house prices to fall 8% from their August level and the volume of sales to fall by up to 60% from its 2020 peak. Martin Beck, chief economic adviser for the forecasting house, EY Item Club, predicts an even greater peak-to-trough fall of 10-15%. For house prices, there appears to be much more room to fall.

This week's thought was by Aron Árnason

Aron is a first year economics undergraduate at St John’s College, Cambridge.

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