Housing market faces serious downsides - Capital Economics
UK Housing

Housing market faces serious downsides

UK Housing Market Outlook
Written by Hansen Lu
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The housing market will take a deep hit from the coronavirus. We expect housing transactions and housebuilding to drop by 70% in Q2 this year, as physical distancing measures halt activity. Meanwhile, house prices will see the biggest fall since the global financial crisis. Admittedly, our base case is for activity and prices to recover fairly quickly. But a credit crunch or larger economic hit could trigger an even deeper downturn.

  • Overview – The housing market will take a deep hit from the coronavirus. We expect housing transactions and housebuilding to drop by 70% in Q2 this year, as physical distancing measures halt activity. Meanwhile, house prices will see the biggest fall since the global financial crisis. Admittedly, our base case is for activity and prices to recover fairly quickly. But a credit crunch or larger economic hit could trigger an even deeper downturn.
  • The Economic Backdrop – The coronavirus will deliver a shock to GDP of unprecedented magnitude. And while we expect a fairly rapid recovery from the worst of the recession, it will take years to fully recover the economic damage.
  • Valuation and Affordability – While house prices are high relative to incomes, the eventual fall in mortgage interest rates will support housing affordability across our forecast. As a result, valuations pose comparatively limited risks to house prices. Indeed, when the housing market eventually turns the corner, valuations are likely to support a recovery in house prices and transactions.
  • The Mortgage Market and Completed Sales – Q2 will see a collapse in housing transactions and lending. But as restrictions are eased in the second half of 2020, activity should restart fairly quickly. Still, continued uncertainty, a weakened economy and risk aversion from banks mean that lending and sales will still be below their pre-coronavirus level in 2022.
  • House Prices – We now expect house prices to fall by around 4% this year, driven by a modest rise in forced sellers. Admittedly, prices will largely recover that decline in 2021. Still, house prices will be around 4% lower by 2022, compared to if the coronavirus had not struck the economy. What’s more, the downside risks to our forecast are significant – a more sustained hit to GDP or a mortgage credit crunch could both trigger a house price crash.
  • The Regional Outlook – House prices and transactions will fall in every region, but it’s hard to know which places will see the biggest hit. Our best guess is that London’s housing market will weather the storm better than elsewhere, while regions that are more reliant on tourism such as Wales and the South West will do comparatively worse.
  • Residential Lettings Market – The shock to demand from rising unemployment will hit rents harder than during the global financial crisis. But we expect rents to recover in 2021 as employment starts to improve.
  • Housing Supply – Housebuilding is likely to fall in line with housing sales, as housebuilders pull back on construction in response to falling revenues. That said, as the market restarts later this year, construction should also restart fairly quickly. We expect that recovery to be supported by the government, which is likely to introduce fresh support for the sector in the coming months.

Main Forecasts

Table 1: Housing Market Forecasts

2019

2020

2021

2022

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

216.8

208.1

216.5

220.8

% y/y

0.5

-4.0

4.0

2.0

Completed transactions

mn

1.18

0.86

1.09

1.13

% y/y

-2.8

-26.8

26.6

4.2

Employment

% y/y

1.1

-3.0

1.5

1.0

ILO Unemployment rate

%

3.8

7.0

5.7

5.3

Average earnings (inc. bonuses)

% y/y

3.5

-0.6

2.5

3.3

Real h’hold disposable income

% y/y

1.3

-5.0

1.4

1.6

Headline CPI Inflation

% y/y

1.8

1.0

1.0

1.6

Real Household spending

% y/y

1.1

-21.0

12.0

4.6

Real GDP

% y/y

1.4

-12.0

10.0

3.7

Affordability & valuation (year-end)

Mortgage affordability

%

35.1

33.2

33.4

32.7

(payments as % of take-home pay)

House price-to-earnings ratio

6.9

6.6

6.7

6.7

Bank Rate

%

0.75

0.10

0.10

0.10

Mortgage Interest Rate

%

1.89

1.70

1.60

1.50

Mortgage lending

Mortgage Approvals – Total

000s

1,550

1,144

1,432

1,449

– for house purchase

000s

790

581

725

761

  for remortgage

000s

589

439

553

526

  other

000s

173

123

154

162

Gross mortgage advances

£bn

268

191

240

248

Net mortgage lending

£bn

47.8

8.9

28.8

40.0

Mortgage arrears (>2.5% of bal.)

% of loans

0.7

2.1

1.4

1.0

Possessions

% of loans

0.02

0.04

0.05

0.03

The rental market

BTL mortgage advances

000s

69.9

36.8

43.2

45.2

(for house purchase)

% of total

9.2

6.2

6.0

6.0

Rental value growth (year-end)

% y/y

1.5

-2.0

1.5

2.0

Gross rental yields (year-end)

%

4.8

4.9

4.7

4.7

Net returns for housing (year-end)

%

5.1

-0.4

7.6

5.6

Housing Supply

Housing starts

000s

151

112

141

153

% y/y

-10.0

-25.9

26.4

8.1

Regional house prices (year-end)

London

% y/y

-1.8

-2.0

4.5

1.5

South East

% y/y

-0.3

-2.0

3.0

2.0

East of England

% y/y

0.1

-3.0

3.0

2.0

South West

% y/y

1.5

-5.5

5.5

2.0

East Midlands

% y/y

0.5

-4.5

3.0

3.0

West Midlands

% y/y

2.7

-4.5

3.0

3.0

North East

% y/y

2.7

-4.5

3.5

2.0

North West

% y/y

1.9

-4.0

3.0

2.0

Yorkshire & the Humber

% y/y

1.6

-2.5

3.5

2.0

Wales

% y/y

1.6

-3.5

2.5

2.0

Scotland

% y/y

2.7

-4.5

5.0

2.0

Northern Ireland

% y/y

1.1

-5.0

3.5

2.0

Sources: Nationwide, Bank of England, MHCLG, UK Finance, ONS, Refinitiv, Capital Economics


The Economic Backdrop

Fiscal policy to the rescue

  • We expect the coronavirus crisis to deliver a sharp shock to GDP of unprecedented magnitude. And, despite a fairly sharp rebound from the worst of the recession, it will take years to fully recover the economic damage.
  • High frequency indicators, such as city centre footfall, illustrate the steep downturn in activity since social distancing measures and the lockdown began. (See Chart 1.)
  • In our view, the incoming recession will look very different to past examples. The slump in GDP will be short but deep – we expect a 25% q/q contraction in the economy at the trough in Q2. (See Chart 2.) In addition, consumption may fall by more than GDP as consumers are instructed to stay home. This goes against the trend seen during the GFC and 1990s recessions, when household spending held up better.
  • Despite a rebound in economic growth during the second half of 2020, we expect some permanent losses. As a result, by the end of 2022, GDP may be about 5% lower than if the virus had never existed. (See Chart 3.) In the event of a second wave of infections, the recovery could be even softer.
  • The government has responded quickly by introducing fiscal measures worth an estimated £100bn (4.5% of GDP), more than double the size of the package seen after the GFC. (See Chart 4.) As a result, when combined with lower tax receipts and increased welfare spending, we expect a spike in government debt.
  • Even with the government’s support to employers through the furlough scheme, significant numbers of workers have already been laid off. As a result, we are forecasting the unemployment rate to jump from 4% to 9% at its peak this year. Many will return to work once restrictions end, but we still expect unemployment to stay elevated at over 5% at the end of 2022. (See Chart 5.)
  • However, the furlough scheme will prevent average earnings and employment falling as far as the slump in hours worked. We have pencilled in a 20% fall in the total number of hours worked across Q1 and Q2, but only a 5% fall in employment. (See Chart 6.) And the guarantee of 80% of wages up to £2,500 per month for furloughed workers, accompanied by the boost to unemployment benefits, will prevent household incomes falling too far.
  • The impact of the coronavirus has been to subdue inflationary pressures. The collapse in energy prices means that CPI inflation will fall close to zero during the second half of the year. (See Chart 7.) With demand remaining below its pre-crisis path, this will limit price pressures, and we expect inflation levels to remain well below target until end 2022.
  • In response to the crisis, the Bank of England slashed interest rates from 0.75% to a record low of 0.10%. (See Chart 8.) It also announced a fresh quantitative easing scheme worth £200bn (9% of GDP). With inflation expected to remain muted, there is little prospect of the Bank raising interest rates over the forecast horizon. As a result, we also expect 10-year Gilt yields will stay near their historic lows until 2021, after which there is a gentle increase.

The Economic Backdrop

Chart 1: Footfall in UK City Centres (% y/y)

Chart 2: Peak-to-Trough Change in Past Recessions (%)

Chart 3: Level of GDP (Q4 2019 = 100)

Chart 4: Gov’t Fiscal Stimulus & BoE QE (% of GDP)

Chart 5: ILO Unemployment Rate (%)

Chart 6: Total Hours Worked, Employment
& Average Earnings (% q/q)

Chart 7: CPI Inflation (%)

Chart 8: Bank Rate & 10-Year Gilt Yield (%)

Sources: ONS, Refinitiv, Springboard, Bank of England, CE


Valuation and Affordability

Falling interest rates will support valuations

  • Housing valuations entered the coronavirus shut-down in a fairly good place. Indeed, once the fall in Bank Rate is passed through to consumers, mortgage affordability will continue its trend of gradual improvement. So housing affordability is likely to assist a recovery in house prices next year.
  • What happens to housing valuations will depend on how the coronavirus pandemic progresses. Yet, relative to the risks from the economy, valuations pose less danger to either transactions or house prices.
  • Of course, house prices are high compared to past norms. They are also much higher than during the last crisis. (See Chart 9.) But in real terms, prices have now been stagnant for the last decade, and are lower than in 2007.
  • Furthermore, over the last few decades, prices have been supported by a sustained fall in mortgage interest rates. (See Chart 10.) That has allowed average mortgage interest payments to stay very low, even as house prices have surged relative to incomes.
  • Admittedly, some other measures of housing valuation are less favourable. For example, rental yields on residential property are much lower than on commercial real estate. (See Chart 11.) But lower residential yields are justified by a few factors. For one, residential rents have tended to outperform commercial property. Residential capital values have also performed better than commercial property – especially during downturns.
  • Looking ahead, the fall in Bank Rate will lead to lower mortgage interest rates. Of course, the data for March suggest that the rate cut has, so far, not been passed through to home buyers. But with most house purchase activity paused and the economic outlook highly uncertain, the fact that lenders aren’t competing for business is, in the current environment, not surprising.
  • That said, assuming that restrictions on house purchase start to be lifted by the end of Q2, we expect the rate cut to be gradually passed on to households. By the end of our forecast in 2022, we expect average effective mortgage rate to fall to just 1.5%. (See Chart 12.)
  • Admittedly, in the near term, the dip in average earnings in Q2 will cause a spike in the house price to earnings (HPE) ratio. But this largely reflects the fact that house prices will be comparatively slow to react to the shock. (See Chart 13.)
  • But, by the second half of 2020, we think the HPE will have declined significantly. (See Chart 14.) And the big picture is that the HPE will end our forecast at 6.7 times in 2022, down from 6.9 times at the end of last year.
  • Driven by both the improving house price to earnings ratio, as well as falling mortgage interest rates, we expect mortgage affordability to improve too. (See Chart 15.) Indeed, even with very high prices in London, low interest rates will push mortgage affordability down to its long-run average. That will help to support valuations, and thus house prices. And from an affordability perspective, house purchase will also stay attractive relative to renting. (See Chart 16.)
  • In all, it seems that the downside risks to the market from housing valuations have fallen, as the shift towards lower for longer interest rates supports house prices in the long-run. Rather, it is the direct effect of the coronavirus on confidence and the economy that currently poses the biggest risk to the market.

Valuation and Affordability

Chart 9: UK House Prices (£000s)

Chart 10: Average Effective Mortgage Interest Rate on New Loan (%)

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Chart 11: Rental Yields (%)

Chart 12: Interest Rate Forecasts (%)

Chart 13: House Prices and Earnings (% y/y)

Chart 14: House Price to Earnings Ratio Forecast

Chart 15: Mortgage Affordability vs Long-Run Average
(Index)

Chart 16: Real House Prices vs Trend (£000s)

Sources: Nationwide, MSCI, UK Finance, Refinitiv, Capital Economics


The Mortgage Market and Completed Sales

Mortgage lending will take time to recover

  • Housing transactions and lending will collapse in Q2. But as restrictions are eased in the second half of the year, the market should restart fairly quickly. Still, continued uncertainty among buyers and a weakened economy will leave activity below its 2019 out to 2022.
  • While housing market activity started the year on a strong note, the coronavirus rapidly halted the recovery. Indeed, the RICS data point to the sharpest single month’s fall in demand and supply on record during March. (See Chart 17.)
  • So, while mortgage approvals and housing transactions were previously on track to see a strong Q2, the opposite is now the case. (See Chart 18.) Indeed, while there is usually a lagged relationship between the RICS data and mortgage approvals, the nature of the virus shutdown implies an immediate collapse in activity from April onwards.
  • Admittedly, it’s impossible to know how much house purchase mortgage approvals and transactions will actually decline in Q2. Our best guess is a 70% q/q fall. (See Chart 19.) This is in part based on the experience of China, where transactions fell by over 90% during the worst part of the crisis.
  • Beyond that, the housing market will continue to be constrained over the remainder of the year by both a weak underlying economy, continued social distancing measures and weakened buyer confidence. Furthermore, banks have also signalled that credit conditions may be significantly tighter in Q2. (See Chart 20.)
  • Of course, tightening credit conditions aren’t too surprising, given the lockdown prevents most housing market activity anyway. Our base case is that, once restrictions start to be eased, buyer interest and credit availability will pick-up fairly quickly.
  • That said, lending will take time to fully recover. We expect first-time buyer lending to stay weaker for longer, as lenders remain cautious on high LTV loans. (See Chart 21.) What’s more, self-employed workers and those with weak credit scores are likely to find it harder to borrow for some time. We expect these factors to keep lending well below its 2019 level even by the end of 2022.
  • Furthermore, there are substantial downside risks to this view. For one, buyers’ online home browsing habits have already changed significantly, which could signal that many won’t want to transact after the lockdown is lifted. (See Chart 22.)
  • Beyond that, there’s also the risk of a new credit crunch. If lenders choose to keep a tight reign on credit availability in light of weak house price expectations or concerns about the economy, then lending could be much weaker than we expect in 2020 and 2021.
  • Perhaps the biggest risk is that coronavirus restrictions have a much larger than expected economic impact. After all, any recovery in transactions and mortgage approvals is entirely dependent how much of the economy and employment comes back online in the second half of 2020. (See Chart 23.)
  • In all, we expect gross lending to slump 30% in 2020, before making up most of that fall by 2022. (See Chart 24.) Net lending, meanwhile, will drop to around zero, but recover fairly promptly. In both cases, the risks to those forecasts are on the downside.

The Mortgage Market and Completed Sales

Chart 17: New Buyer Enquiries and Sales Instructions
(% Balance)

Chart 18: Newly Agreed Sales and House Purchase Mortgage Approvals

Chart 19: Mortgage Approvals for House Purchase and Transactions Forecast (000s per Qtr.)

Chart 20: Banks’ Factors Contributing to Change in Credit Availability (% Balance)

Chart 21: Mean FTB and Mover LTV (%, Dec 2019)

Chart 22: Web Searches for Property Portals (Index)

Chart 23: Employment and House Purchase Mortgage Approvals Forecast

Chart 24: Gross and Net Lending Forecasts
(£bn, 4 Qtr Sum)

Sources: HMRC, RICS, Refinitiv, Google, Capital Economics


House Prices

Largest house price fall in a decade

  • The coronavirus will push down house prices by around 4%. And while we expect a recovery in 2021, the downside risks are substantial. A larger than expected hit to GDP or a mortgage credit crunch could drive prices down much further and for much longer.
  • The main measures of house prices point to a pick-up in growth at the start of 2020. (See Chart 25.) But with the coronavirus having put the housing market on ice, house prices are now expected to fall. Consistent with that, data from the RICS suggest that house price expectations among surveyors collapsed in March. (See Chart 26.)
  • An important point to note is that the main house price indices all rely on lending data. If very few homes are sold in April, May or June, then prices can’t be measured either. Indeed, the LSL/Acadametrics measure has already hinted that they may not publish at all in the coming months. Other house price indices may choose to follow suit. What’s more, those indices that are published might be inaccurate or hard to interpret.
  • Arrears and possessions will be a key determinant of how much house prices fall. After all, house prices are sticky. It takes a large rise in forced sellers to trigger a collapse in prices, as owners will typically wait for conditions to improve rather than accept a steep discount on price.
  • Worryingly, we expect mortgage arrears exceed their Global Financial Crisis (GFC) level in 2020. (See Chart 27.) That reflects both the size of the hit to the economy, as well as the widespread take up of the mortgage holiday scheme.
  • But the picture possessions will probably be better. (See Chart 28.) For one, the high levels of possessions during the GFC in part reflected the poor credit quality of lending at the time. Given much stronger regulatory oversight since then, possessions are likely to stay lower this time around.
  • Furthermore, banks were struggling with liquidity and capital problems in 2007, which gave them a greater incentive to foreclose mortgages. But lenders appear to be in a much stronger position this time around.
  • Finally, the fairly rapid pick-up in employment implies that, for many households, the break in income will be reasonably short. (See Chart 29.) This, combined with an accommodative approach from lenders, further suggests that possessions will be lower in this crisis than during the last one.
  • Still, we expect the economic downturn and loss of both jobs and confidence will lead to a fall in house prices of around 4% in 2020. (See Chart 30.) That will be the largest drop in prices in a decade. But we expect that drop to be largely made up in 2021, and for prices to grow in line with earnings in 2022.
  • On the whole, we’re forecasting a shallower dip in house prices compared to the GFC. (See Chart 31.) But the downside risks to that view are significant. Perhaps the biggest risk is from a deeper and more prolonged economic hit. Another risk is a credit crunch. Large loan losses or reduced risk appetite mean lenders could severely constrain credit after the initial shutdown eases. Similar to what was seen during the last crisis, that could weaken housing demand and trigger much larger house price falls. (See Chart 32.)

House Prices

Chart 25: House Prices (% 3m/3m)

Chart 26: House Price Expectations (% Balance)

Chart 27: Mortgage Arrears and Unemployment

Chart 28: Mortgage Possessions and Unemployment

Chart 29: House Prices and GDP (% y/y)

Chart 30: House Price Forecast (% y/y)

Chart 31: House Prices Months from Peak (Index)

Chart 32: Housebuilders’ Reported Constraints on Demand (%)

Sources: Halifax, Nationwide, RICS, Refinitiv, Capital Economics


The Regional Outlook

Prices in London to be comparatively resilient

  • House prices will fall in every region. But it is hard to know which regions will see a bigger hit. Owing to its larger share of desk-based employment, our best guess is that London and will do better than elsewhere. Meanwhile, we expect the South West, Midlands and devolved regions to be hit the hardest.
  • Regional house price growth was rebounding at the start of the year. Across most of the regions, quarterly house price growth picked up to an annualised rate of 4% or more during Q1. (See Chart 33.)
  • But looking ahead, the impact of the coronavirus shutdown will be felt strongly in every region. As a result, the outlook for house prices in every part of the UK is now very weak. Indeed, we expect the coronavirus to push house prices into negative territory in every region this year.
  • That said, it stands to reason that some places will be hit harder than others. One factor that may determine regional performance is the breakdown of employment across the sectors.
  • Chart 34 shows the percentage of regional employment in sectors that are primarily desk-based, and thus may be less vulnerable to the current economic shutdown. Out of all the regions, London appears to have significantly more of such jobs than anywhere else. Moreover, other regions in its immediate vicinity – the East of England and South East – also rank highly. Outside this group, the difference between regions is quite small.
  • Meanwhile, chart 35 shows the share of jobs in sectors we suspect will be hit comparatively hard – hotels, restaurants, pubs and the arts. This suggests that the South West, Scotland, Wales and London are the most exposed to the coronavirus shutdown.
  • Combining both measures paints one possible regional picture of the lockdown. London, the South East and East of England may be the least vulnerable to house price falls. (See Chart 36.) Yorkshire & the Humber and the South West stand out as most at risk.
  • But that is hardly the whole picture. Another way to consider the problem is the role of exports – which we expect to hold up better than domestic demand. That again points to London being less vulnerable, and Yorkshire & the Humber and the South West among the most exposed. (See Chart 37.)
  • Another factor to consider is migration. London sees the largest net migration share of all the regions – which supports housing demand. With migration likely to fall sharply this year, the impact on London will be greater than elsewhere. (See Chart 38.)
  • Finally, housing valuation measures in the south of England are the worst of all the regions – making prices there more vulnerable to a fall. (See Chart 39.) Meanwhile, valuations elsewhere appear more sustainable, which will support house prices in a recovery.
  • On balance, we expect no region to be shielded from a house price fall. Our best guess is that, based on its more resilient employment mix, London will see the smallest drop in house prices, of around 2%, in 2020. (See Chart 40.) Meanwhile, we expect the South West to see the biggest drop, of around 5.5%, largely based on its reliance on tourism.
  • That said, we think house prices will recovery fairly quickly and evenly in 2021 and 2022. And as the lockdown eases, regions that saw larger price drops are more likely to see larger recoveries – although the risks to price gains across the UK on the downside.

The Regional Outlook

Chart 33: UK Regional House Price Growth
(Q1 2020, % q/q Annualised)

Chart 34: Employment in Finance, IT, Professional, Technical & Administration (% per Region, 2019)

Chart 35: Employment in Accommodation, Food Services, Arts and Recreation (% per Region, 2019)

Chart 36: Employment in Less Vulnerable vs More Vulnerable Sectors (% of Employment, 2018)

Chart 37: Exports as a % of Regional GVA, 2018

Chart 38: Net International Migration by Region
(000s, 2018)

Chart 39: Regional House Price to Earnings Ratio

Chart 40: Regional House Price Forecasts (% y/y)

Sources: RICS, ONS, Nationwide, Refinitiv, Capital Economics


Residential Lettings Market

Demand shock will hit rents

  • As rental demand falls and the coronavirus restrictions give tenants an upper hand in negotiations, rents will decline in 2020 by more than during the GFC. And it may be a year or more before the recovery in employment allows rents to return to their pre-coronavirus level.
  • Just a few months ago, the outlook for rents was strong, with rental growth having already picked up to 1.5% y/y by the end of 2020. (See Chart 41.)
  • Rising rents reflected an imbalance between rental demand and supply. For one, landlord instructions had been falling. (See Chart 42.) That reflected past tax rises that had reduced the profitability of buy-to-let. Also, strong employment and accelerating wage growth had been boosting rental demand.
  • Looking ahead, both trends are unlikely to persist. For one, we expect the rise in unemployment and fall in wage growth to cut rental demand. After all, strengthening demand in part reflected fewer young adults living with their parents. (See Chart 43.) Looking ahead, worsening job prospects will almost certainly halt that trend.
  • Indeed, looking more broadly, lower paid sectors such as retail and hospitality may see the biggest economic downside. That in turn implies a disproportionate hit to renters, who tend to be lower paid, compared to owner occupiers.
  • At the same time, we also expect the impact of the virus to raise landlord instructions. After all, the hit to employment will force some tenants to seek cheaper accommodation or to move back in with family – raising active rental supply faster than rental demand.
  • Yet, beyond that, there are moving parts in terms of demand and supply that are harder to measure. For example, migration is a key driver of population growth, and most migrants rent – at least initially. Migration – both domestic and international – is likely to fall sharply this year. But it’s difficult to estimate the size and scope of the hit.
  • Furthermore, with tourism close to zero, most if not all Airbnb’s are currently empty. Such properties are highly concentrated on a regional level, with Scotland, Wales, the South West and London the main hotspots. (See Chart 44.) If tourism stays very weak and Airbnbs move to the long-term rented sector en-masse, the shock to supply could be significant.
  • Encouragingly, the fundamentals of rental market pricing were on fairly solid ground before the crisis hit. After all, in every region bar London, rental affordability was better than it was a decade ago. (See Chart 45.)
  • Our best guess is that rents will fall by 2% y/y in 2020 – larger than during the GFC and broadly proportionate to our forecast fall in employment. (See Chart 46.) That said, assuming a fairly strong recovery later this year, we expect rents to largely make up that decline by 2021.
  • In all, with rents and house prices falling in line, we expect yields to stay broadly steady. (See Chart 47.) That will leave total returns on residential property at just under zero in 2020, before recovering to around 7.5% in 2021. On the whole, that is consistent with the historic data, which shows residential property outperforming commercial property through economic downturns. (See Chart 48.)

Residential Lettings Market

Chart 41: Rental Market Tightness and Rental Growth

Chart 42: Tenant Demand and Landlord Instructions
(% Balance.)

Chart 43: Change in Young Adults Living with Parents
(000s, 2018 vs 2017)

Chart 44: Regional Estimate of Entire Home AirBnbs as a % of Private Rented Dwellings, 2018

Chart 45: Rental Affordability (Index)

Chart 46: Rents and Employment Forecast
(% y/y)

Chart 47: House Prices, Rents and Yield Forecast

Chart 48: Total Returns (%)

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Sources: VOA, RICS, MHCLG, Refinitv, MSCI, Capital Economics


Housing Supply

Construction to fall in line with housing sales

  • Housebuilding will slump alongside housing sales in Q2. But with underlying demand for housing strong and the government likely to introduce fresh support for the sector, there’s a good chance that housebuilders will restart production fairly quickly.
  • Housing completions and net additions to the dwelling stock are at a record high. (See Chart 49.) But housing starts are a leading indicator of completions, and they suggest that the pace of construction slowed last year.
  • That probably reflected weakening demand in 2018 and 2019. (See Chart 50.) More recently though, rising housing market activity had led to improved conditions for housebuilders. That in turn caused a brief pick-up in construction in February. (See Chart 51.)
  • Yet, that surge in activity has proved to be short lived. After all, the PMI data for March showed a fresh fall in construction.
  • Admittedly, the housing component of the PMI showed a much weaker fall than the wider construction sector. (See Chart 52.) Still, with many housebuilders closing sites in early April, we expect construction to have since fallen much further.
  • In fact, we expect housing starts to fall by as much as 70% in Q2. That reflects a number of factors. Firstly, housebuilders will have shut down sites out of concern for the safety of their workers. Secondly, especially for smaller developers, the closure of builders’ merchants, lack of delivery capacity and other supply constraints will also have forced site closures.
  • But, perhaps the most significant factor is financial. Admittedly, housebuilders ended 2019 in a good financial position. Financial accounts for the nine largest listed housebuilders show high cash reserves and very low debt. (See Chart 53.)
  • Still, housebuilders’ financial room is limited. The industry’s cash reserves currently sit at 25% of annual operating expenses. (See Chart 54.) So even if housebuilders expected demand to rebound in the future, they only have enough cash to run for a few months while revenues are very low.
  • This implies that construction will be limited by housing sales – which will be strongly dependent on confidence, mortgage availability and house prices. All three factors posed a major problem for housebuilders during the last crisis. (See Chart 55.) And it was intervention through the Help to Buy scheme, combined with a wider recovery in the housing market, that played a key role in restarting construction last time around.
  • Looking ahead, the Help to Buy scheme is due to end in 2023. But given the size of the crisis now engulfing the sector, we expect the government to soon renew the scheme beyond that date.
  • Taking all this together, we expect housing starts to slump in Q2, by a hefty 70% y/y. Such a fall will be broadly in line with the historic relationship with transactions. (See Chart 56.) But beyond that, we think a combination of government support and a recovery in housing demand will bring about a fairly prompt recovery in construction.
  • Still, by the end of 2022, we expect housing starts to be 9% below its 2018 peak. Moreover, there are serious downside risks to that forecast. If the broader housing market recovery is slower than we expect, then the outlook for housebuilding will also be weaker.

Housing Supply

Chart 49: Housing Starts (000s per Year)

Chart 50: New Home Net Reservations and Housebuilders’ Use of Sales Incentives

Chart 51: Housing Starts and Housing Activity PMI

Chart 52: Construction PMI and Housing Activity PMI (Index)

Chart 53: Cash and Debt Position of Top 9 UK Listed Housebuilders (£m)

Chart 54: Cash as a % of Annual Operating Expense of Top 9 UK Listed Housebuilders

Chart 55: Reported Constraints on Demand from Builders (% Balance)

Chart 56: Transactions and Housing Starts Forecast
(000s, 4q Rolling Sum)

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Sources: MHCLG, ONS, NHBC, Refinitiv, Capital Economics


Andrew Burrell, Chief Property Economist, andrew.burrell@capitaleconomics.com
Hansen Lu, Property Economist, hansen.lu@capitaleconomics.com
James Yeatman, Research Assistant, james.yeatman@capitaleconomics.com