Housing market surge to be short-lived - Capital Economics
UK Housing

Housing market surge to be short-lived

UK Housing Market Outlook
Written by Andrew Burrell
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The post-lockdown recovery in house price growth and housing market activity has exceeded expectations. But the economy will act as a drag on the housing market in the coming months, while pent-up demand will soon be expended and the stamp duty cut will end early next year. As a result, we expect the nascent housing mini-boom to soon end – stalling house price growth, pushing activity back below its pre-virus level and limiting the recovery in housing construction. Meanwhile, we expect rents to see a modest fall next year, as virus restrictions hit renters harder than owner occupiers.

  • Overview – The post-lockdown recovery in house price growth and housing market activity has exceeded expectations. But the economy will act as a drag on the housing market in the coming months, while pent-up demand will soon be expended and the stamp duty cut will end early next year. As a result, we expect the nascent housing mini-boom to soon end – stalling house price growth, pushing activity back below its pre-virus level and limiting the recovery in housing construction. Meanwhile, we expect rents to see a modest fall next year, as virus restrictions hit renters harder than owner occupiers.
  • The Economic Backdrop – As virus cases surge again, fresh restrictions are likely to stall the economic recovery in Q4. Meanwhile, future fiscal support is set to be weaker than what was seen during the initial part of the crisis. That said, interest rates are set to stay at their current very low levels, while further monetary loosening in the form of QE is likely.
  • Valuation and Affordability – Despite surging house prices, measures of housing valuations have deteriorated only slightly since March. Admittedly, with signs that lenders are raising mortgage interest rates, the downside risks to mortgage affordability are rising. But our view is that, once the recent surge in mortgage demand starts to wane, lenders will once again lower their rates to compete.
  • The Mortgage Market and Completed Sales – The recent rise in mortgage approvals has exceeded all expectations. But the surge in housing demand is likely to cool in the coming months as pent-up demand from lockdown eases, the stamp duty cut expires and additional virus measures raise uncertainty. We expect lending and transactions to end next year down by around 10% compared to their pre-virus levels, and still 5% below by the end of 2022.
  • House Prices – House prices have surged over the last few months. That in part reflects the stamp duty cut, but also the release of pent-up demand from lockdown. But we expect house price growth to slow to a standstill next year as those factors unwind. And as the economy recovers from the virus, we expect house price growth edge back up – reaching 2% y/y in 2022.
  • The Regional Outlook – London and the South of England have performed better than expected in the wake of the virus. But the end of the stamp duty cut will hit those more expensive regions more than elsewhere. So we expect prices in the South of England to underperform in both 2021 and 2022.
  • Residential Lettings Market – The rental market has proved fairly resilient so far. But further virus restrictions are likely to hit renters harder than owner occupiers. So we expect rents to fall by around 3% next year, before recovering gradually in 2022.
  • Housing Supply – Private housebuilding has already recovered to around 90% of its pre-virus level, and the industry will benefit from favourable supply conditions. However, the main constraint on construction is demand, which will keep housebuilding weaker than its 2018 level for the foreseeable future.

Main Forecasts

Table 1: Housing Market Forecasts

2019

2020

2021

2022

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

216.4

225.1

225.0

226.5

% y/y

1.4

4.0

0.0

0.7

Completed transactions

mn

1.18

1.04

1.10

1.11

% y/y

-1.1

-12.0

5.8

1.5

Employment

% y/y

1.1

-0.9

-2.3

2.1

ILO Unemployment rate

%

3.8

4.6

6.8

6.8

Average earnings (inc. bonuses)

% y/y

3.4

1.4

3.5

1.5

Real h’hold disposable income

% y/y

1.7

-0.5

-0.3

2.0

Headline CPI Inflation

% y/y

1.8

0.9

1.3

1.6

Real Household spending

% y/y

0.8

-12.7

7.6

5.0

Real GDP

% y/y

1.3

-10.4

6.0

4.5

Affordability & valuation (year-end)

Mortgage affordability

%

35.1

36.3

34.7

33.5

(payments as % of take-home pay)

House price-to-earnings ratio

6.9

7.2

7.0

6.8

Bank Rate

%

0.75

0.10

0.10

0.10

Mortgage Interest Rate

%

1.89

1.80

1.60

1.50

Mortgage lending

Mortgage Approvals – Total

000s

1,550

1,327

1,409

1,428

– for house purchase

000s

790

679

714

746

  for remortgage

000s

588

489

525

504

  other

000s

173

160

170

178

Gross mortgage advances

£bn

268

248

226

236

Net mortgage lending

£bn

48.1

44.5

31.0

38.4

Mortgage arrears (>2.5% of bal.)

% of loans

0.8

0.9

1.4

1.2

Possessions

% of loans

0.02

0.02

0.02

0.04

The rental market

BTL mortgage advances

000s

71.7

69.5

66.6

64.6

(for house purchase)

% of total

9.3

10.1

9.5

8.7

Rental value growth (year-end)

% y/y

1.4

0.7

-2.5

1.5

Gross rental yields (year-end)

%

4.8

4.6

4.5

4.5

Net returns for housing (year-end)

%

2.0

4.5

0.5

1.2

Housing Supply

Housing starts

000s

152

115

139

137

% y/y

-10.0

-24.1

21.0

-1.4

Regional house prices (year-end)

London

% y/y

-1.8

3.5

-2.0

0.0

South East

% y/y

-0.4

3.5

-0.5

2.0

East of England

% y/y

0.1

4.0

-0.6

2.0

South West

% y/y

1.5

3.5

0.0

2.0

East Midlands

% y/y

0.4

5.0

0.0

3.0

West Midlands

% y/y

2.6

4.5

0.0

2.0

North East

% y/y

2.6

3.5

1.0

2.0

North West

% y/y

1.8

4.0

1.0

2.0

Yorkshire & the Humber

% y/y

1.6

4.5

1.0

2.0

Wales

% y/y

1.5

5.0

1.0

2.0

Scotland

% y/y

2.8

2.0

0.0

2.0

Northern Ireland

% y/y

1.1

2.5

0.0

2.0

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


The Economic Backdrop

Recovery takes a turn for the worse

  • We think that GDP will not rise at all in the final three months of the year due to new COVID-19 restrictions. (See Chart 1.) Assuming that restrictions tighten further, they last for at least six months and that a “thin” Brexit deal is reached before 31st December 2020, it is unlikely that GDP will return to its pre-crisis peak until the end of 2022. (See Chart 2.)
  • Taking into account the renewed tightening in COVID-19 restrictions, we expect the government to provide continued fiscal support and put on hold its ambition to balance the books. That said, future fiscal support will be weaker than what was seen in the initial stages of the pandemic. This is despite the Chancellor extending the VAT cut for the hospitality and tourism sectors and launching further worker support schemes. This withdrawal of fiscal stimulus is a major reason why we think the economy will stall in the final few months of the year.
  • Despite a paring back of fiscal support, the public finances are set to worsen across our forecast. We expect the budget deficit to reach £390bn (20% of GDP) in 2020/21 and the debt to GDP ratio to settle at just over 100%. (See Chart 3.)
  • Between February and August, employment fell by a modest 482,000 (1.5%) as most of the 5.5 million workers who had left the national furlough scheme by August returned to employment. However, it appears that the worst is yet to come for the labour market, as fiscal support fades and restrictions tighten.
  • The Job Support Scheme and the local furlough schemes will only soften the blow as the national furlough scheme comes to an end. We expect the jobless rate to rise from 4.5% in August to almost 8.0% by the end of next year. (See Chart 4.) With a rising unemployment rate, it is likely that earnings growth will only recover slowly from this year’s small fall.
  • More timely demand indicators suggest that consumer spending has bounced back from its 23.6% q/q drop in Q2. However, as with output, the revival in consumer spending is likely to stall in the next few quarters. (See Chart 5.) Furthermore, we expect the risk of future lockdowns to weigh on consumer confidence until next spring.
  • We forecast the inflation rate to rise from close to zero in August towards 2% by the end of 2021. (See Chart 6.) This rise will in part be driven by the ending of some government policies which were designed to kickstart the recovery, such as the Eat Out to Help Out scheme and temporary VAT cuts, which helped hold down prices. But there are also upside risks. In the event of a no deal Brexit, inflation could peak at an above-target rate of over 3% as sterling weakens. Looking further ahead to 2022, the inflation rate is likely to settle closer to 1.5% than the Bank’s 2.0% target.
  • Below-target inflation and sustained high unemployment reinforce our view that monetary policy will be loosened further. We expect the Bank to keep interest rates no higher than 0.10% for the next five years. (See Chart 7.) That said, it is unlikely that rates will drop into negative territory in the next 6-12 months.
  • We expect the steady outlook for Bank Rate to be accompanied by an extra £250bn of asset purchases over the next year, which is significantly higher than the consensus view. (See Chart 8.)

The Economic Backdrop

Chart 1: Monthly GDP (February 2019 = 100)

Chart 2: Quarterly GDP (Q4 2019 = 100)

Chart 3: Public Sector Net Borrowing (As a % of GDP)

Chart 4: ILO Unemployment Rate (%)

Chart 5: Consumer Spending (Q4 2019 = 100)

Chart 6: CPI Inflation (%)

Chart 7: Expectations for Bank Rate (%)

Chart 8: Forecasts for the Stock of QE Purchases (£bn)

Sources: ONS, Refinitiv, Bank of England, Capital Economics


Valuation and Affordability

Housing valuations still broadly supportive

  • After dipping in the immediate aftermath of the initial virus lockdown, house prices have since recovered strongly. (See Chart 9.) Indeed, the two main indices showed prices rising to well above their pre-virus level in September.
  • Compared to other asset classes, the housing market has outperformed. For example, while house prices have risen this year, the FTSE 100 remains down by around 20% compared to February. (See Chart 10.) House prices have also outperformed commercial property, which has so far seen a 4% fall in capital values since the start of the year.
  • Wages have already recovered their initial virus-related fall, helping to support the recovery in house prices. (See Chart 11.) In fact, with wages and house prices now rising together, the price to earnings ratio has risen only a touch despite the recent mini-boom in the housing market.
  • Looking ahead, the HPE is probably close to its medium-term peak. Our expectation is for a slowdown in house price growth over the next few months, combined with modest medium-term growth in wages. This implies that the HPE will fall gently across our forecast horizon. (See Chart 11 again.)
  • Of course, given the uncertainty over the path of the virus and how further restrictions may impact confidence and buyer behaviour, the outlook is harder than usual to predict. Still, the big picture is that, despite the high level of house prices relative to incomes, the housing market fundamentals are relatively favourable. That reflects the low level of mortgage interest rates, which, despite high house prices, have kept the cost of mortgage repayments manageable compared to historic norms. (See Chart 12.)
  • Admittedly, quoted mortgage interest rates have been rising – particularly in the high LTV segment. (See Chart 13.) One risk is that rising interest rates make mortgage repayments less affordable. That could make the current high level of house prices less palatable to prospective buyers. After all, even a relatively small increase or decrease in mortgage interest rates can have a substantial impact on house prices in the long run. (See Chart 14.)
  • That said, despite the rise in quoted rates, the average effective mortgage rate – which reflects the price of loans actually taken out – has so far held steady. (See Chart 14.) This supports our view that the surge in mortgage interest rates mainly reflects credit rationing. Lenders – awash with demand for loans – are in effect choosing to focus on less risky low LTV products.
  • The implication is that, once the current surge in housing demand wanes, product availability at higher LTVs will improve. Indeed, we expect the average rate on a new mortgage to edge up only a little next year, before declining in 2022. (See Chart 15.) That supports our view that the fundamentals in the owner occupier market will broadly support house prices over the next few years.
  • The outlook for the rental market is also favourable. While rental affordability deteriorated sharply during lockdown, the recovery in wages has already reversed it. (See Chart 16.) Looking ahead, our forecasts imply that rents will become even more favourable relative to incomes, while rental yields will see a small decline out to 2022.

Valuation and Affordability

Chart 9: UK House Prices (£000s)

Chart 10: House Prices and FTSE 100

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Chart 11: House Prices and Earnings (% y/y)

Chart 12: Mortgage Affordability and House Price to Earnings Ratio Forecast (%)

Chart 13: Average Quoted Mortgage Interest Rate on
2-Year Fixed Rate Loan (%)

Chart 14: Mortgage Interest Rates, Mortgage Affordability and Long-Run House Prices

Chart 15: Interest Rate Forecasts (%)

Chart 16: Rental Yield and Rental Affordability

Sources: Nationwide, Halifax, ONS, RICS, Refinitiv, CE


The Mortgage Market and Completed Sales

Activity surge to end next year

  • Pent up demand and the stamp duty cut have pushed mortgage approvals above their pre-virus level. (See Chart 17.) And the RICS survey pointed to still rising new buyer enquiries in September.
  • That said, Google search data for property portals is a timelier indicator of demand, and has shown tentative signs of weakening. (See Chart 18.). But this indicator also needs to be interpreted cautiously. Its historic relationship with mortgage approvals for house purchase and housing transactions is far from perfect. Moreover, it reflects only the frequency of web searches for online portals, which may be influenced by factors unrelated to demand.
  • One surprising aspect of the pandemic so far has been the performance of first-time lending. (See Chart 19.) Admittedly, like the rest of the market, FTB mortgage advances slumped by 46% y/y in Q2. But that performance was better than the 49% decline in home movers and 47% fall in buy-to-let.
  • This has happened despite the surge in high LTV interest rates and steep decline in the availability of high LTV mortgages. First-time buyers are disproportionately reliant on such loans, which suggests they should have seen a disproportionately large impact from tightening credit conditions. (See Chart 20.)
  • The resilience of FTB lending so far likely reflects the timing of the housing sales pipeline. Mortgages advanced in Q2 would mostly have been approved before the virus struck in Q1. But high LTV interest rates rose at only the end of the quarter, so the hit to high LTV lending – and thus first-time buyers – may still be to come.
  • Admittedly, we do expect mortgage availability to improve next year. When that happens, we think quoted mortgage interest rates will largely reverse their recent fall. But there are few signs this will happen imminently. The Bank’s Credit Conditions Survey shows that, lenders do not expect to reverse the steep fall in loan availability seen in Q2 and maintained in Q3. (See Chart 21.)
  • Indeed, with fresh virus restrictions coming into force and economic uncertainty rising, credit availability in the final quarter may be worse than lenders had expected when they replied to the survey last month. On top of that, the recent rise in house prices will weigh on buyer demand – especially given the environment of elevated risk.
  • Additionally, lending and transactions will face further headwinds next year as the end of the stamp duty holiday cuts weight on housing demand.
  • In all, we expect mortgage approvals for house purchase, remortgaging and transactions to end 2020 down by around 10% compared to their pre-virus level. In 2021, we expect house purchase lending and transactions to still be around 5% lower than their pre-virus level. (See Chart 22.)
  • Meanwhile, our forecast is for remortgaging to weaken once more from 2021 onwards, as past increases in the popularity of longer duration mortgage fixes cuts refinancing demand. (See Chart 23.)
  • All this implies that gross lending will end 2020 at £248bn – down by around 8% compared to 2019. (See Chart 24.) But we expect a further fall in 2021 as the end of the stamp duty cut shifts housing market activity away from the more expensive parts of the market.

The Mortgage Market and Completed Sales

Chart 17: Mortgage Approvals for House Purchase
(000s per Month)

Chart 18: Google Property Portal Searches and
Mortgage Approvals

Chart 19: Mortgage Advances (000s per Qtr)

Chart 20: New Mortgage Sales at 85% LTV or Above (%)

Chart 21: Lenders’ Reported Factors Affecting the Availability of Credit (% Balance)

Chart 22: Mortgage Approvals for House Purchase Forecast (000s, Cumulative per-year)

Chart 23: Remortgaging Forecast (000s per Qtr)

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

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


House Prices

Mini-boom to give way to stagnation

  • Remarkably, house prices are having their strongest year since 2014. But that will not continue. Pent up demand from the lockdown is fading, banks are wary of house price falls and reacting by raising interest rates on riskier mortgages, and the stamp duty holiday will end next March. That said, very low interest rates and generous forbearance is likely to mean that a fall in house prices is avoided.
  • House prices did fall back in May and June after the housing market was forced to shut down. But since then prices have been bid up by competition between buyers who were forced to delay their purchase and others who have been encouraged to bring their purchase forwards by the stamp duty holiday. (See Chart 25.) But the surge in house price growth to 5% y/y in September probably marks the peak. (See Chart 26.)
  • As stamp duty is worth an average of 1% of the purchase price of a property, even if it was fully capitalised into house prices it cannot explain all the increase. (See Chart 27.) But it may have allowed buyers to upsize their deposit or equity contribution to their new home, increasing valuations. Regardless of its size, the boost will end when the holiday ends in March.
  • The resurgence in house prices has been at odds with the wider economic data, so we doubt it can continue. Consumer confidence is consistent with significant falls in house prices. (See Chart 28.) And buyer enquiries are now falling back faster than instructions, suggesting that prices have peaked. (See Chart 29.) Easing buyer enquiries may reflect banks growing wary of house price falls. In response they have stopped very high LTV lending and raised interest rates on riskier products.
  • At face value, our forecast that the unemployment rate will peak at nearly 8% next year suggests a similar proportion of mortgages will enter possession as in the financial crisis. (See Chart 30.) However, we doubt that will be the case for two reasons. First, unemployment has been concentrated in younger and low-income workers that worked in the service industries worst affected by COVID-19, and who generally participate in the rental rather than owner occupier market. Second, banks are aware of that they could precipitate a fall in prices with forced sales, so are likely to continue to exercise generous forbearance.
  • Moreover, while house price to earnings valuations are high, mortgages repayments remain very affordable thanks to near-zero interest rates. While we doubt that the Bank of England will take interest rates below zero in the next 6-12 months at least, we don’t think they will rise above 0.10% for the next five years. The upshot is that the main support to high house price valuations will remain in place. (See Chart 31.)
  • Overall, after a 4% increase in house prices this year, we expect them to stagnate in 2020 and 2021. (See Chart 32.) That said, the housing market outlook still carries significant uncertainty. We cannot completely rule out a collapse if the rise in unemployment broadens out or if lenders become much more cautious than we expect. And if overly negative house price expectations become widespread, that could also trigger a collapse.

House Prices

Chart 25: Nationwide House Prices
(Dec. of Year Before = 100)

Chart 26: House Price Growth (% y/y)

Chart 27: SDLT Savings as a % of Purchase Price
(% of Transactions)

Chart 28: Consumer Confidence & House Prices

Chart 29: RICS Demand/Supply Balance & House Prices

Chart 30: Mortgage Possessions and Unemployment

Chart 31: Mortgage Payments as a % of Full-Time Earnings

Chart 32: House Prices (% y/y)

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


The Regional Outlook

London’s strong performance to reverse soon

  • On a regional basis, the hard data suggest that house prices in the south of England have risen more strongly in the wake of the pandemic. (See Chart 33.) Indeed, London, the South East and South West have all seen house prices rise faster than the other regions. Data from the official UK House Price Index in August tell a similar story.
  • The strength of southern house price gains stand in contrast to reports from surveyors. They point to London house prices having seen the weakest performance over the last few months. (See Chart 34.)
  • Recent economic performance does a poor job of explaining why some regions have seen stronger house price growth than others. ONS data show that the South East and South West have seen a comparatively large rise in unemployment versus the rest of the UK. (See Chart 35.) There is currently no obviously discernible relationship between employment growth and house prices. (See Chart 36.)
  • A lack of relationship between the economy and regional house prices in the short-term isn’t too surprising, as it takes time for one to affect another.
  • But beyond timing issues, it might also reflect support from policy. For example, the furlough scheme has smoothed out the economic impact of the virus on households’ incomes. And by supporting existing homeowners, the mortgage holiday scheme is helping to prevent a rise in forced sellers.
  • Indeed, regional housing markets currently face conflicting pressures that are both pushing up and pulling down house prices. For example, we know that before the virus, regions with a high number of office-based jobs also tended to have higher prices. (See Chart 37.)
  • On the one hand, office-based workers are less likely to be disrupted by the virus, and places with higher house prices will also see a greater benefit from the temporary stamp duty cut. (See Chart 38.) But on the other hand, housing demand in places with more office-based workers will see greater disruption from increased in working from home.
  • These competing forces make the near-term outlook for regional house prices particularly uncertain. In the near-term, virus-related disruption is likely to worsen, as the UK imposes further restrictions. But charting the likely regional spread of the virus is impossible, so it is hard to predict which places will be harder hit by restrictions on a three month horizon.
  • However, looking on a six month to one-year horizon, virus restrictions are more likely to loosen than tighten. Rather, factors such as the end of the stamp duty cut next year will rise in prominence. That will hit London and the South of England harder than elsewhere. On top of that, our work on the future of property after COVID-19 suggests that large expensive global cities will see a larger disruption to demand from working from home. (See our Focus.) This again points to underperformance in the capital.
  • On balance, we expect London house prices to reverse much of their recent gain in 2021, and we expect prices in the south of England to perform comparatively poorly next year too. (See Chart 39.) Meanwhile, we expect modest house price growth across most of the other regions. But the big picture is that regional house price differentials will remain large. (See Chart 40.)

The Regional Outlook

Chart 33: Nationwide Regional House Price Growth
(Q3 2020, % y/y)

Chart 34: Surveyors’ Reported Rise in Prices
(September 2020, % Balance)

Chart 35: Change in Regional Unemployment Rate
(Mar 20 to Aug 20, % pts.)

Chart 36: Employment and House Prices by Region

Chart 37: House Prices and Employment in Office-Based Sectors (2019)

Chart 38: Average House Price and Previous Stamp Duty Threshold (£000s)

Chart 39: Regional House Price Forecasts (% y/y)

Chart 40: Regional House Price to Earnings Ratio

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


Residential Lettings Market

Rental market weakness still to come

  • Tenant demand has risen for four consecutive months following lockdown, although the pace of growth slowed a touch in September. (See Chart 41.) Meanwhile, landlord instructions have been broadly flat since August.
  • Taken together, the balance of demand and supply suggests that rental market pressures are at close to pre-virus levels. On past form, that result would typically point to rents rising at around 2% per year. (See Chart 42.)
  • However, the coronavirus has left the rental market outlook particularly uncertain, and there are reasons to suggest that further downward pressure on rents may be on the way.
  • For one, renewed coronavirus restrictions have left the economic outlook weaker than we previously thought. What’s more, there are reasons to suggest that fresh virus rules will hit renters harder than owner occupiers.
  • Indeed, the data show that younger adults are much more likely to rent rather than own a home. (See Chart 43.) And younger adults have also seen a disproportionately large economic impact compared to other age groups. ONS data show that the fall in employment among workers aged between 18 and 24 since February has been greater than all the other groups combined.
  • Combined, these two facts suggest that renters have been hit harder by virus restrictions than owner occupiers. Such an assertion is supported by the effect of a recent methodological correction on the labour market statistics. After including more renters and fewer owner occupiers, employment and unemployment have been revised to a level that is materially worse than previously thought. (See Chart 44.)
  • Admittedly, renters have seen some policy support from the eviction ban, which had suspended court hearings. Those courts have since reopened, but pent-up evictions probably won’t have a material impact on rents. (See our Update.) Also, the government has extended the notice period for evictions to six months – delaying the time between when a landlord wishes to evict a tenant and when it can be enforced by the courts.
  • What’s more, on a fundamental basis, rents are not very expensive compared to past norms. (See Chart 45.) So aside from in London, where rental affordability is comparatively poor, that should support rents across our forecast.
  • Still, with fresh virus restrictions likely to hit employment and renters set to be affected more, the rental market outlook is weak. We expect rents to fall by a peak of 3% during 2021, before recovering gradually across the rest of our forecast. (See Chart 46.) That is broadly in line with its previous relationship with employment.
  • We think that weaker rents, combined with the surge in house prices, will drive a modest fall in gross rental yields to around 4.5% by the end of 2021. (See Chart 47.) We expect yields to stay at roughly that level across 2022 as well. All this suggests that while total returns on residential property will perform well this year – far exceeding commercial property in 2020 – cooling house price growth and falling yields will hit total returns from 2021 onwards. (See Chart 48.)

Residential Lettings Market

Chart 41: Tenant Demand and Landlord Instructions
(% Balance)

Chart 42: Lettings Supply/Demand Balance and England Rents

Chart 43: Fall in Employment and % Renters by Age

Chart 44: Revisions to Employment (Millions)

Chart 45: Rent and Mortgage Affordability
(As a Percentage of Net Income, %)

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 recovery limited by weaker demand

  • Alongside the wider housing market, housebuilders have enjoyed a rapid recovery in new home reservations. (See Chart 49.) That follows the sharp deterioration in demand and sales during and immediately after lockdown.
  • Admittedly, the data suggest that the new home market may have seen a slower recovery than the market for existing homes.
  • Furthermore, housebuilders reported a fall in year-on-year site visits in August. (See Chart 50.) But that could reflect prospective buyers viewing homes less frequently due to fears around the spread of COVID-19, rather than a sign of weakness in new home demand.
  • Indeed, the big picture is that private housing output has already recovered to just over 90% of its pre-virus level. (See Chart 51.) And while public sector housebuilding has experienced a slower ascent, it makes up a much smaller part of housing construction.
  • That said, fresh virus restrictions are coming into force, which will weaken the economic backdrop over the next few months. This is also likely to introduce fresh uncertainty into the housing market, which will also act as a drag on demand.
  • So, while the fairly rapid recovery in demand after lockdown led to a drop in reported demand constraints faced by builders, that improvement may see a modest reversal across Q4 and Q1 next year. (See Chart 52.)
  • Still, taking a step back, housebuilders benefit from a highly resilient financial position. They enjoy historically high margins. (See Chart 53.) Given the continuation of the Help to Buy scheme to 2023 and recent rise in house prices, those margins are likely to stay large.
  • Furthermore, housebuilders also have large cash reserves. This means that, even if the housing market were to see a substantial slowdown over the next three or six months, builders are unlikely to experience financial difficulty because of it.
  • In fact, with unemployment rising and property development in the commercial sector likely to be weak for some time, housebuilders may benefit from favourable material and labour availability over the next few years. (See Chart 54.) And any further virus restrictions will have comparatively little effect on construction, which was also spared from a shutdown in April and May. Both these supply-related factors will support housebuilding.
  • The main constraint facing builders is demand. While housing sales in the wider market have surged over the last few months, that will soon fade as pent-up demand is expended and the stamp duty cut expires.
  • Moreover, while Help to Buy will remain in place for some time, the scheme will be pared back from early next year, which will have a modest downward effect on demand.
  • In all, we expect to see 115,000 housing starts in 2020, down from 152,000 last year. But that will most reflect the steep fall in construction seen during Q2. By 2021, we expect starts to rise to 139,000 and stay at roughly that level in 2022 as well. (See Chart 55.)
  • That profile is also broadly in line with the weak level of house price growth we have pencilled in for the next two years. (See Chart 56.)

Housing Supply

Chart 49: New Home Reservations and New Buyer Enquiries (% Balance)

Chart 50: New Home Site Visits and Net Reservations
(% Balance)

Chart 51: Housing Construction Output in Great Britain
(Index, 2018 = 100)

Chart 52: Reported Constraints on Demand from Builders (% Balance)

Chart 53: UK Listed Housebuilder Gross Margin (%)

Chart 54: Builders Reporting Labour and Materials Constraints (% Balance)

Chart 55: Transactions and Housing Starts Forecast
(000s, 4q Rolling Sum)

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

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


Andrew Burrell, Chief Property Economist, 020 7811 3909, andrew.burrell@capitaleconomics.com
Hansen Lu, Property Economist, +44 7941 425 127, hansen.lu@capitaleconomics.com
Sam Hall, Assistant Property Economist, sam.hall@capitaleconomics.com