Housing market tail risks recede - Capital Economics
UK Housing

Housing market tail risks recede

UK Housing Market Outlook
Written by Hansen Lu
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Lockdown slammed the brakes on activity and house price growth, but policy interventions have cushioned the blow for housing. As a result, our initial fears of a house price collapse have waned. That said, we still expect house prices to fall 3.5% in 2020, before reversing that dip in 2021. Meanwhile, as the economy restarts, housing transactions and construction will see a quick initial recovery. But the lasting impact of the coronavirus on the economy means that both will struggle to reach their pre-virus levels by the end of our forecast horizon.

  • Overview – Lockdown slammed the brakes on activity and house price growth, but policy interventions have cushioned the blow for housing. As a result, our initial fears of a house price collapse have waned. That said, we still expect house prices to fall 3.5% in 2020, before reversing that dip in 2021. Meanwhile, as the economy restarts, housing transactions and construction will see a quick initial recovery. But the lasting impact of the coronavirus on the economy means that both will struggle to reach their pre-virus levels by the end of our forecast horizon.
  • The Economic Backdrop – GDP will recover fairly slowly across our forecast period and as the furlough scheme ends a further wave of redundancies is likely. But we now expect the unemployment rate to peak later and lower than we previously thought. Meanwhile, we expect Bank Rate to hold at 0.1% across our forecast, and further monetary stimulus is likely.
  • Valuation and Affordability – Housing affordability entered the crisis in a good place. While the house price-to-earnings ratio is high compared to past norms, low interest rates mean mortgages are cheap to service. Looking ahead, as mortgage interest rates gradually respond to the latest rate cut and monetary policy is loosened further, the outlook for affordability is good.
  • The Mortgage Market and Completed Sales – The withdrawal of high LTV lending will hinder the housing market recovery, with first-time buyers hit particularly hard. But relative to the GFC, credit availability should recover fairly promptly. In all, we expect a strong initial rebound in lending, although a weakened economy means that, even by the end of 2022, mortgage approvals and transactions will still be below their pre-virus level.
  • House Prices – House prices are set to fall by 3.5% this year on the back of a damaged economy. But housing market confidence is surprisingly strong and that will be bolstered by the stamp duty cut. As a result, the risk of a house price collapse has been significantly reduced. As the economy improves next year, we expect prices to recover their post-virus dip.
  • The Regional Outlook – We expect house prices to fall everywhere in 2020. But with a higher share of office-based jobs and the stamp duty cut to support transactions at higher price points, London will do better than the other regions. In 2021, as the economy and confidence improve, we expect house prices to rise across the whole of the UK.
  • Residential Lettings Market – The rental market has emerged from the crisis in surprisingly good shape. But a second wave of redundancies means rents will see a peak-to-trough fall of 2%. Given the high proportion of short-let properties, rents in Scotland and London are at risk of larger falls.
  • Housing Supply – While housebuilding collapsed during lockdown, the rebound in housing demand combined with builders’ strong financial position suggests that activity will rebound quickly. That will be supported by government policy, which is likely to place housing construction high on its priority list.

Main Forecasts

Table 1: Housing Market Forecasts

2019

2020

2021

2022

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

216.7

209.2

217.6

222.0

% y/y

1.5

-3.5

4.0

2.0

Completed transactions

mn

1.18

0.92

1.08

1.14

% y/y

-1.1

-21.8

17.3

5.2

Employment

% y/y

1.1

-1.0

-0.8

2.0

ILO Unemployment rate

%

3.8

5.0

6.7

5.5

Average earnings (inc. bonuses)

% y/y

3.5

-0.7

2.0

2.0

Real h’hold disposable income

% y/y

1.3

-2.3

0.4

2.0

Headline CPI Inflation

% y/y

1.8

0.6

1.2

1.3

Real Household spending

% y/y

1.0

-17.4

14.0

4.2

Real GDP

% y/y

1.5

-11.0

9.5

3.3

Affordability & valuation (year-end)

Mortgage affordability

%

35.1

33.5

33.5

32.9

(payments as % of take-home pay)

House price-to-earnings ratio

6.9

6.7

6.8

6.7

Bank Rate

%

0.75

0.10

0.10

0.10

Mortgage Interest Rate

%

1.89

1.75

1.60

1.50

Mortgage lending

Mortgage Approvals – Total

000s

1,550

1,255

1,457

1,482

– for house purchase

000s

790

616

720

761

  for remortgage

000s

588

518

593

570

  other

000s

173

123

144

152

Gross mortgage advances

£bn

268

215

251

260

Net mortgage lending

£bn

48.2

42.6

33.6

43.6

Mortgage arrears (>2.5% of bal.)

% of loans

0.7

1.4

1.3

1.1

Possessions

% of loans

0.02

0.02

0.05

0.04

The rental market

BTL mortgage advances

000s

70.0

62.6

66.0

64.3

(for house purchase)

% of total

9.4

11.4

9.5

9.3

Rental value growth (year-end)

% y/y

1.5

0.8

-1.4

1.5

Gross rental yields (year-end)

%

4.8

5.0

4.7

4.7

Net returns for housing (year-end)

%

2.1

-2.8

4.5

2.6

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

-1.0

2.5

1.5

South East

% y/y

-0.3

-1.0

2.0

2.0

East of England

% y/y

0.1

-2.5

2.0

2.0

South West

% y/y

1.5

-4.5

4.5

2.0

East Midlands

% y/y

0.5

-4.0

3.0

3.0

West Midlands

% y/y

2.7

-4.0

4.0

2.0

North East

% y/y

2.7

-4.5

3.5

2.0

North West

% y/y

1.8

-4.0

3.0

2.0

Yorkshire & the Humber

% y/y

1.6

-2.5

3.5

2.0

Wales

% y/y

1.5

-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

Sunak’s big summer spend

  • GDP is likely to recover slowly for the rest of the year and may not reach pre-crisis levels until 2022 at the earliest. (See Chart 1.) This is due to social distancing measures, which are hindering activity in industries which make up a large share of GDP such as entertainment and hospitality. On top of that, Brexit-based uncertainty is expected to stall a much-needed response in business investment.
  • The Chancellor’s Summer Economic Update contained an additional £30bn of support measures, including a coronavirus “Job Retention Bonus” and a restaurant discount scheme to encourage eating out. These “phase two” measures sit on top the furlough scheme and other initial measures which the OBR estimates have already cost £133bn.
  • However, the latest spending announcements probably won’t be sufficient to boost the recovery enough for the UK to catch up to the economic path of other major economies. (See Chart 2.)
  • Encouragingly, consumer and business confidence have both started to recover as the UK returns to work and the high street following the lifting of lockdown restrictions. (See Chart 3.) That said, the recovery in confidence is likely to moderate as the deadline of the UK-EU transition period approaches come this December.
  • We predict unemployment will peak at around 7% in mid-2021. This is lower than we had previously anticipated and reflects the success of the government’s furlough scheme. In fact, headline employment fell by only 360,000 (1.1%) between February and May, though we expect this figure to rise to 5% over the next 12 months. (See Chart 4.)
  • The combination of a 15% cut in the standard rate of VAT for hospitality and tourism and August’s “Eat Out to Help Out” restaurant discount scheme means the UK could experience a temporary bout of deflation in July or August. (See Chart 5.)
  • But whether this happens will depend on the extent to which businesses pass on the VAT cut and how many participate in the discount scheme. Since these measures are temporary, they should incentivise households to spend, pulling up GDP and inflation towards the tail-end of 2020.
  • The government’s large fiscal stimulus comes amidst falling tax receipts and increased welfare spending from the economic fallout of the coronavirus. Hence, we expect the public deficit to top £380bn this year (19.4% of GDP) and total public debt to jump from 80% of GDP to about 105%. This would push public debt to a level which hasn’t been seen since the Second World War. (See Chart 6.)
  • In the long-run, the inflation rate looks likely to settle closer to 1.5% rather than the Bank of England’s 2% target.
  • As a result, we expect the Bank will soon need to loosen policy further. We expect a larger expansion in QE than most other forecasters, with an extra £250bn of purchases by the end of 2021. (See Chart 7.) We expect this to be accompanied by interest rates of 0.10% across our forecast. In turn, we expect this to keep 10-year Gilt yields at historic lows out to the end of 2022. (See Chart 8.)

The Economic Backdrop

Chart 1: Level of GDP (Q4 2019 = 100)

Chart 2: Level of GDP Across Major Economies
(Q4 2019 = 100)

Chart 3: Consumer and Industrial Confidence Indicators

Chart 4: Employment (000s)

Chart 5: CPI Inflation (%)

Chart 6: Public Sector Net Borrowing (% of GDP)

Chart 7: Forecasts for the Stock of QE Purchases (£bn)

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

Sources: Refinitiv, BoE, Bloomberg, European Commission, GfK, CE


Valuation and Affordability

Low interest rates to boost affordability

  • House prices have fallen since the coronavirus hit the UK. But the decline has so far been limited. (See Chart 9.) Indeed, prices are still in line with levels seen a year earlier. Combined with the hit to incomes from lockdown, the house price-to-earnings ratio (HPE) has actually risen slightly across the first half of 2020. (See Chart 10.)
  • This unexpected pick-up in the HPE should be temporary, and in part reflects the different speed at which the recession has hit house prices and incomes, as well as the surge in prices at the start of the year. Over the next few months, as house prices fall, the HPE ratio is likely to fall too.
  • While a weakening economy has weighed heavily on housing demand, housing valuations will be broadly supportive of prices across our forecast. Indeed, we expect measures of valuation and affordability to improve over the next few years.
  • As mentioned previously, that will in part reflect a falling HPE ratio. But it will also reflect lower interest rates. (See Chart 11.) From 1.9% at the end of last year, we expect the average effective mortgage interest rate to fall to 1.75% by the end of 2020, 1.6% in 2021 and 1.5% in 2022. That would put mortgage pricing at an all-time low.
  • Cheaper mortgages, combined with a lower HPE ratio, mean mortgage affordability will reach its most favourable level since 2002. (See Chart 12.)
  • Of course, the recession will weigh on housing in the near-term. A particular concern is rising uncertainty, which means there is currently an increased risk premium on buying a house. And a decline in house price expectations is also a negative for the house price outlook. When house prices are expected to fall in the future, then the price that a buyer would be willing to pay for a house in the present will also fall.
  • Then again, while house price expectations became exceedingly negative during and immediately after lockdown, they have already recovered most of that fall. (See Chart 13.)
  • Of course, further house price falls may once again make buyers more pessimistic about future prices. But set against that, interest rates are now set to be lower for longer. By our calculation, the 40bps fall in mortgage interest rates we have forecast will raise the long-run equilibrium house price by around 5%. (See Chart 14.) In the near-term, cheaper mortgage pricing will at least partly counteract the rise in the risk premium on housing. And once house prices expectations recover further, falling interest rates will make valuations look more attractive.
  • Looking beyond owner occupiers, valuations in the rental market will also be supportive. Admittedly, our measure of rental affordability has sharply deteriorated over the last quarter. That reflects the immediate impact of lockdown on earnings, which should reverse as the economy reopens. (See Chart 15.) The bigger picture is that rents are unlikely to collapse, which will keep investment looking attractive for landlords.
  • Indeed, we think residential will continue to look attractive relative to commercial property. That reflects the tendency for residential capital values to be less volatile during a crisis. On top of that, growth in residential rents have tended to outperform commercial in the long-run. (See Chart 16.)

Valuation and Affordability

Chart 9: UK House Prices (£000s)

Chart 10: House Price-to-Earnings Ratio

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Chart 11: Interest Rates (%)

Chart 12: Mortgage Payments as a % of Average Full-Time Pay

Chart 13: House Price Expectations (% Balance)

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

Chart 15: Rental Yield and Rental Affordability (rent payment as share of earnings)

Chart 16: Residential and Commercial Rents (Index)

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


The Mortgage Market and Completed Sales

Stamp duty cut will support the recovery

  • House purchase mortgage approvals fell to 15,800 in April and 9,300 in May due to lockdown. (See Chart 17.) That put lending down by 76% and 86% respectively during those two months. That was broadly in line with our expectations.
  • Looking ahead, we expect activity to recover fairly swiftly. After all, the RICS data show a sharp rise in new buyer enquiries and new sales instructions in June. (See Chart 18.) Households therefore seem more keen to transact than we had expected. Furthermore, the stamp duty cut will convince many hesitant buyers to complete transactions before it expires.
  • Yet, we remain cautious about the pace of the recovery. First, unemployment will rise out to the middle of 2021 as the furlough scheme is withdrawn. Uncertainty is also set to persist, as the economy grapples with the risk of the coronavirus. After pent-up demand from lockdown is released, that will keep demand suppressed relative to pre-virus levels.
  • Lenders have also pulled back on riskier types of loans. High LTV lending has been withdrawn en-masse, while tighter credit scoring has limited loan availability at lower LTVs. That reflects fears about the economic outlook and house prices, as well as lenders tightening their risk appetite. (See Chart 19.)
  • The withdrawal of high LTV lending will affect first-time buyers (FTB) more than the other sectors. Around 10% of new mortgage advances are above 90% LTV, but that rises to a quarter for FTBs. (See our Update.)
  • Also, the stamp duty cut has temporarily eliminated a tax advantage for FTBs. They also tend to purchase cheaper homes than movers, which makes them even less likely to benefit from the tax break. Taken together, this means FTB lending will underperform the wider market in 2020. (See Chart 20.)
  • Beyond 2020, our expectation is for credit availability to recover fairly quickly. Admittedly, the end of the stamp duty cut will weigh on activity next year. But that will be offset by improving credit conditions. After all, lenders are in a strong financial position – they are well capitalised, have enjoyed central bank liquidity support and have mortgage books that are resilient to severe house price shocks. (See Chart 21.)
  • Taking all this together, mortgage approvals and transactions will see a rapid bounce back in Q3, but the recovery to hit a wall at around 90% of its pre-virus level. (See Chart 22.) This will leave lending below its pre-virus level across our forecast. We expect to see 920,000 transactions in 2020, rising to 1.08 million in 2021 and 1.14 million in 2022.
  • Meanwhile, the outlook for remortgaging is brighter. On an annual basis, approvals for refinancing fell by only a third across April and May. (See Chart 23.) This is unsurprising, as remortgaging typically carries a lower risk for both the borrower and lender. It also has lower requirements for physical access to a property. Our forecast is for remortgaging to recover quickly and reach its pre-virus level by the start of 2021.
  • In all, we expect gross lending to fall from £268bn in 2019, to £215bn in 2020, before rising to £251bn in 2021 and £260bn in 2022. (See Chart 24.) Net lending however, has held up surprisingly well. That reflects the pause on repayments from the mortgage holiday scheme. We expect net advances to hold broadly steady at around £40bn a year across our forecast horizon.

The Mortgage Market and Completed Sales

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

Chart 18: New Buyer Enquiries and Sales Instructions
(% Balance)

Chart 19: Banks’ Reported Reasons for Changing Credit Availability

Chart 20: Mortgage Advances by Buyer Type
(% y/y)

Chart 21: Forecast Effect of Stress Scenarios on UK Banks’ Mortgage Book LTVs (% of Book)

Chart 22: Employment and House Purchase Mortgage Approvals (wrong title or chart!)

Chart 23: Remortgaging Approvals (000s per Qtr) (Move forecast line)

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

Sources: Bank of England, RICS, Refinitiv, UK Finance, HMRC, CE


House Prices

Risk of a house price crash has receded

  • Having surged following December’s election, house prices are now falling. Data on the pace of the decline is limited, but the Halifax has recorded a much steeper fall than the Nationwide. (See Chart 25.) Meanwhile, Rightmove data point to a 2.4% rise in asking prices between March and June.
  • So far, downward house price pressures seem restrained relative to what was seen during the GFC. Months’ of unsold supply, a leading indicator of house price movements, points to only a modest fall in prices over the coming months. (See Chart 26.) Indeed, data from the RICS and Zoopla show a post-lockdown surge in demand.
  • Looking ahead, several factors mean the likelihood of house price falls this year have narrowed. First, we now know that government support for households has delayed and prevented many redundancies – flattening out the peak in unemployment. (See Chart 27.)
  • Second, regulatory and government interventions mean lender forbearance is much more generous than during the last crisis. Indeed, with 1.9 million already signed up, the mortgage holiday scheme is unprecedented in size and generosity.
  • Combined, these two factors point to only a modest rise in arrears and possessions across our forecast. In turn, this points to far fewer forced sellers than during the last recession.
  • Third, lenders are well capitalised and enjoy substantial policy support. So, while risker mortgages have been withdrawn in recent months, we expect credit provision will be restored sooner rather than later. Indeed, the Nationwide has already signalled a return to 90% LTV mortgages. We think other major lenders will soon follow. Resilient mortgage availability will help to prop-up demand, supporting prices during the downturn.
  • Fourth, falling interest rates have supported housing valuations. Mortgage affordability has in the past been a signal of overvaluation and an impending house price collapse. (See Chart 28.) But with interest rates likely to fall over the next two and a half years, this time around affordability will support prices.
  • The stamp duty holiday will also have a positive impact on prices, although the direct effect will be small. On average, buyers will save around 1% of the value of their purchase and not all of that saving will be passed through to house prices. (See Chart 29.)
  • That said, the housing market outlook still carries significant uncertainty. We cannot completely rule out a collapse if the economy becomes unexpectedly weak or if lenders become much more cautious than we expect. Furthermore, overly negative house price expectations could also trigger collapse. (See Chart 30.)
  • But for now, housing market confidence is unexpectedly strong, and that was only been has been bolstered by the stamp duty cut. Assuming that house price expectations do not spiral down, we expect prices to fall by 3.5% in 2020. But as the recovery builds momentum, we expect prices to rise by 4% in 2021. (See Chart 31.)
  • That forecast compares favourably to what was seen during the GFC, when prices fell by 18% and remained down by 10% from its peak two years later. (See Chart 32.)

House Prices

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

Chart 26: Months of Unsold Stock and House Prices

Chart 27: Mortgage Possessions and Unemployment

Chart 28: Mortgage Payments as a % of Full-Time Earnings

Chart 29: House Price Expectations and House
Price Growth (This should be 30)

Chart 30: SDLT Savings as a % of Purchase Price
(% of Transactions) (This should be 29)

Chart 31: House Prices
(% y/y)

Chart 32: House Prices Months from Crisis
(Index 100 = Peak)

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


The Regional Outlook

London prices will be resilient

  • Regional house prices have weakened in response to the coronavirus. But low housing market activity continues to affect the accuracy of the data, so it’s hard to gauge how prices have performed since the virus hit.
  • Data from the Nationwide suggests that, on an annual basis, prices in Q2 were flat or up across every UK region. (See Chart 33.) But data from Acadametrics show larger regional variations in annual price growth, with some regions seeing a fall and other regions, primarily in the south, rising strongly. (See Chart 34.)
  • In reality, neither index can be fully trusted, particularly when regional prices rely on sample sizes that are 90% smaller compared to the national index.
  • Looking ahead, we probably won’t have a good picture of regional house prices for at least several months. But we do know that regional housing markets will be dependent on regional economic performance.
  • So far, London, Scotland, the South West and Northern Ireland have been hardest hit in terms of employment. (See Chart 35.) By contrast, employment in the North East, Wales and Yorkshire & the Humber have been the most resilient.
  • That seems to reflect the make-up of those regions’ economies. After all, places with the largest falls in employment have also tended to have more jobs in industries hit hardest by lockdown – accommodation, food services, the arts and recreation. (See Chart 36.)
  • Yet, with unemployment to rise further in the coming months, that regional picture could change drastically.
  • Across our forecast, we still think house prices in London, the South East and East of England will do better than elsewhere, as those regions have a higher concentration of jobs in sectors that are the least vulnerable to the virus. (See Chart 37.) And unlike jobs linked to tourism and hospitality, those higher paid sectors are more likely to drive owner occupier demand.
  • Furthermore, the stamp duty cut will have a regional dimension. Houses in the South of England are more expensive, meaning homes there are more likely to benefit from the tax cut. (See Chart 38.) Indeed, with an average house costing £470,000, the typical London buyer is set to enjoy a stamp duty saving close to the maximum 3% of a home’s value.
  • Of course, the tax cut will be reversed in 2021. For regions supported this year, the recovery in prices will be softer next year.
  • What’s more, there is a broader question of whether a shift towards working from home will affect demand for housing on a regional level. We will explore this question in an upcoming Focus. (See Global Property Update.)
  • In all, we expect house prices across all the regions to fall this year. But we think prices in London, the South East and East of England will fall by between 1% to 3% this year. That will be less than the 4% to 5% fall we expect to see across the rest of the UK. (See Chart 39.) In 2021 we expect that trend to reverse, with London and its surrounding regions seeing a comparatively weaker rebound.
  • In terms of regional valuations, the crisis will be broadly neutral. Following the initial shift due to lockdown, we expect the regional house price to earnings ratios to be broadly flat across our forecast. (See Chart 40.)

The Regional Outlook

Chart 33: Nationwide Regional House Price Growth
(Q2 2020, % y/y)

Chart 34: Acadata Regional House Price Growth
(May 2020, % y/y)

Chart 35: Change in Regional Employment
(Mar 20 to May 20, %)

Chart 36: Employment in Accommodation, Food Services, Arts and Recreation (% per Region, 2019)

Chart 37: Employment in Finance, IT, Professional, Technical & Administration (% per Region, 2019)

Chart 38: Average House Price and Pre-Budget 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 falls still to come

  • ONS data show rental growth at 1.5% y/y in June. This was unchanged on May, although the data can be slow to respond to underlying market conditions. (See Chart 41.)
  • Pre-COVID, demand and supply conditions had pointed to sharply accelerating rental growth. But the virus means this is now unlikely. Rather, the demand and supply data now point to modest rental growth on an 18-month horizon. Consistent with that, there are signs of a recovery in lettings demand in June. (See Chart 42.)
  • On the face of it, the UK rental market has emerged from lockdown in surprisingly good shape. Data from Knight Frank show the residential rent collection rate falling to only 94% during lockdown, before starting to recover in May. (See Chart 43.) That stands in sharp contrast to commercial property. For example, reported retail rent collection has dipped as low as 30% since lockdown commenced.
  • High levels of rent collection reflect the Furlough scheme, which has allowed many households to maintain income even though they have been unable to work. Once the scheme ends later this year, rising unemployment will probably trigger a fresh fall in rental demand. That will have a knock-on effect on rents next year.
  • Our valuation metrics show that, outside of London, rents are not particularly high. (See Chart 44.) In nearly every region, rental affordability looks better than it was a decade ago. This suggests that any slump in rents is unlikely to become permanent.
  • Then again, there are risks to the rental market outlook. The biggest is from Airbnb. Landlords with short-let properties have been heavily affected by the drop in tourism. If conditions do not improve soon, a large numbers of properties may be switched to the long-let market. That could flood the market and lead to a collapse in rents.
  • Admittedly, many regions have a small exposure to Airbnbs. (See Chart 45.) But the South West, Wales, London and Scotland do not. Rightmove has already reported a sharp rise in rooms for rent in Edinburgh and London. This suggests that rents there could fall faster and further than elsewhere.
  • Taking all this together, we expect rents to see a peak to trough fall of 2%, with the market bottoming out at the end of 2021. (See Chart 46.) But, as the economy recovers next year, we expect rents to respond positively, triggering a 1.5% rise during 2022. That forecast is broadly consistent with the historic relationship between rents and employment growth.
  • As a result, rental yields are set to see a gentle rise across 2020, as house prices fall back more quickly than rents as a result of the pandemic. (See Chart 47.) That will be reversed as the owner occupier market recovers in 2021 and rents fall back. Gross yields will end 2022 at 4.7%, slightly lower than the 4.8% seen in 2019.
  • Residential property will see an average total return of 4.5% across the years 2020 to 2022. That compares favourably to the 4.1% we have forecast for all commercial property. (See Chart 48.)

Residential Lettings Market

Chart 41: Rental Market Tightness and Rental Growth

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

Chart 43: Rent Collection Rates (2020, %)

Chart 44: Rental Affordability (Index)

Chart 45: Regional Estimate of Entire Home Airbnbs as a % of Private Rented Dwellings, 2018

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

Strong financials point to housebuilding recovery

  • Housebuilders reported a collapse in demand during lockdown. (See Chart 49.) According to the HBF survey, the balance of builders reporting falling site visits compared to a year earlier fell to minus 84% in May. That was the lowest reading on record.
  • Unsurprisingly, the rate of construction also fell sharply during lockdown. ONS data show that construction output in April dropped to just 37% of its 2019 level. (See Chart 50.)
  • Of course, by late April, some builders had already started to reopen their sites. But the pace of that reopening was slow. Construction data for May show that output was still down by more than half compared to 2019.
  • Looking ahead, there are reasons to be optimistic about the recovery. After all, June’s housing PMI rose to 59, up from just 31 in May. (See Chart 51.) That suggests construction has recovered much more strongly since May’s disappointing result.
  • Indeed, we expect construction to recover fairly quickly over the next few months for a number of reasons. First, housing construction is heavily constrained by how quickly the market can absorb newly built homes. Signs of a strong rebound in demand across June and July means builders will have the confidence to ramp up construction.
  • Second, housebuilders are in a good financial position. (See Chart 52.) Financial data on the UK’s nine largest listed housebuilders show large cash reserves and low levels of debt ahead of lockdown. They have the financial resources to act in their long-term interests, boosting construction output now ahead of the market fully recovering.
  • Third, at an average of 27% in 2019, housebuilders’ gross margins were very healthy before the crisis hit. (See Chart 53.) As long as demand picks up as expected, new homes can be sold profitably even if house prices fall by 5% or 10%.
  • Finally, the Help to Buy scheme will support demand for new homes. Indeed, just under half of the scheme’s funding is still to be used before March 2023. (Chart 54.) What’s more, while the scheme is due to end in 2023, we think it will probably be renewed.
  • Having said all that, despite what is likely to be a rapid initial recovery, construction will struggle to rise back to its pre-virus level within the next two years. That reflects the long-lasting effects of unemployment and confidence on housing demand, which will constrain the ability of builders to sell homes. (See Chart 55.)
  • We think housing starts probably slumped by a hefty 70% y/y in Q2. But as housing demand recovers in Q3 and Q4, we expect starts to bounce back rapidly. (See Chart 56.) Relative to 2019, we expect to see a 25% fall in housing starts during 2020.
  • Beyond that, we expect construction to recover by 25% y/y in 2021. That will still leave activity down by around 5% versus its 2019 level. Housing starts will only rise back to their pre-virus level by 2022.
  • The risks to this forecast are increasingly balanced. For example, if demand or prices end up weaker than we expect, then housebuilding may also underperform. But if the wider housing recovery is faster than we expect, or if the replacement for Help to Buy ends up more generous than we anticipate, construction might also outperform.

Housing Supply

Chart 49: Site Visits and New Buyer Enquiries
(% Balance)

Chart 50: Housing Construction Output in Great Britain
(Index, 2016 = 100)

Chart 51: Housing Construction PMI and Housing Starts

Chart 52: Cash and Debt Position of Top 9 UK Listed Housebuilders (£m)

Chart 53: UK Listed Housebuilder Gross Margin (%)

Chart 54: Help to Buy Completions and Funding (£bn)

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

Chart 56: Transactions and Housing Starts (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
Bradley Saunders, Research Assistant, bradley.saunders@capitaleconomics.com