Limited housing market recovery next year - Capital Economics
UK Housing

Limited housing market recovery next year

UK Housing Market Outlook
Written by Andrew Burrell
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Regardless of the Brexit outcome, we don’t expect a rebound in either house prices or transactions in 2019. Rather, there is hope of a modest improvement in housing market activity in both 2020 and 2021, assuming a no-deal Brexit is avoided in October. That said, house price growth is unlikely to accelerate anytime soon, although we do think the outlook for rental growth is improving.

  • Overview – Regardless of the Brexit outcome, we don’t expect a rebound in either house prices or transactions in 2019. Rather, there is hope of a modest improvement in housing market activity in both 2020 and 2021, assuming a no-deal Brexit is avoided in October. That said, house price growth is unlikely to accelerate anytime soon, although we do think the outlook for rental growth is improving.
  • The Economic Backdrop – Our economic forecasts are now comprised of three key scenarios. But the big picture is that, assuming a no-deal Brexit is avoided, interest rates are set to rise, which will in turn push up mortgage interest rates. Meanwhile, a no-deal outcome could be disruptive in the short-run, but we think the economy would recover quickly.
  • Valuation and Affordability – House prices are very high relative to incomes, in part reflecting the low level of mortgage interest rates. Looking ahead, rising mortgage interest rates over the next few years are unlikely to cause payment difficulties among borrowers. In the event of a no-deal Brexit, rate cuts could lead to a fresh decline in mortgage interest rates, which would help to prop up demand.
  • The Mortgage Market and Completed Sales – While buyer and seller activity rose in June, we don’t expect a recovery in mortgage approvals or transactions this year. That said, in both our Brexit deal and repeated delay scenarios, a modest recovery in activity can be expected in 2020 and 2021 – driven by a solid underlying economy and a decline in the house price-to-earnings ratio. And while we think a no-deal exit could drive a short, sharp drop in activity, it probably wouldn’t trigger a prolonged decline in housing sales.
  • House Prices – House price growth is sluggish and unlikely to bounce back, regardless of the Brexit outcome. After all, the economic shock of a no-deal Brexit would keep housing demand subdued and buyers wary of bidding up prices. But even without such a shock, we think high house prices and rising interest rates would prevent prices growing any faster than 2% per-year.
  • The Regional Outlook – London’s house price decline has a little further to run, while prices in the South East will also fall a little this year. But across the rest of the country, we expect house prices to grow at between 1% and 4% per year out to 2021, with the North of England and Northern Ireland seeing some of the strongest gains.
  • Residential Lettings Market – Rental growth is accelerating, and we expect that to continue out to 2021. That reflects the landlord sell-off, which is constricting the supply of rented properties, as well as continued strong wage growth, which will support rental demand.
  • Housing Supply – Housing construction has peaked. Much of that reflects changes to Help-to-Buy, which will restrict the scheme’s eligibility in 2021. Indeed, we take easing labour constraints as a sign that builders have already moderated their demand expectations in preparation for this policy change. So even assuming no disruptive no-deal Brexit, we expect housebuilding to fall by 1% per-year, out to 2021.

Main Forecasts

Table 1: Housing Market Forecasts (Repeated Delay Scenario)1

2018

2019

2020

2021

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

213.4

215.5

218.7

223.1

% y/y

0.5

1.0

1.5

2.0

Completed transactions

mn

1.19

1.18

1.19

1.23

% y/y

-2.8

-1.0

1.5

3.0

Employment

% y/y

1.2

0.9

0.4

0.4

ILO Unemployment rate

%

4.1

3.9

4.0

4.0

Average earnings (inc. bonuses)

% y/y

2.9

3.7

3.6

3.5

Real h’hold disposable income

% y/y

2.2

2.1

1.2

1.1

Headline CPI Inflation

% y/y

2.5

1.9

2.4

2.2

Real Household spending

% y/y

1.8

1.8

1.8

1.7

Real GDP

% y/y

1.4

1.4

1.5

2.0

Affordability & valuation (year-end)

Mortgage affordability

%

36.7

36.2

36.3

37.5

(payments as % of take-home pay)

House price-to-earnings ratio

7.0

6.8

6.7

6.6

Bank Rate

%

0.75

0.75

1.00

1.25

Mortgage Interest Rate

%

2.15

2.25

2.40

2.55

Mortgage lending

Mortgage Approvals – Total

000s

1,535

1,549

1,555

1,566

– for house purchase

000s

781

773

785

809

  for remortgage

000s

584

603

594

576

  other

000s

171

173

177

182

Gross mortgage advances

£bn

266

262

266

272

Net mortgage lending

£bn

44.8

39.9

42.7

42.5

Mortgage arrears (>2.5% of bal.)

% of loans

0.8

0.9

1.0

1.1

Possessions

% of loans

0.01

0.01

0.02

0.03

The rental market

BTL mortgage advances

000s

67.2

63.4

65.1

67.6

(for house purchase)

% of total

8.5

8.3

8.4

8.4

Rental value growth (year-end)

% y/y

1.0

1.5

2.5

3.5

Gross rental yields (year-end)

%

4.8

4.8

4.8

4.9

Net returns for housing (year-end)

%

1.4

1.8

1.9

2.4

Housing Supply

Housing starts

000s

165

163

161

160

% y/y

0.4

-1.2

-1.0

-1.0

Regional house prices (year-end)

London

% y/y

-0.9

-3.0

-1.0

0.0

South East

% y/y

-0.7

-1.0

0.0

0.0

East of England

% y/y

1.9

1.0

0.0

1.0

South West

% y/y

1.9

1.0

1.5

0.0

East Midlands

% y/y

4.0

2.0

3.0

3.0

West Midlands

% y/y

3.0

2.0

3.0

3.0

North East

% y/y

1.0

3.0

2.0

3.5

North West

% y/y

2.2

1.0

2.0

3.0

Yorkshire & the Humber

% y/y

3.7

2.0

2.5

3.5

Wales

% y/y

3.9

1.0

2.0

2.5

Scotland

% y/y

0.9

1.0

2.0

3.5

Northern Ireland

% y/y

5.9

2.5

3.0

3.5

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

1Based on a scenario in which Brexit is repeatedly delayed. For forecasts based on a deal or a no deal, please see our UK Economics Update “Pick your own Brexit forecast,” 1st July 2019.


Main Forecasts (continued)

Table 2: Selected Housing Market Forecasts (October Deal Scenario)

2018

2019

2020

2021

Housing Market and Mortgage Lending

Nationwide house prices (Q4 on Q4)

£000s

213.4

215.5

218.7

223.1

% y/y

0.5

1.0

1.5

2.0

Completed transactions

mn

1.19

1.18

1.21

1.24

% y/y

-2.8

-0.7

2.0

2.5

Mortgage approvals for house purchase

000s

195

194

201

206

Mortgage Interest Rate

%

2.15

2.25

2.40

2.80

The Economy

ILO Unemployment rate

%

4.1

3.9

4.0

4.0

Average earnings (inc. bonuses)

% y/y

2.9

3.7

3.6

3.5

Headline CPI Inflation

% y/y

2.5

2.0

2.2

2.2

Real GDP

% y/y

1.4

1.4

1.7

2.2

Bank Rate

%

0.75

0.75

1.00

1.50

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

Table 3: Selected Housing Market Forecasts (No Deal Scenario)

2018

2019

2020

2021

Housing Market and Mortgage Lending

Nationwide house prices (Q4 on Q4)

£000s

213.4

214.5

217.7

222.0

% y/y

0.5

0.5

1.5

2.0

Completed transactions

mn

1.19

1.15

1.11

1.19

% y/y

-2.8

-3.0

-3.6

7.3

Mortgage approvals for house purchase

000s

195

175

193

199

Mortgage Interest Rate

%

2.15

2.20

1.95

2.10

The Economy

ILO Unemployment rate

%

4.1

4.0

4.3

4.5

Average earnings (inc. bonuses)

% y/y

2.9

3.6

3.6

3.4

Headline CPI Inflation

% y/y

2.5

2.1

3.0

2.7

Real GDP

% y/y

1.4

1.1

0.5

2.2

Bank Rate

%

0.75

0.50

0.25

0.50

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


The Economic Backdrop

Brexit continues to shape the UK outlook

  • The UK economy probably contracted in Q2 for the first time since 2012, though we doubt that will mark the start of a recession. Much of the weakness reflects activity being shifted from Q2 into Q1 ahead of the original Brexit deadline. So just as the 0.5% q/q gain in GDP in Q1 made the economy look stronger than it was, a fall in Q2 (we’re expecting -0.1% q/q) will overstate its weakness. GDP is expected to rise again in Q3. (See Chart 1.)
  • Looking ahead, we think Brexit will be the main influence on the UK economy in the near-term, and we now have forecast scenarios based on three different Brexit outcomes. These are a deal in October, no deal in October and repeated Brexit delays. Each scenario shows how the economy could be pushed along different paths over the next few years. (See Chart 2.)
  • In the event of a no deal, there are a wide range of outcomes for GDP growth, depending on the state of preparations, tariffs, the government’s policy response and UK/EU relations. Our assumption is that interest rate cuts and looser fiscal policy would help GDP rebound from the initial slump quicker than is widely expected. (See Chart 3.)
  • In contrast, if a Brexit deal is struck by October, reduced uncertainty would lead firms to restart stalled investment plans. (See Chart 4.) In that event, GDP growth could then rise from about 1.4% y/y this year to around 2.2% y/y in 2021.
  • Meanwhile, If Brexit were to be repeatedly delayed until the end of 2021, business investment would probably recover as well. We would expect that to push up GDP growth to 2.0% y/y in 2021.
  • Aside from Brexit, there are three economic trends that can be identified. First, over the next year or so, we think the global economy will be more of a drag on UK activity than most others expect. (See Chart 5.) So, despite a more subdued outlook for real incomes, we expect domestic demand, led by consumer spending, to continue to underpin economic growth.
  • Second, fiscal policy will be looser in all Brexit scenarios. After a no deal, this stimulus would play an important role in supporting the economy. In other Brexit scenarios, it would provide an extra impetus to growth. A stronger economy is expected to reduce the deficit and perhaps even eliminate it by 2022/23, which will create the room for extra fiscal spending relative to existing plans. (See Chart 6.)
  • Third, as businesses pass on past rises in wage growth in their pricing, inflation is expected to exceed the official 2% target. (See Chart 7.) The increase would be most marked after no deal, as the boost to import prices from a weaker pound could lift inflation to above 3%. No deal is expected to push the pound down from its current $1.25 to around $1.15. By contrast, other Brexit outcomes could result in the pound rising.
  • Looser fiscal policy and higher inflation also point to higher interest rates. That said, even if there is a deal or Brexit is delayed, the softer global backdrop would mean rates aren’t hiked before the middle of 2020. And if there were to be a no deal, rates would be cut initially, from 0.75% to 0.25%, although we expect that these moves would begin to be reversed from 2021. (See Chart 8.)

The Economic Backdrop

Chart 1: Real GDP (% y/y)

Chart 2: GDP under Different Brexit Outcomes (%y/y)

Chart 3: GDP in Different No Deal Outcomes (% y/y)

Chart 4: Investment (% y/y)

Chart 5: Trade Partner GDP & UK Exports (% y/y)

Chart 6: Public Sector Net Borrowing (Exc. Banks, £bn)

Chart 7: CPI Inflation (%)

Chart 8: Bank Rate (%)

Sources: ONS, Refinitiv, Capital Economics


Valuation and Affordability

Mortgage affordability to stay favourable

  • House prices are very high compared to where they have been in the past. At £214,400 in Q2, the average house now costs 16% more than the peak recorded before the financial crisis, in 2007. (See Chart 9.) What’s more, house prices look comparatively expensive when compared to a multitude of other assets.
  • For example, prices are elevated relative to rents. Admittedly, in recent months, the house price to rent ratio has dropped a little. But at just under 26 times, it is nonetheless just shy of a record high, and higher than it was in the run-up to the financial crisis, when it peaked at around 25 times. (See Chart 10.)
  • House prices are also very high relative to commercial property prices. Taking the first quarter of 2000 as a baseline, house prices in nominal terms have risen by 160%. (See Chart 11.) By comparison, commercial property prices have risen by just 40%. And despite weakening house price growth, the ratio of commercial to residential property prices has held largely steady over the last year.
  • Meanwhile, the house price to earnings ratio has admittedly eased a little in the last year or two. That reflects both the pick-up in wage growth, as well as the broad slowdown in house price gains. Importantly, however, the size of the change has been fairly small. With the HPE ratio still very high versus past norms, this means the downward adjustment may still have further to run.
  • An underappreciated driver of the current state of the housing market has been mortgage interest rates. Borrowers paid an average of 9% in the 1970s and 1980s to borrow for a home, falling to around 5% in the 1990s and 2000s, up to the financial crisis. But the latest data show that the average effective mortgage interest rate has fallen to just over 2%. (See Chart 12.)
  • That cheap credit has made borrowers more willing and able to take on more debt, and lenders more willing to extend it – in part explaining the rise in mortgage loan-to-income ratios. (See Chart 13.) And that is a key factor underpinning the high house prices currently seen in the market. (See Chart 14.)
  • Looking ahead, if a Brexit deal is agreed in October, we expect mortgage interest rates to rise, reaching 2.4% in 2020 and 2.8% in 2021. (See Chart 15.) And if Brexit is delayed in October, we expect just one fewer rate hike across our forecast, leaving mortgage interest rates at 2.6% by the end of 2021. Meanwhile, a no-deal Brexit would lead to two rate cuts, leaving mortgage interest rates at 2% by the end of 2020, rising to 2.1% in 2021.
  • The big picture is that mortgage affordability will stay favourable in both our Brexit deal and repeated delay scenarios. (See Chart 16.) So while rising interest rates might make buyers more wary of taking out larger mortgages, they are unlikely to cause any repayment difficulties.
  • Meanwhile, if the UK were to exit the EU with no deal in October, falling mortgage interest rates combined with weaker house price growth and resilient income growth would lead to a substantive improvement in mortgage affordability. That will help to counterbalance the likely drop in sentiment that would come about following a no-deal exit from the EU.

Valuation and Affordability

Chart 9: House Prices (£000s)

Chart 10: House Price to Rent Ratio

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Chart 11: House Prices and Commercial Property Prices
(2010 = 100)

Chart 12: Bank Rate and Mortgage Interest Rate Forecast
(Brexit Delay Scenario)

Chart 13: Loan to Income Ratio and Mortgage Interest Rates

Chart 14: Mortgage Affordability and House Price to Earnings Ratio

Chart 15: Mortgage Interest Rate Forecasts (%)

Chart 16: Mortgage Affordability Forecasts
(Payments as a % of Income)

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


The Mortgage Market and Completed Sales

Too soon to call a recovery in activity…

  • Mortgage approvals for house purchase are still in the middle of the 62,000 to 72,000 loans per month range seen since 2014. (See Chart 17.) Meanwhile the data on transactions have been more downbeat. HMRC statistics showed a 6.2% m/m drop in housing transactions, and a hefty 11.3% annual decline, during May. (See Chart 18.)
  • The reason for that fall is not clear. Admittedly, the RICS data on sales per surveyor have been falling for some time. But with that data having deviated from the main transactions seriessince 2016, that might reflect problems with the survey, rather than an actual decline in housing market activity. Furthermore, the mortgage approvals data, which should be a leading indicator of transactions, do not show a sudden decline.
  • Indeed, the latest data from the RICS pointed to a rebound in demand during June. (See Chart 19.) And the new sales instructions data point to a rise in active supply too. That result suggests that, whatever the cause of May’s slump in sales, it probably won’t be repeated.
  • The RICS survey also reported an improvement in both short and long-term house price expectations in June, suggesting that Brexit uncertainty may have started to ease, at least temporarily. (See Chart 20.)
  • Meanwhile, credit availability has held up well. Weak demand has driven up competition between lenders, who despite the perceived risks of Brexit, have continued to compete strongly for business. That can be seen in the interest premium on high LTV loans, which fell to a fresh post-crisis low. (See Chart 21.)
  • Yet, despite all this, it is still too soon to call a recovery in the market. After all, despite the sharp drop in mortgage pricing, high LTI lending has risen by only a few percentage points over the last two years. (See Chart 22.) Furthermore, high loan-to-income ratios show that borrowers are already stretched, limiting the prospect of a fresh credit-fuelled boom. Indeed, with October’s Brexit deadline still to come, even the recent improvement in sentiment may be short lived.
  • In our view, the near-term outcome for mortgage approvals and transactions will depend on what happens with Brexit. Admittedly, we expect either repeated Brexit delays or a Brexit deal in October to have a similar impact on activity, with house purchase approvals falling in 2019 by around 1% in both scenarios. After all, the pipeline of new housing transactions would take some time to rebuild, given the delay between buyer enquiry and sale completion.
  • Beyond that, if a Brexit deal were to be agreed soon, we think house purchase mortgage approvals and transactions could rise by a modest 2% in 2020 and 3% in 2021 – driven by improving buyer sentiment and a solid economic backdrop. (See Charts 23 & 24.)
  • In our Brexit delay scenario, we think house purchase mortgage approvals would still rise by 1.5% in 2020 and 3% in 2021. That would reflect Brexit fatigue, as buyers returned to the market and transacted despite ongoing uncertainty.
  • In the event of a no deal Brexit, the outcomes for the housing market would be more negative. We think lending and transactions would drop in total by as much as 10% by the middle of 2020, as cautious buyers hold back from purchasing. That said, any turmoil would be short-lived, and we think activity could quickly bounce back.

The Mortgage Market and Completed Sales

Chart 17: Mortgage Approvals for House Purchase

Chart 18: Transactions and Sales Per Surveyor

Chart 19: New Buyer Enquiries and New Sales Instructions (% Balance)

Chart 20: House Price Expectations (% Balance)

Chart 21: Interest Margin Between 95% and 75% LTV 2-Year Fixed Rate Mortgage (%)

Chart 22: New High LTI and High LTV Lending
(% Share)

Chart 23: House Purchase Mortgage Approvals Forecasts
(000s per Qtr)

Chart 24: Transactions Forecasts (000s per Qtr)

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


The Mortgage Market and Completed Sales (continued)

… and no BTL comeback is due

  • If Brexit were to be delayed again, we think the mix of owner-occupier and house purchase mortgage lending would stay broadly steady, as any impact on confidence and the economic backdrop would affect both buyers in a similar way. (See Chart 25.) Meanwhile, if a Brexit deal were to be agreed, we think the outcome would be similar.
  • The size of Help-to-Buy is set to grow substantially in the next few years. (See Chart 26.) And changes to the scheme will favour FTBs over movers, as the latter will be excluded from participating after 2021. Yet the scheme only covers new homes, which is a relatively small part of the wider market, meaning the overall effect on house purchase activity will be fairly small.
  • Beyond that, there are few reasons why the ratio of movers to FTBs will soon shift. And while a no-deal Brexit could cause a short-term shift in the roughly 50:50 ratio of FTBs to movers, the precise effect is very hard to accurately predict.
  • In the BTL market, the latest mortgage lending data for Q1 2019 show that there has been no recovery in net BTL lending since the stamp-duty surcharge was introduced in 2016. (See Chart 27.) We take this as a sign that the sell-off among landlords has continued. (See our Update.)
  • Looking ahead, we expect BTL activity to stay depressed. Much of that reflects changes to the taxation – the stamp duty surcharge and reduction in BTL mortgage interest tax relief – which have discouraged many existing and prospective investors.
  • Another factor discouraging BTL is that house prices are very high relative to rents, versus both the past and compared to other countries – which points to low rental returns (See Chart 28.) And with house price growth sluggish, capital gains are also weaker than before.
  • We don’t expect returns to improve by much across our forecast. After all, house price growth will stay sluggish and we expect rental yields to stay low. So even if a Brexit deal is agreed this year, or if Brexit is delayed, those underlying factors will still discourage investment in BTL. Thus, we expect BTL mortgage advances to see little growth over the next three years. (See Chart 29.)
  • Compared to the house purchase market, we expect Brexit to have a comparatively small effect on remortgaging. Rather, we expect that sector to be driven by the flow of existing mortgage deals coming to an end. According to UK Finance, that figure is set to peak in 2019, as the previous rise in longer fixed-rate mortgages cuts refinancing need. (See Chart 30.) We expect that to drive a gentle reduction in remortgaging volumes in 2020 and 2021, of 1.5% y/y and 3% y/y respectively.
  • Taking all this together, in our Brexit delay scenario, we expect gross lending to drop slightly, to £262bn in 2019, down from £266bn in 2018. (See Chart 32.) But we expect lending to tick back up to £266bn in 2020, before rising to £273bn in 2021. Meanwhile, we expect net lending to hold broadly steady at around £40bn a year across our forecast.
  • If a Brexit deal were to be agreed in October, our outlook for gross and net lending would be broadly similar. Meanwhile, in a no-deal exit, we would expect a short term drop in both gross and net lending. But with our forecast for transactions, we would expect lending to rebound in 2020 and 2021.

The Mortgage Market and Completed Sales (continued)

Chart 25: Owner Occupier Mortgage Advances
(000s, Brexit Delay Scenario)

Chart 26: Help to Buy Completions and Budget (£bn)

Chart 27: Net Change in the Stock of BTL Mortgages (000s)

Chart 28: House Price to Rent Ratio
(Index, 1981 = 100)

Chart 29: Buy to Let Mortgage Advances (000s)

Chart 30: Existing Fixed Duration Mortgage Deals Coming to an End (000s)

Chart 31: Remortgaging Approvals Forecast
(000s per Qtr)

Chart 32: Gross and Net Lending Forecasts
(£bn, Brexit Delay Scenario)

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


House Prices

Price growth sluggish in all scenarios

  • The latest house price data show a divergence between the Nationwide and Halifax indices. On the one hand, the Nationwide index recorded prices rising by 0.5% y/y in June – broadly in line with our expectations. (See Chart 33.) But on the other hand, the Halifax index recorded a surge in annual house price growth, to 5.7%.
  • Admittedly, our measure of months of unsold supply suggests that house prices should be growing at a much faster rate than at present. (See Chart 34.) That said, this indicator has been unreliable for several years now. For example, back in 2017 and 2018, it suggested that house prices should be growing as quickly as 15% y/y – a pick-up in the market never materialised.
  • Of course, the latest RICS data suggests that the market may be starting to turn. (See Chart 35.) Yet on past form, the relationship between house price growth and new buyer enquiries is sketchy at best. And in any case, the relationship is lagged by at least 9 months. So even if demand were to see a sustained recovery now, the effects on house price growth probably wouldn’t be felt until later this year, and early 2020.
  • Our outlook, however, is for house price growth to stay sluggish for the foreseeable future. And we expect that forecast to hold regardless of the Brexit outcome. That is driven primarily by the fact that house prices are very high – constraining effective housing demand.
  • So why are house prices so high? A key factor is the fact that borrowers are taking on much larger mortgages than in the past. (See Chart 36.) That has been enabled by the record low level of interest rates, which have made borrowers more willing and able to take on larger loans, and lenders more willing to extend such loans. (See our Focus: “Will house prices boom again?”)
  • Looking ahead, if there is a delay to Brexit or a no deal exit, interest rates will start to rise – curbing the supportive effect that cheap credit has had on house prices. On top of that, the current regulator-mandated mortgage affordability test limits buyers’ maximum loan-to-income ratio to around 5 times. (See Chart 37.) But as interest rates rise, the maximum available LTI may drop to 4.5 times or less, constraining credit availability.
  • Of course, this specific effect of regulation is not certain. It is dependent on standard variable rates rising, and no adjustment to the existing rules on mortgage affordability – both of which are likely but not guaranteed.
  • Taking all this together, if we assuming that a no-deal Brexit is avoided in October, we expect house price growth of 1% in 2019, accelerating to 2% in 2021 – in line with the gentle recovery in mortgage approvals in our forecast. (See Chart 38.) In turn, that will allow for a gradual downward adjustment in house prices in real terms. (See Chart 39.)
  • Meanwhile, in the event of a no-deal Brexit later this year, the shock to the economy and confidence is likely to hit housing demand fairly hard. But we expect any economic impact to be fairly short and sharp, with only a small rise in unemployment. Moreover, we also think a no-deal would trigger rate cuts. All this means that a no-deal Brexit probably won’t trigger a wave of forced sellers, and thus a collapse in house prices. (See Chart 40.)

House Prices

Chart 33: House Price Growth (% y/y)

Chart 34: Months of Unsold Supply and House Prices

Chart 35: New Buyer Enquiries and House Prices

Chart 36: Debt to Disposable Income Ratios (%)

Chart 37: Effect of Mortgage Affordability Test on Maximum LTI

Chart 38: House Price and Transactions Forecast
(% y/y, Brexit Delay Scenario)

Chart 39: Real House Price Forecast
(£000s, Brexit Delay Scenario)

Chart 40: Unemployment Rate and Arrears
(No Deal Scenario)

Sources: Halifax, Nationwide, RICS, UK Finance, Capital Economics


The Regional Outlook

London’s adjustment set to continue

  • Transactions in London saw a small annual gain in the latest reliable data, which are for November. (See Chart 41.) That was only the second such rise in 14 months. That said, the data can be fairly volatile. And the RICS data on newly agreed sales are consistent with falling transactions in the first half of 2019.
  • Meanwhile, house prices in London continued to fall. According to the official UK house price index, house prices in London fell by 4.4% in the 12 months to May 2019. But the Nationwide data was slightly less negative, recording just a 0.8% y/y drop for Q2.
  • Digging deeper into the data, London’s fall in prices was fairly evenly spread across the boroughs in June. (See Chart 42.) That reflects a partial recovery in prime central London prices, after the large drop in Q1.
  • Interestingly, London saw a rise in new buyer enquiries – the first such rise in nine months. (See Chart 43.) Meanwhile, the fall in new sales instructions also paused, suggesting that seller confidence has improved.
  • Consistent with that, house price expectations improved a little. Most notably, surveyors were, on balance, neutral about the prospects for house prices a year ahead – a much more positive outlook than what was typically recorded six months ago. (See Chart 44.)
  • But that isn’t a sign that Brexit related fears have gone away. After all, a fall in prices is still expected over the next three months. Moreover, with October’s deadline approaching, Brexit uncertainty is far from over. We doubt that a sentiment-led rebound in London house prices is imminent.
  • Indeed, the big picture is that London’s housing market has, in recent years, been characterised by rising stock levels. (See Chart 45.) That reflects the fact that effective housing demand in London has been constrained by the high level of prices relative to incomes. With sellers generally reluctant to drop prices to shift their homes, more properties are being left unsold on the market for longer.
  • Admittedly, the last few months have seen a slight reduction in unsold stock per surveyor in London. (See Chart 46.) That has driven an improvement in months of unsold stock – signalling a slight turn in market conditions back in favour of sellers. Yet, on past form, that measure is still consistent with a fall in house prices by the end of the year.
  • Assuming a no-deal Brexit is avoided, our expectation is that London house prices will fall by 3% this year, followed by a 1% fall in 2020 and flat prices in 2021. (See Chart 47.) That reflects the high level of prices in the capital, as well as our expectation of a rise in interest rates, which will impact London buyers more than elsewhere.
  • Those forecasts suggest that London’s house price to earnings ratio will fall further than it already has done, from a peak of 13 times in 2016, to just under 11 times by 2021. (See Chart 48.) That will allow mortgage affordability to improve across our forecast, despite a gentle rise in interest rates.
  • Meanwhile, London might take a bigger hit from a no-deal Brexit than elsewhere. But, as for the UK as a whole, any economic slowdown would likely be short and sharp. And London buyers would also benefit the most from a rate cut. So we doubt that London prices would collapse in the event of no-deal, although transactions in the capital could fall more sharply in the short-run.

The Regional Outlook

Chart 41: London Newly Agreed Sales and Housing Transactions

Chart 42: London House Price Growth (% y/y)

Chart 43: London New Buyer Enquiries and New Sales Instructions (% Balance)

Chart 44: London House Price Expectations
(% Balance)

Chart 45: London Unsold Stock per Surveyor

Chart 46: London Months of Unsold Stock and House Price Growth

Chart 47: London House Price Forecast
(% y/y, Brexit Delay Scenario)

Chart 48: London Mortgage Affordability and House Price to Earnings Ratio (Brexit Delay Scenario)

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


The Regional Outlook (Continued…)

… but prices will keep growing in the regions

  • Of all the UK regions, the South East recorded the worst performance in Q2, with prices dropping by 1.7% y/y. (See Chart 49.) But, the other regions bar London recorded rising prices, with Northern Ireland, Wales and Yorkshire & the Humber performing fairly strongly.
  • The South East’s weakness is unsurprising given its proximity to London, which has seen falling prices for some time. Indeed, the historic data show a correlation coefficient of 0.9 the South East and the capital – stronger than anywhere else. (See Chart 50.)
  • The underlying driver of the weakness in the South East reflects the high level of house prices there. With buyers increasingly unwilling or unable to pay asking prices, our measure of months of unsold stock has pointed to flat or gently falling prices for some time now. (See Chart 51.)
  • Yet we don’t expect prices in the South East to drop by much more than they already have done. After all, months of homes for sale has not risen by nearly as much in the South East as in London, where prices have only seen fairly modest falls. Given our expectation that London price falls will peak this year at minus 3%, prices in the South East probably won’t see much more than a 1% fall in 2019, before flattening out in 2020 and 2021.
  • Looking elsewhere, we do not expect house prices to fall in any other region across our forecast. Much of that view reflects the fact that house price-to-earnings ratios across the rest of the country, while high relative to the past, aren’t nearly as bad as they are in London or the South East. (See Chart 52.) Most regions of the UK are fairly well insulated against rising interest rates, which pose more of a danger to prices in London and the South of England.
  • Indeed, the other UK regions have not exhibited the falling transactions and rising stock levels seen in London and the South East. (See Chart 53.) This suggests that conditions in those regions are more favourable to sellers than buyers, which if anything points to faster house price growth in the medium term.
  • Finally, house prices in all the regions continue to be supported by a solid economic backdrop. After all, looking at the last two years, all of the regions bar the East Midlands have seen a flat or falling unemployment rate. (See Chart 54.) And the data for Q1 show that, with only a few exceptions, all the UK regions have seen a decent rate of wage growth over the last year.
  • At the same time, a fresh boom in regional house price growth is also unlikely. After all, even if a no-deal Brexit is avoided this year, economic growth will pick-up fairly gradually, while confidence in prices is likely to take at least a few months to bounce back.
  • Assuming a no-deal Brexit is avoided, we expect the UK regions bar London and the South East to see modest rates of house price growth, of between 1% to 4% per year, out to 2021. (See Chart 55.) That will drive a gradual convergence in the regional house price-to-earnings ratios across our forecast. (See Chart 56.)
  • If the UK exits the EU with no deal, regional house price growth would likely be weaker than if a deal is struck or Brexit is delayed. But with any negative impact on the economy to be fairly short-lived, any dip in house prices would likely be minor, and brief.

The Regional Outlook (Continued…)

Chart 49: Regional House Price Growth
(Q2 2019, % y/y)

Chart 50: Regional House Price Growth Correlation with London

Chart 51: South East Months of Unsold Stock and House Price Growth

Chart 52: Regional House Price to Earnings Ratio

Chart 53: Transactions and Stock Per Surveyor
(% Change, Jan 2015 to Present)

Chart 54: Unemployment Rate by Region (%)

Chart 55: Regional House Price Forecast
(Brexit Delay Scenario)

Chart 56: Regional House Price to Earnings Ratio
Forecast (Brexit Delay Scenario)

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Sources: ONS, Nationwide, RICS, Capital Economics


Residental Lettings Market

Rise in rental growth ahead

  • Rental growth recovered in Q2. According to inflation data, rents rose at 1.3% y/y in June – up from 1.1% in April. (See Chart 57.) And the ONS IPHRP also recorded rents rising by 1.3% y/y in June.
  • Rising rental growth reflects strong underlying rental market conditions. Data from the RICS show another fall in landlord instructions. (See Chart 58.) That reflects tax changes to BTL, which have driven some existing landlords away and discouraged many others from expanding their portfolios.
  • At the same time, tenant demand has been rising – a shift that is harder to explain. It might reflect low unemployment, and the subsequent rise in demand from more households looking to rent. Another possible explanation is that Brexit uncertainty has pushed buyers to delay house purchase decisions, leaving them renting for longer.
  • Admittedly, without more hard evidence, it is hard to show why demand is rising. But what we do know is that, across the UK as a whole, rents are not overly high. Indeed, compared to past norms, rents are fairly cheap after taking into account rising incomes. (See Chart 59.) And, while rents look high compared to payments on a new mortgage, that gap doesn’t account for the exceptionally low level of mortgage interest rates, which is likely to reverse in the coming years.
  • Looking ahead, wages are expected to grow faster than 3% a year out to 2021. (See Chart 60.) That is likely to support tenant demand, especially if it helps to bring some of the young adults currently living with their parents back onto the rental market. In any case, with rents tending to rise broadly in line with incomes, our forecast for wage growth is consistent with rents rising faster than now.
  • The lettings demand and supply data also point to accelerating rental growth over the next year or so. (See Chart 61.) And the rent expectations data show a broad upward trend over the last 6 quarters, which is strongly associated with rising rental growth.
  • In all, assuming a no-deal Brexit is avoided, we expect annual rental growth to pick up to 1.5% in 2019, to 2.5% in 2020 and 3.5% in 2021.
  • Importantly however, that would still leave gross rental yields broadly steady over our forecast. (See Table 4.) With Bank Rate set to rise, the spread between mortgage interest rates and rental yields will narrow, keeping BTL investment looking unattractive. (See Chart 62.)
  • That said, the outlook for the build-to-rent (BTR) sector looks more favourable. While total returns on commercial property have tended to beat residential since the financial crisis, that outperformance is set to reverse in the coming years. (See Chart 63.) With the case for BTR strengthening, investment in the sector is likely to maintain its current pace, or even strengthen, out to the end of our forecast. (See our Focus: “Assessing the case for build-to-rent.”)
  • Meanwhile, residential rental growth is likely to be a little slower in a no-deal Brexit scenario. But history shows that rents tend to be resilient in the face of economic shock, suggesting that the effect of no-deal on rents would be fairly minor.

Residental Lettings Market

Chart 57: Growth in Rents (% y/y)

Chart 58: Tenant Demand and Landlord Instructions

Chart 59: Mortgage Payments and Rents as a % of Full-Time Disposable Earnings (Brexit Delay Scenario)

Chart 60: Rental Growth and Earnings (% y/y)

Chart 61: England Rents and Lettings Supply & Demand Balance

Table 4: Annual Residential Property Returns
(Interest-Only Mortgage, Brexit Delay Scenario)

Chart 62: Mortgage Interest Rate and Gross Rental Yields (%, Brexit Delay Scenario)

Chart 63: Total Returns on Property (%)

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Sources: VOA, RICS, DCLG, UK Finance, Refinitv, Capital Economics


Housing Supply

Early signs of construction drop

  • In recent years, a key factor holding back growth in housing construction has been a shortage of labour and materials. But the latest data show that those shortages have all but disappeared. (See Chart 64.) So why has this happened?
  • Looking at construction employment, easing labour shortages have come at a time of fairly rapid employment growth in the construction industry. (See Chart 65.) Indeed, ONS data suggest that employment grew by 4% y/y across the first three months of 2019.
  • Combined with the fact that unemployment is so low, this means that the easing in labour constraints probably does not reflect falling employment in another construction sector making labour easier to find for housebuilders. Rather, we think it reflects reduced demand from housebuilders themselves, who face worsening demand conditions. Indeed, builders responding to the HBF survey have reported 20 consecutive months of falling site visits, while the use of sales incentives has been elevated since mid-2018. (See Chart 66.)
  • Admittedly, that has not yet translated to a drop in new home sales. The latest reliable data from the Land Registry show that sales were broadly stable, on an annual basis, in November last year. (See Chart 67.) But the HBF survey data, which are more timely and a fairly good leading indicator of new home sales, point to a fall in the first half of 2019.
  • Indeed, there are signs that construction has already dropped in response to slowing demand. The housing construction PMI data for June slumped to 45.1, down from 52.3 in May. (See Chart 68.) Admittedly, the relationship with housing starts is not perfect, and we wouldn’t put too much weight on a single month’s data. Furthermore, there are some reasons to believe that the sharp drop in the PMI might in part reflect the very wet weather seen in early June. (See Chart 69.)
  • But it’s telling that for the last two quarters, housebuilders have considered their work in progress and planned housing starts to be sufficient to meet demand. (See Chart 70.) That stands in contrast to the period between 2013 and 2018, where a solid majority of builders reported that production capacity was insufficient to meet demand.
  • What’s more, future changes to Help-to-Buy will only further dampen demand for new homes. After all, home movers will no longer be eligible for HTB after the current scheme ends in 2021. And those using the revised scheme from 2021 to 2023 will face tighter limitations on maximum house price, which will dampen overall demand for new homes.
  • Combined with the effects of high house prices, evidence of slowing demand, weakening PMI data and the risk of further Brexit uncertainty in the months ahead, the weight of evidence strongly supports our view that housing starts have passed their peak, and will slow over the next few years.
  • Assuming a no-deal Brexit is avoided, our forecast is for housing starts to fall by around 1% per-year, out to 2021. (See Chart 71.) That will start to bring the relationship between transactions and housing starts back towards its long-run trend. And if the UK exits the EU with no deal, that adjustment will come a little quicker, although with any economic disruption set to be short-lived, we doubt that builders would slash their output in response.

Housing Supply

Chart 64: Builders Reporting Constraints on Production (%)

Chart 65: Employment in the Construction Industry (000s)

Chart 66: Builders Reporting Constraints on Buyer Demand (%)

Chart 67: Builders Reporting a Rise in Net Reservations and Newbuild Sales

Chart 68: Housing Starts and Housing Construction PMI

Chart 69: Construction PMI and Rainfall

Chart 70: Housebuilders Reporting Work in Progress and Completed Stocks Adequate to Meet Demand (%)

Chart 71: Transactions and Housing Starts
(000s, Brexit Delay Scenario)

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


Andrew Burrell, Chief Property Economist, 020 7811 3909, andrew.burrell@capitaleconomics.com
Hansen Lu, Property Economist, 020 7808 4988, hansen.lu@capitaleconomics.com

Written by
Hansen Lu Property Economist
hansen.lu@capitaleconomics.com +44 (0)20 7808 4988