Near-term pain, medium-term gain - Capital Economics
UK Housing

Near-term pain, medium-term gain

UK Housing Market Outlook
Written by Andrew Wishart
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Rising unemployment and the withdrawal of the raft of policies that supported the housing market in 2020 means that the pandemic will finally take its toll this year. The end of the stamp duty holiday will cause transactions to slump at the same time as rising unemployment feeds through to a modest rise in forced sales. We think that the result will be a 4% drop in house prices this year, reversing much of the 6.5% increase recorded in 2020. The medium-term outlook is more promising. Vaccination will allow the economy to recover quickly and we expect Bank Rate to remain at 0.10% for the foreseeable future, allowing mortgage rates to decline a bit further. If we are right, house price growth is likely to outpace pay growth from 2022.

Global State of Play, 28th January, 0800 GMT and 1600 GMT. In the first of our regular briefings of the year, Group Chief Economist Neil Shearing will lead a discussion about the economic impact of vaccination programmes, another US fiscal stimulus package and fresh lockdowns in China.

  • Overview – Rising unemployment and the withdrawal of the raft of policies that supported the housing market in 2020 means that the pandemic will finally take its toll this year. The end of the stamp duty holiday will cause transactions to slump at the same time as rising unemployment feeds through to a modest rise in forced sales. We think that the result will be a 4% drop in house prices this year, reversing much of the 6.5% increase recorded in 2020. The medium-term outlook is more promising. Vaccination will allow the economy to recover quickly and we expect Bank Rate to remain at 0.10% for the foreseeable future, allowing mortgage rates to decline a bit further. If we are right, house price growth is likely to outpace pay growth from 2022.
  • The Economic Backdrop – A successful vaccination program should allow the economy to rebound faster than many forecasters expect. Nonetheless, employment will probably drop further this year and we think that Bank Rate will need to stay at 0.10% for the next five years to support the recovery.
  • Valuation and Affordability – Because we think that interest rates will stay low, high house prices will remain affordable. Indeed, rather than causing this year’s house price falls, valuation and affordability will help limit the decline.
  • The Mortgage Market and Completed Sales – The end of the stamp duty holiday, tight lending standards, and rising unemployment will cause a deep slump in home sales in Q2. But our forecast that the economic recovery will be swift, and that Bank Rate will remain low, should mean that the drop in transactions is temporary.
  • House Prices – With unemployment set to rise further and policy support to be withdrawn, much of 2020’s increase in house prices will be reversed this year. But as we doubt unemployment will be elevated for long and mortgage rates have a bit further to fall, prices should start to rise again in 2022.
  • The Regional Outlook – London should see the biggest fall back in prices this year as all the factors driving the national house price dip will be amplified in the capital. It is where the stamp duty holiday has had the largest impact, employment has fallen the most, and where demand will be most affected by more remote working. That said, house prices are likely to dip in all regions this year.
  • Residential Lettings Market – Much of the sharp drop in London rents will be reversed when social distancing restrictions ease, but some of the decrease compared to rents elsewhere will be permanent. Outside the capital, a further rise in unemployment and the eventual end of the evictions ban is likely to cause rental growth to stall.
  • Housing Supply – While construction has recovered well from the first lockdown, builders appear hesitant to start new projects. That won’t change if we are right that transactions will slump, and house prices will dip this year. New supply is therefore likely to be limited for the next two years.

Main Forecasts

Table 1: Housing Market Forecasts

  

2019

2020

2021

2022

House prices, transactions, and the economy

    

Nationwide house prices (Q4)

£000s

215.7

229.6

220.5

226.0

 

% y/y

0.8

6.5

-4.0

2.5

Completed transactions

mn

1.18

1.04

1.16

1.19

 

% y/y

-1.1

-11.5

11.0

3.0

Employment

% y/y

1.1

-0.4

-1.3

2.0

ILO Unemployment rate

%

3.8

4.5

6.0

5.5

Average earnings (inc. bonuses)

% y/y

3.5

1.4

4.0

1.7

Real h’hold disposable income

% y/y

1.9

0.8

2.5

1.2

Headline CPI Inflation

% y/y

1.8

0.8

1.3

1.7

Real Household spending

% y/y

1.1

-11.7

7.5

8.8

Real GDP

% y/y

1.4

-10.0

5.5

6.5

Affordability & valuation (year-end)

   

Mortgage affordability

 

35.1

36.1

33.2

33.3

(payments as % of take-home pay)

     

House price-to-earnings ratio

 

6.9

7.1

6.7

6.8

Bank Rate

%

0.75

0.10

0.10

0.10

Mortgage Interest Rate

%

1.89

1.84

1.50

1.30

Mortgage lending

     

Mortgage Approvals – Total

000s

1,550

1,410

1,440

1,515

– for house purchase

000s

789

820

770

785

  for remortgage

000s

588

455

505

565

  other

000s

173

135

165

165

Gross mortgage advances

£bn

268

247

252

274

Net mortgage lending

£bn

48.1

65.0

44.0

36.5

Mortgage arrears (>2.5% of bal.)

% of loans

0.7

0.8

1.4

1.0

Possessions

% of loans

0.02

0.01

0.05

0.03

The rental market

     

BTL mortgage advances

000s

72.0

72.0

68.5

67.0

(for house purchase)

% of total

9.4

9.7

9.3

8.8

Rental value growth (year-end)

% y/y

1.4

1.3

-1.0

1.2

Gross rental yields (year-end)

%

4.8

4.6

4.7

4.6

Net returns for housing (year-end)

%

1.4

6.6

-3.5

3.0

Housing Supply

     

Housing starts

000s

152

122

130

130

 

% y/y

-10.0

-20.0

7.0

0.0

Regional house prices (Q4)

   

London

% y/y

-1.8

6.2

-6.0

1.5

South East

% y/y

-0.4

6.7

-5.0

1.5

East of England

% y/y

0.1

6.4

-4.5

2.0

South West

% y/y

1.4

6.4

-4.0

2.5

East Midlands

% y/y

0.4

8.5

-4.0

3.0

West Midlands

% y/y

2.6

7.4

-4.0

2.5

North East

% y/y

2.6

6.4

-2.5

3.0

North West

% y/y

1.8

8.0

-3.0

3.0

Yorkshire & the Humber

% y/y

1.5

7.6

-3.0

3.0

Wales

% y/y

1.4

6.6

-1.0

3.0

Scotland

% y/y

2.7

3.1

-3.0

3.0

Northern Ireland

% y/y

1.0

5.9

-2.5

2.5

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


The Economic Backdrop

A fast and full recovery will limit labour market damage

  • We are more optimistic than most in expecting COVID-19 vaccines to allow the economy to surge back to its pre-crisis size by Q1 2022. Nonetheless, the withdrawal of policy support this year will lead to a further drop in employment. And inflation and interest rates will stay low until the economy has fully recovered. We expect Bank Rate to stay at 0.10% for the foreseeable future.
  • The second wave of COVID-19 and associated restrictions will cause GDP to fall again, albeit not as low as during the first lockdown. But if the promising start to the rollout of vaccines is sustained, then a steady easing in COVID-19 will follow from Q2, allowing GDP to rebound rapidly in Q2 and Q3. (See Chart 1.)
  • We think that by 2025 GDP will be back on its pre-COVID-19 trajectory. Admittedly, investment will take time to recover as firms face higher debt burdens and there will be plenty of spare capacity. But a surge in household saving during the pandemic has left consumers in a strong position to ramp up their spending. (See Chart 2.)
  • For all the talk of possible tax rises in the March Budget, we think government spending is likely to remain high until COVID-19 is firmly in the rear-view mirror. While it appears the stamp duty holiday will end as planned, we have pencilled in an extra £25bn (1.3% of GDP) of spending between now and 2022 for vaccinations and further support for the hardest-hit sectors.
  • Of course, the recovery won’t be painless. The scheduled expiry of the furlough scheme at the end of April may mean that the relatively modest 1.4% fall in employment seen so far turns into a 3.0% decline by the end of the year. (See Chart 3.) But it would be a huge success if the furlough scheme meant that the 25% peak-to-trough fall in GDP seen last year only led to the unemployment rate increasing from 3.8% to a peak of 6.5% later this year.
  • What’s more, given our view that the economy’s potential won’t be permanently damaged by the crisis, we suspect that the labour market recovery will be quicker than after previous recessions. By the end of 2022, we think that the unemployment rate will have returned to 5.0%. (See Chart 4.)
  • Average earnings growth has held up relatively well due to compositional effects with job losses concentrated in low-income occupations. But a 20% pay cut for most furloughed workers has taken its toll. (See Chart 5.) As these workers return to work, average earnings growth should rebound. However, it is likely to be muted further ahead given the spare capacity in the economy at the outset of the recovery.
  • Higher oil and food prices and the end of the VAT cut for the hospitality sector will probably push up CPI inflation to almost 2.5% in early 2022. (See Chart 6.) But given soft pay growth, it will probably then ease to 1.5% by the end of next year.
  • As the Bank of England still has plenty of ammunition to use within the existing QE envelope, and because we think that the economy will recover strongly as restrictions are eased, we don’t think it will announce more asset purchases or negative interest rates. (See Chart 7.) And we think the Bank will be slower to raise rates than investors anticipate too, given it has said it needs to be convinced that inflation will stay above 2.0% before it tightens policy. (See Chart 8.)

The Economic Backdrop

Chart 1: Quarterly Real GDP (Q4 2019 = 100)

Chart 2: H’hold Saving Ratio (% of Disposable Income)

Chart 3: Employment & GDP

Chart 4: ILO Unemployment Rate (%)

Chart 5: Total Average Weekly Earnings (3m Average, % y/y)

Chart 6: CPI Inflation (%)

Chart 7: Bank of England Quantitative Easing (£bn)

Chart 8: Bank Rate Expectations (%)

 

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


Valuation and Affordability

Low interest rates will continue to support high prices

  • Because interest rates are very low, and we think that they will remain so, high house prices will remain affordable. Indeed, it is the combination of the withdrawal of policy support and rising unemployment that underpins our view that house prices will slip back this year, rather than high prices. In fact, valuation and affordability will help limit the drop in house prices and prevent it from turning into an outright crash.
  • At first glance, house prices are worryingly high. And the 6.5% surge in 2020 has pushed the house price-to-earnings ratio back up above seven, close to its level before the 2008 crash. (See Chart 9.)
  • Moreover, the outperformance of housing relative to other assets since the pandemic hit suggests that some pull back is overdue. The rise in house prices in 2020 compares to an 8.6% drop in commercial property capital values and a 9.0% drop in equity prices. (See Chart 10.)
  • But lofty valuations are not why we are forecasting a 4% decline in house prices this year. Instead, we think that the current high level of house prices is justified by very low interest rates. Indeed, mortgage affordability remains favourable by historical standards, and nowhere near the levels that preceded the house price crashes of the early 1990s or 2008. (See Chart 11.)
  • Neither do houses look expensive when viewed purely as an income generating asset. The rental yield of residential property looks attractive relative to that of inflation-linked bonds and the earnings yield of equities. The spread between residential and commercial property yields has been relatively stable. Even so, housing may have become more attractive as the pandemic is likely to have worse implications for office and retail rents than residential rents. (See Chart 12.)
  • The biggest risk to house prices is interest rates, so the recent spike in mortgage rates on high Loan-to-Value (LTV) loans is a concern. (See Chart 13.) The number of high LTV products available has also dropped. It’s not clear whether this is mainly due to high demand for mortgages, or banks’ concerns that house prices will fall after the stamp duty holiday. If it is the latter, it will take longer for borrowing rates to come back down and mortgage availability to improve.
  • Even in that case, the strong economic recovery we expect later this year should mean the spike in mortgage rates is short-lived. Ultimately, Bank Rate of 0.10% should mean that mortgage rates decline a bit further. (See Chart 14.) If we are right, and the average rate on new mortgages drops from 1.8% to 1.3% over the next two years, house prices could rise another 6% with affordability remaining at the same level. (See Chart 15.)
  • The Bank of England’s Loan to Income Ratio rule and interest rate stress test on new mortgages could prevent such an increase in house prices being realised. But the FPC appears set to make its guardrails less stringent this year given the lower-for-longer outlook for interest rates. If it does, loan-to-income ratios could rise a bit further.
  • The implication is that, once high LTV mortgages return at competitive prices, the house price-to-earnings ratio could rise further without mortgage affordability suffering. That raises the prospect that after a drop back in prices this year, they could outpace earnings growth somewhat in the medium term. (See Chart 16.)

Valuation and Affordability

Chart 9: UK House Prices (£000s)

Chart 10: Capital Values & Stock Prices (Q4 ‘19 = 100)

Chart 11: Mortgage Affordability and House Price to Earnings Ratio Forecast (%)

Chart 12: Real Yields (%)

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

Chart 14: Interest Rate Forecasts (%)

Chart 15: Mortgage Interest Rate and Loan-to-Income Ratio

Chart 16: Average Weekly Earnings & House Prices (% y/y)

 

Sources: Nationwide, MSCI, Refinitiv, BoE, CE


The Mortgage Market and Completed Sales

End of stamp duty holiday to put handbrake on activity

  • Unless there is an unexpected U-turn, the stamp duty holiday will end as planned at the end of March. The withdrawal of that boost, tight lending standards, and rising unemployment all point to a deep slump in housing market activity in Q2. But our forecast that the economic recovery will be swift, and that Bank Rate will remain low, should mean that the drop is temporary.
  • There is already evidence that the looming stamp duty rise and concerns about viewings and moving while the prevalence of the virus is high are causing buyer demand to drop. Google searches for property portals are down year-on-year for the first time since the first lockdown. (See Chart 17.) The agreed sales balance of the RICS survey is likely to follow, suggesting we are close to the peak in mortgage approval numbers. (See Chart 18.) Indeed, a balance of 22% of surveyors expected sales to be lower in three months’ time in December.
  • The stamp duty holiday turbocharged demand in 2020. Activity would probably have risen anyway, as it has in other countries, due to pent up demand from the initial lockdown, a reassessment of location and space due to remote working, and a decline in mortgage interest rates. Together with the stamp duty holiday, these factors drove mortgage approvals in November up to their highest level since 2007.
  • The stamp duty holiday was generous compared to those we have seen in the past. That means the the incentive to bring purchases forward is larger, and the slump in activity afterwards will be bigger. (See Chart 19.) In 2008/9 the 0% threshold was raised from £125,000 to £175,000, making about 45% of transactions zero-rated. The increase in the 0% rate threshold to £500,000 this time around makes 90% of properties exempt.
  • Meanwhile, the availability of mortgages is limited. The number of 90% LTV products available is 79% lower than before the pandemic, and interest rates on high LTV loans are still high. As a result, the share of loans advanced at high LTV ratios has dropped. (See Chart 20.) And banks have tightened lending criteria in other ways too, such as excluding bonuses from their assessment of borrowers’ incomes.
  • Admittedly, banks report that they expect their risk appetite to improve, and the availability of mortgages to start to recover, in Q1. (See Chart 21.) But the new lockdown announced after the survey was taken and the likelihood that house prices dip after March means that credit standards are only likely to be loosened gradually. If so, credit conditions will also weigh on demand in the near term.
  • Our forecast is that after spiking at 485,000 in Q1, the most in any quarter since 1988, transactions will slump to 190,000 in Q2. (See Chart 22.) The recovery won’t be immediate if we are right that unemployment will rise further and house prices will dip this year. But by Q2 2022, transactions should recover to their pre-virus level of about 300,000 a quarter and continue to increase thereafter given the likely further drop in mortgage rates.
  • Remortgaging should also pick up as the outlook for individuals’ finances becomes clearer and banks are less preoccupied with new business. (See Chart 23.)
  • Putting this all together, lending will surge in Q1 and drop in Q2, before climbing back to pre-virus levels by Q2 2022. (See Chart 24.)

The Mortgage Market and Completed Sales

Chart 17: Google Property Portal Searches & RICS Agreed Sales Balance

Chart 18: RICS Agreed Sales Balance & Mortgage Approvals

Chart 19: Transactions (000s per month)

Chart 20: Proportion of New Mortgages over 90% LTV (%)

Chart 21: Change in Availability of Mortgage Credit

(% Balance)

Chart 22: Mortgage Approvals for House Purchase Forecast (000s per Month)

Chart 23: Mortgage Approvals for Remortgage (000s per Quarter)

Chart 24: Gross and Net Lending Forecasts (£bn per Quarter)

 

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


House Prices

Much of the 2020 price surge will be reversed

  • The negative economic impacts of COVID-19 have largely bypassed the housing market so far due to the extraordinary support measures put in place by the government, regulators, and banks. But while policy has probably reduced and delayed the impact, it will not mitigate it entirely and the pandemic will take its toll on prices this year. That said, the correction will be far smaller than in previous recessions. And if the economy recovers swiftly as we anticipate, prices will rise again in 2022.
  • After house price growth accelerated to 6.5% y/y in Q4 2020, leading indicators are suggesting that it has now peaked. The ratio of sales to stock has started to edge down, indicating that competition between buyers has started to ease. (See Chart 25.) And Rightmove’s index of asking prices suggests that house price inflation will drop back substantially from February as the boost from the stamp duty holiday comes to an end. (See Chart 26.)
  • Indeed, by pulling demand into 2020 from 2021, the stamp duty holiday has created problems. At the end of the much less generous stamp duty holiday in 2008-9 there was a clear change in momentum in house prices. (See Chart 27) We expect to see a similar phenomenon this time around.
  • Given the promising roll out of the vaccine, we have revised down our forecast for unemployment somewhat. But if the furlough scheme ends as planned in April, we still think that the unemployment rate will rise to 6.5% by Q4 this year. The historical relationship between unemployment and house prices suggests that is consistent with a double-digit decline in house prices. (See Chart 28.)
  • To date, the effect of rising unemployment has been mitigated by mortgage payment holidays and the ban on possessions. Indeed, possessions have dropped close to zero. (See Chart 29.) But mortgage payment holidays will end by 31st July and the possessions ban appears set to finish on 1st April.
  • As a result, the effect of higher unemployment on arrears will come through this year. But there are three reasons why we think the fall in house prices will be smaller than that implied by the rise in unemployment.
  • First, banks will be more reticent to repossess homes than in the financial crisis, given their large capital buffers and the prospect of a swift economic recovery. Second, the drop in employment has been concentrated in low paid occupations, in which workers are less likely to be homeowners. And third, due to low interest rates, mortgage payments are affordable and will remain so.
  • Nonetheless, we expect a modest rise in repossessions over the summer. (See Chart 30.) The resulting forced sales will come when transactions volumes are thin following the end of the stamp duty cut. That points to a sudden change in the supply and demand balance of the market that we think will see much of the 2020 price surge reversed. (See Chart 31.) Our forecast is that house prices will drop by 4% y/y in Q4 2021, below most other forecasters’ predictions. (See Chart 32.)
  • However, favourable mortgage affordability, a gradual loosening of credit conditions, and a decline in mortgage rates will prevent the drop in prices we expect evolving into a severe and protracted slump. And with the economy recovering strongly, we have pencilled in a 2.5% rise in house prices in 2022.

House Prices

Chart 25: RICS Sales to Stock Ratio & House Prices

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

Chart 27: Nationwide House Price Index (% 3m/3m)

Chart 28: Changes in the Unemployment Rate & House Prices

Chart 29: The Unemployment Rate & Possessions

Chart 30: Mortgage Arrears & Possessions (% Mortgages)

Chart 31: Nationwide House Price Index

Chart 32: Forecasts for House Prices (Q4 2021, % y/y)

 

Sources: Nationwide, RICS, Rightmove, Refinitiv, UK Finance, HMT, CE


The Regional Outlook

London to record the biggest drop in prices in 2021

  • London should see the biggest fall back in prices this year, as all the reasons we think UK house prices will dip are amplified there. It is where the stamp duty holiday has had the largest impact, employment has fallen the most, and where demand will suffer the most from more remote working. That said, house prices are likely to dip in all regions this year.
  • According to the ONS’s House Price Index house prices in London were up by 9.7% in November, the joint largest regional increase alongside Yorkshire & Humber. However, other house price indexes tell a different story. (See Chart 33.) Indeed, the ONS’s estimate may be suffering from a limited sample size because of delays to registering transactions while solicitors are dealing with very high volumes.
  • In any case, the RICS balance of agreed prices suggests that any momentum that there was in London prices has now petered out. (See Chart 34.) Meanwhile, the near-term prospects for house prices seem to be best in the North West and Wales, where new buyer enquiries continued to rise in December despite the end of the stamp duty holiday nearing.
  • Regardless of what happened in 2020, London house prices look set to underperform over the next couple of years. First, the savings from the increase in the stamp duty threshold from £125,000 to £500,000 were largest in London and the South East. (See Chart 35.) It follows that when the stamp duty holiday ends, these regions will see the deepest slump in buyer demand. Meanwhile, continued strong activity in Wales reflects that the savings from the stamp duty holiday are much less of a factor due to lower house prices.
  • Second, the drop in employment in London has been the largest in any region, and the proportion of the workforce still on furlough is high too. That means the capital has the biggest risk of a further drop in employment when the scheme ends, implying a larger potential rise in forced sales. At the other end of the spectrum, employment has been most resilient in Northern Ireland and the North East. (See Chart 36.)
  • Finally, the strong relationship between house prices and office-based employment should be diluted somewhat by increased remote working after the pandemic. (See Chart 37.) The regions that currently benefit most from this location premium, and will therefore be most disadvantaged by this shift, are London, the South East, and the East of England.
  • That’s why we think that London house prices will drop by 6% this year and continue to underperform in 2022 when UK house prices start to rise again. The South East and the East of England are also set to perform relatively poorly. Wales, Scotland, Northern Ireland, and the North East should see the most limited dip in prices and the strongest recovery in 2022. (See Chart 38.) The upshot is that the price of London housing relative to elsewhere will continue to drop, and to below its long-term trend. (See Chart 39.)
  • Because we expect some of the increase in remote working will prove permanent, the lower location premium of cities should be sustained. That said, given the productivity benefits of working in proximity with colleagues and clients, there are good reasons to think that firms will want to retain a large degree of office working. As a result, regional house price differentials will remain large. (See Chart 40.)

The Regional Outlook

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

Chart 34: Surveyors’ Reported Rise in Prices & New Buyer Enquiries (December 2020, % Balance)

Chart 35: Average House Price and Previous Stamp Duty Threshold (£000s)

Chart 36: Regional Employment & Furlough Use

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

Chart 38: Regional House Price Forecasts (% y/y)

Chart 39: London House Prices as a % of UK Average

Chart 40: Regional House Price to Earnings Ratio

 

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


Residential Lettings Market

London to remain hardest hit, but other regions will suffer too

  • Much of the sharp drop in London rents will be reversed when social distancing restrictions ease. But some of this decline compared to rents elsewhere will be permanent. Outside the capital, a further rise in unemployment and the eventual end of the evictions ban is likely to cause rental growth to stall.
  • After dipping in the first lockdown, national rental demand and rent expectations have been remarkably resilient to the pandemic. (See Chart 41.) Our measure of the balance of demand and supply in the rental market points to a pick-up in rental growth from 1.4% in December to over 2% y/y. (See Chart 42.)
  • However, the national average masks a disparity between rental demand in cities and rural locations. Mandatory working from home and the closure of many attractions and shops has eliminated many of the reasons to live in cities. London has been worst affected. Rents on new leases were down 5.2% y/y in the capital in November 2020 and we think the drop will grow to 8% in Q1 this year. (See Chart 43.)
  • Assuming vaccines are successful at ending the pandemic, much of that will be reversed. The return to office working (even if only for two or three days a week), the reopening of attractions, and the promise of interaction with friends and colleagues will draw many renters back to the capital.
  • But some of the drop in London rents relative to elsewhere is likely to be sustained. Living with parents or renting or buying a house in a more affordable area will be a more attractive option than before given increased home working, it will take time for the larger drop in employment in London to be made back up, and some jobs in the retail and hospitality sectors that were sustained by office workers may be permanently lost.
  • Outside London, we suspect that rental growth will slow as unemployment continues to rise. And the end of pandemic restrictions on evictions will potentially increase supply. A National Residential Landlords Association survey recently showed that 7% of tenants were in arrears, up from 1% before the pandemic. And based on past form, the rise in unemployment to 6.5% that we anticipate this year is consistent with a 2% drop in national average rents. (See Chart 44.)
  • However, a swift economic recovery means that we don’t expect unemployment to be elevated for long, so we doubt rents will drop by that much. New let prices may fall further for a time, but the ONS rents index we forecast, which measures the price of rents on all rental properties, is less volatile. We suspect it will bottom out at minus 1% this year. (See Chart 45.)
  • Note, though, that predominantly reflects a drop in rents in London. Outside the capital we think rents will stagnate rather than fall outright. (See Chart 46.)
  • Gross yields dropped back last year as capital values surged. As we think much of the increase in capital values will be reversed later this year, gross yields are likely to reverse their decline in 2021. (See Chart 47.)
  • Indeed, if we are right to think that house prices will slip this year, that will be the main driver of total returns on residential property. As a result, in contrast to the past few years, we think that residential property will underperform commercial property in the near term. (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: Zoopla Rent on New Lets Index (% y/y)

Chart 44: Change in the Unemployment Rate & Rents

Chart 45: Zoopla & ONS Private Rents Index

Chart 46: ONS Private Rents Index (Jan. 20 = 100)

Chart 47: House Prices, Rents and Gross Yields

Chart 48: Total Returns (%)

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Sources: RICS, ONS, Zoopla, Refinitv, Capital Economics, MSCI


Housing Supply

Completions rebound, but development pipeline is weak

  • The strong recovery in housing construction reflects housebuilders pressing on with existing projects. But they have been hesitant to start new ones. That won’t change if we are right to think that transactions will slump, and house prices will dip, after the stamp duty holiday ends. As a result, new supply is likely to be weaker than it has been in the recent past over the next two years.
  • Completions made a quick and full recovery from the April 2020 lockdown judging by the number of Energy Performance Certificates issued for new dwellings. (See Chart 49.) We suspect that housebuilders have tried to finish as many units as possible before the stamp duty holiday ends and while former owner occupiers can still benefit from the Help to Buy (HTB) scheme.
  • In contrast, housebuilders have been much more hesitant to break ground on new developments which will weigh on new supply further ahead. The rebound in new starts was substantially more muted than that in completions, at least up to Q3 2020. (See Chart 50.)
  • Given operational difficulties due to COVID-19 and the uncertain outlook for the housing market, it is unsurprising to see builders exercise caution. The HBF survey suggests that the recovery in sales of new builds has been weaker than that in the overall market too. (See Chart 51.)
  • Admittedly, the ongoing recovery in construction might be an indication that new starts have since recovered further as housebuilders react to the recent surge in house prices and transactions. Housing construction output was just 3% below pre-virus levels in November, compared to 14% below in Q3. (See Chart 52.) No doubt housing has been the strongest part of the construction sector in 2020, but we suspect the PMI is over egging the near-term outlook.
  • At least the restriction of the HTB Equity Loan to first time buyers shouldn’t detract too much from demand for new homes. Only 17% of those who used the scheme were former owner occupiers in 2019. (See Chart 53.) Moreover, the government has set out to reform the planning system to boost the supply of new homes.
  • But we think that the number of houses builders can sell at prevailing market prices, the “net absorption rate”, will continue to be the predominant driver of housebuilding. (See Chart 54.)
  • The slump in transactions and house prices we expect will outweigh the continued boost from HTB. Our forecasts are consistent with a renewed dip in new dwelling starts this year. (See Chart 55.) It appears house builders are alive to the likelihood that the housing market will go through a rough patch in 2021. Despite reporting that work in progress is only just adequate to meet demand, they have already reduced the number of planned new starts. (See Chart 56.)
  • Our forecast is that having dropped from 152,000 in 2019 to 122,000 last year due the collapse in starts in Q2 2020, starts will remain weak for the next two years. We have pencilled in 130,000 new dwelling starts in both 2021 and 2022.
  • Finally, despite the muted outlook for new home construction and the 4% dip in selling prices we expect this year, high margins and strong cash positions should mean that housebuilders avoid financial difficulties.

Housing Supply

Chart 49: Number of EPCs for New Dwellings per Week

Chart 50: Starts & Completions (000s per Quarter)

Chart 51: RICS Agreed Sales & HBF Net Reservations (Balance, %)

Chart 52: Housing Activity PMI & Construction Output

Chart 53: Completions (000s per Quarter)

Chart 54: Transactions & New Dwelling Starts (4Q Rolling Sums,000s)

Chart 55: House Prices & New Dwelling Starts

Chart 56: Work in Progress Adequate to Meet Demand & Planned Housing Starts (Balances)

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Sources: MHCLG, RICS, NHBC, HBF, ONS, Markit, Refinitiv, CE


Andrew Wishart, Property Economist, +44 (0)7427 682 411, andrew.wishart@capitaleconomics.com
Andrew Burrell, Chief Property Economist, andrew.burrell@capitaleconomics.com