Weak fundamentals keep lid on housing activity - Capital Economics
UK Housing

Weak fundamentals keep lid on housing activity

UK Housing Market Outlook
Written by Andrew Burrell
Cancel X

While the decisive election result could lead to a modest increase in housing demand over the next couple of years, we doubt that this will translate into a substantive pick-up in transactions or house prices. Indeed, any improvement in sentiment will peter out towards the end of the year as the trade deal with the European Union goes down to the wire. And in any case, the housing fundamentals – high house prices and rock-bottom interest rates – aren’t conducive to any meaningful pick-up. As a result, we expect housing market activity to remain muted. That said, with tenant demand rising and supply limited, we expect rental growth to pick up over the next two years.

  • Overview – While the decisive election result could lead to a modest increase in housing demand over the next couple of years, we doubt that this will translate into a substantive pick-up in transactions or house prices. Indeed, any improvement in sentiment will peter out towards the end of the year as the trade deal with the European Union goes down to the wire. And in any case, the housing fundamentals – high house prices and rock-bottom interest rates – aren’t conducive to any meaningful pick-up. As a result, we expect housing market activity to remain muted. That said, with tenant demand rising and supply limited, we expect rental growth to pick up over the next two years.
  • The Economic Backdrop – Following Boris Johnson’s election victory, we now have one set of forecasts. But his pledge not to extend the transition period past the 31st December means at least some of the Brexit-related uncertainty is set to linger, leading us to expect weak GDP growth in 2020. Nevertheless, with activity set to pick up next year, we are forecasting one 25bps hike in interest rates in the first half of 2021.
  • Valuation and Affordability – Even though prices are very high, housing has remained relatively affordable due to low interest rates. And with lending costs set to stay low over the forecast period, we expect affordability to stay supportive. Meanwhile, with wage growth outpacing house price inflation, there has been a stealthy improvement in valuations, which we expect to continue.
  • The Mortgage Market and Completed Sales – With some political and economic uncertainty set to lift, lending and transactions could pick up a little over the next two years. But weak fundamentals will keep a lid on any gains. Meanwhile, with remortgaging set to fall and no recovery in buy-to-let due, we expect no growth in gross or net lending over the next two years.
  • House Prices – Despite some tentative evidence that housing demand has risen following the election result, with prices already very high, we doubt that this will translate into a substantive increase in house prices this year or next. After all, we don’t think the housing fundamentals can sustain house price growth of more than around 2% y/y in the medium term.
  • The Regional Outlook – We don’t expect to see a rise in London house price growth in the medium term, but with the recent survey data pointing to a pick up in demand the risks to our forecast lie to the upside. Meanwhile, in the regions we expect house price growth to remain below 3.5%, with increases stronger in the North and devolved regions.
  • Residential Lettings Market – Rental growth rose last year, and with the gap between tenant demand and lettings supply widening, we expect to see a further acceleration. Indeed, the main takeaway for property investors is that residential returns will beat commercial property across our forecast.
  • Housing Supply – Housing starts fell sharply in the first half of 2019. And with Help-to-Buy set to be pared back next year, the outlook for housebuilding in 2020 and 2021 is weak.

Main Forecasts

Table 1: Housing Market Forecasts

2018

2019

2020

2021

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

213.4

216.5

219.7

224.1

% y/y

0.5

1.4

1.5

2.0

Completed transactions

mn

1.19

1.18

1.20

1.23

% y/y

-2.8

-0.6

1.8

2.2

Employment

% y/y

1.2

1.0

0.3

0.6

ILO Unemployment rate

%

4.1

3.9

3.9

3.8

Average earnings (inc. bonuses)

% y/y

2.9

3.5

3.1

3.3

Real h’hold disposable income

% y/y

2.2

1.0

1.7

1.8

Headline CPI Inflation

% y/y

2.5

1.8

1.6

1.7

Real Household spending

% y/y

1.6

1.2

1.5

1.6

Real GDP

% y/y

1.4

1.3

1.0

1.8

Affordability & valuation (year-end)

Mortgage affordability

%

36.6

35.5

34.8

35.4

(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

0.75

1.00

Mortgage Interest Rate

%

2.15

2.05

2.00

2.25

Mortgage lending

Mortgage Approvals – Total

000s

1,534

1,545

1,544

1,555

– for house purchase

000s

781

785

797

820

  for remortgage

000s

583

586

573

556

  other

000s

170

174

174

179

Gross mortgage advances

£bn

269

262

261

267

Net mortgage lending

£bn

44.5

43.8

41.5

40.0

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

68.5

67.5

65.5

65.5

(for house purchase)

% of total

8.7

8.8

8.4

8.1

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)

%

1.0

2.0

2.1

2.6

Housing Supply

Housing starts

000s

170

160

157

155

% y/y

3.5

-6.0

-1.8

-1.3

Regional house prices (year-end)

London

% y/y

-0.9

-1.9

-1.0

0.0

South East

% y/y

-0.7

-0.3

0.0

0.0

East of England

% y/y

1.9

0.1

0.0

1.0

South West

% y/y

1.9

1.5

1.5

0.0

East Midlands

% y/y

4.0

0.4

3.0

3.0

West Midlands

% y/y

3.0

2.7

3.0

3.0

North East

% y/y

1.0

2.7

3.0

3.0

North West

% y/y

2.2

1.8

2.0

3.0

Yorkshire & the Humber

% y/y

3.7

1.6

2.5

3.5

Wales

% y/y

3.9

1.5

2.0

2.5

Scotland

% y/y

0.8

2.7

2.0

3.5

Northern Ireland

% y/y

5.1

1.1

3.0

3.5

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


The Economic Backdrop

Fiscal policy to the rescue

  • Following December’s decisive general election result, we now have one scenario and one set of forecasts. But with Boris Johnson’s pledge not to extend the transition period past the 31st December, some uncertainty will linger. Given the low starting point at the start of 2020, we expect growth will slow this year.
  • The good news is we think that activity will step up in the second half of the year, boosted by the government’s proposed fiscal stimulus.
  • We previously expected a boost to the economy from an increase in business investment as sentiment improved. But with Boris Johnson’s pledge not to extend the transition period past the end of this year, business investment probably won’t rise by much. As a result, we think that investment will edge up by only 0.5% y/y this year. But with an expected piecemeal approach to a trade deal that eventually rules out a WTO no deal at the end of this year or later, business investment could grow by 2.5% y/y in 2021. (See Chart 1.)
  • Instead, the main driver of the acceleration in the quarterly rate of GDP growth that we expect is a loosening of fiscal policy. Boris Johnson’s government appears far more willing to spend than the previous one. With Chancellor Sajid Javid changing the fiscal rules, the budget deficit can now rise to 3% of GDP. (See Chart 2.)
  • As a result, fiscal spending will become a tailwind rather than a headwind. (See Chart 3.) We expect an increase in spending equivalent to around 1% of GDP, or over £20bn. As a result, GDP should rise by an additional 0.9% over the next two years.
  • All told, while we expect a step up in activity in the second half of the year, the lack of momentum at present means that annual growth will still edge down from 1.3% y/y in 2019 to 1% y/y in 2020. (See Chart 4.) Further ahead though, economic growth will accelerate to 1.8% y/y in 2021.
  • Turning to monetary policy, we expect the Bank of England to keep interest rates on hold in 2020. Admittedly, there is a growing risk that Bank Rate could soon be cut. Indeed, the current level of the all-sector PMI suggests that rates should have already been lowered. (See Chart 5.) But the Bank has put off any move due to the potential rise in sentiment following the election result. Our hunch is that rates will be kept on hold as evidence of a “Boris-bounce” comes to the fore.
  • Further ahead, the rebound in economic activity means that we expect one hike to Bank Rate in the first half of next year, from 0.75% to 1%. But the big picture is that the path for interest rates is shallow. (See Chart 6.)
  • Meanwhile, the labour market will remain tight. Admittedly, the survey data suggest that employment growth is set to slow. (See Chart 7.) But the hard data have continued to surprise to the upside. And even if employment growth does slow slightly, the unemployment rate will remain close to 4%.
  • That said, the labour market may not be as tight as it first appears. We think the natural rate of unemployment is 3.75%, close to the current rate. So, while wage growth should remain robust, with unemployment broadly flat, we doubt it will accelerate much more – hovering just above 3.0% y/y over the next couple of years. (See Chart 8.)

The Economic Backdrop

Chart 1: Business Investment & Uncertainty

Chart 2: Public Sector Net Borrowing
(exc. Public Sector Banks, % GDP)

Chart 3: Fiscal Impulse (Change in Cyclically-Adjusted deficit, % GDP)

Chart 4: UK GDP

Chart 5: Change in Bank Rate & All-Sector PMI

Chart 6: Bank Rate (%)

Chart 7: Employment Surveys & Employment Growth

Chart 8: Average Weekly Earnings (3m av. of % y/y)

Sources: ONS, Refinitiv, IHS Markit/CIPS, Capital Economics


Valuation and Affordability

A stealthy improvement in valuations

  • Given that mortgage interest rates are set to stay lower for longer, we expect affordability to remain sustainable. And with wage growth likely to outpace house price growth, the stealthy improvement in valuations will continue.
  • At 1.4% y/y, the Nationwide measure of house price growth was sluggish in 2019. But despite that weakness, with the average house costing £215,300 in December 2019 – around 15% above the pre-crisis peak in 2007 – house prices are still very high by past standards. (See Chart 9.)
  • What’s more, house prices look relatively expensive compared to other assets. For one, in nominal terms, they have risen by around 170% from 2000, compared to just 35% for commercial property. (See Chart 10.) And, house prices are elevated compared to rents as well. (See Chart 11.)
  • But despite the unfavourable valuation metrics, housing is relatively affordable. Declining interest rates have allowed mortgage borrowers to take out larger loans, while keeping repayments as a percentage of income low. Indeed, at 35% in Q3 2019, our measure of affordability is still well below its long-run average. (See Chart 12.) And with the path for Bank Rate shallow, mortgage affordability should remain sustainable over the medium term.
  • However, the relatively low level of initial mortgage payments masks potentially higher long-run costs that buyers may not be aware of. After all, using long-run projections for interest rates, house price growth and wages, a buyer can expect to pay around 4% more of their income over the lifetime of a 15-year mortgage now compared to five years ago. That’s despite mortgage interest rates having declined. (See Chart 13.)
  • Encouragingly though, there has been a stealthy improvement in valuations. With wage growth exceeding house price growth last year, the house price to earnings ratio (HPE) has edged down from a peak of 7.2 in late-2017 to 6.8 in Q3 2019. (See Chart 14.)
  • What’s more, this improvement has been fairly broad based. For instance, in areas where valuations are stretched such as London and the South East, the HPE has fallen to a greater extent than those areas where valuations are more in line with past norms. (See Chart 15.)
  • Looking ahead, we expect growth in pay to continue to outperform house prices pushing the HPE ratio down further. But we don’t expect a substantive fall. Indeed, we think it will edge down slowly to around 6.7 at the end of this year and to 6.6 by the end of 2021.
  • That will leave the HPE ratio only just below its record high and well above its long-run average of just 4.3. As a result, deposits will still be onerous to raise, and households will continue to need large mortgages to buy a house, even by the end of our forecast period.
  • What’s more, while affordability is likely to remain on a sustainable footing, we doubt there will be a further improvement as mortgage interest rates are already close to their floor – hovering around 2% this year, before rising to just below 2.3% in 2021 (See Chart 16.)

Valuation and Affordability

Chart 9: House Prices

Chart 10: House Prices and Commercial Property Prices (2000 = 100)

empty cellempty cellempty cellempty cell

Chart 11: House Price to Rents Ratio

Chart 12: Mortgage Affordability (Payments as a % of Full-Time Average Worker Income)

Chart 13: Average Mortgage Affordability over the Lifetime of a 15-Year Loan

Chart 14: House Price to Earnings Ratio

Chart 15: Selected Regional Prices and House Price to Earnings Ratio

Chart 16: Mortgage Interest Rates (%)

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


The Mortgage Market and Completed Sales

Lending surge unlikely despite pick-up in buyer enquiries

  • House purchase activity held broadly steady in 2019. Looking ahead, with political and economic uncertainty easing a little, lending and transactions could pick up modestly over the next two years. But the fundamentals – high house prices and already low interest rates – will keep a lid on any gains.
  • Mortgage approvals for house purchase weakened from 65,600 loans in August to 65,000 loans in November. But on the whole, lending was broadly unchanged in the run-up to December’s election. Indeed, approvals have remained within the 62,000 to 72,000 loans per month range seen since 2013. (See Chart 17.)
  • Meanwhile, the transactions data were stronger than expected in November, rising to 102,000 loans, from 98,800 in October. (See Chart 18.) But over the last few months, early readings have at times seen unusually large revisions. (See Chart 19.)
  • It takes time for HMRC to receive all the submissions from property buyers. To account for this delay, HMRC adjusts the initial release of its transactions data to account for the home sales it expects to receive, based on the data it already has. The rules for submitting transactions changed in March last year, and this could explain why early estimates in the HMRC data have been particularly volatile.
  • Indeed, a number of data sources measuring activity have become less reliable. For example, the historic data show a good correlation between HMRC’s measure of transactions, and the RICS measure of sales per surveyor. But that relationship has weakened. Also, the RICS data on newly agreed sales has tended to be a good leading indicator of transactions in the past. But the latest results have consistently pointed to weaker transactions and mortgage approvals than has actually materialised. (See Chart 20.)
  • What this implies is that the rise in the newly agreed sales balance to 8.9% in December, its strongest level since 2016, could signal an end to the malaise in transactions growth that has prevailed for so long.
  • Indeed, looking at the RICS measures of new buyer enquiries, new sales instructions and surveyors’ expectations of housing sales, there seemed to have been a broad-based rebound in housing market activity and sentiment in December. (See Chart 21 & 22)
  • But claims there will soon be a rebound in actual transactions and lending – a “Boris bounce” – are premature. The RICS survey data can be fairly volatile, and it’s often tempting to read too much into a single month’s data.
  • The underlying fact is that housing market activity is being held back by high house prices. Furthermore, improving sentiment will do nothing to improve the ability to save for a deposit, nor will it lead to a meaningful loosening in credit conditions. And despite easing uncertainty, the labour market and economic backdrop are unlikely to provide much of a boost to the underlying drivers of housing demand this year. (See Chart 23.)
  • As a result, the recovery in activity we have pencilled in for 2020 and 2021 is modest. We expect house purchase mortgage approvals and transactions to rise by between 1.5% and 3% per-year over the next two years. (See Chart 24.) And even if a Boris bounce were to materialise, we expect any jump in housing market activity to be modest and short-lived.

The Mortgage Market and Completed Sales

Chart 17: Mortgage Approvals for House Purchase

Chart 18: Transactions and Sales per Surveyor

Chart 19: Transactions by Month of Release (000s)

Chart 20: Newly Agreed Sales (% Balance)

Chart 21: New Buyer Enquiries and New Sales Instructions (% Balance)

Chart 22: Surveyors Expecting a Rise in Housing Sales
(% Balance)

Chart 23: Employment and Mortgage Approvals
(% y/y)

Chart 24: House Purchase Mortgage Approvals and Transactions Forecasts (000s per Qtr)

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

The Mortgage Market and Completed Sales (continued)

Zero sum game for lending price war

  • Lending growth to first-time buyers (FTB) has outperformed home movers. This is likely to continue given increasing competition in the high loan-to-value (LTV) segment and support from Help-to-Buy (HTB). But with remortgaging set to fall and no recovery in buy-to-let lending due, we expect no growth in gross or net lending over the next two years.
  • According to the UK Finance data, mortgage advances in the owner occupier housing market declined. Lending to movers performed particularly poorly, falling by 4.1% y/y in October on a four-quarter rolling basis. (See Chart 25.) Meanwhile, advances to FTBs also fell by a more modest 1.6% y/y.
  • The relative resilience of FTB lending partly reflects support from the HTB scheme, as well as cheaper high LTV loans – both of which are more likely to help deposit – constrained buyers like FTBs.
  • Data from the Bank of England show that the price of a five-year 95% LTV loan dropped by 50 bps in the 12 months to November to a record low of 3.34%. (See Chart 26.) This fall reflects rising competition between banks. Keen to redeploy funding following the introduction of ring-fencing, lenders have been cuting their high LTV pricing to attract new business.
  • Looking ahead, the high LTV lending spread could in theory fall further. After all, we have previously calculated that the additional cost of providing a 95% LTV loan is unlikely to exceed 65 bps. (See our Update: “How much cheaper can high LTV lending get?”) With the spread at closer to 150 bps now, modest price cuts would still leave high LTV loans more profitable than other products.
  • Yet lenders expect to tighten credit availability in the first quarter of 2020. (See Chart 27.) And looking further ahead, the big picture is that price cuts have been a zero sum game. Banks have taken market share from each other at the expense of lower margins, but the overall size of the mortgage market has not grown.
  • Thus, returns from price competition among lenders have probably been low. And this in turn hints that further pressure on high LTV prices will be limited.
  • Beyond that, the outlook for buy-to-let is weak. Advances have struggled to break 6,000 a month since 2016, when the stamp duty surcharge was introduced. (See Chart 28.) Looking ahead, rental growth is improving, but yields and capital gains will stay low. Both factors will keep the attractiveness of buy-to-let investment low. (See Chart 29.)
  • Meanwhile, remortgaging is unlikely to grow further. True, buyers have plenty of incentive to refinance. After all, the gap between the average SVR and the rate on a new mortgage is large. (See Chart 30.) But with the yield curve relatively flat, longer duration fixed-rate loans are particularly attractive. Such long-fix loans reduce remortgaging demand, as buyers need to refinance less often. We expect approvals for remortgaging to fall by 2% in 2020 and 3% in 2021. (See Chart 31.)
  • Taking all this together, we expect gross mortgage advances to be broadly flat in 2020, and to rise by 2.3% in 2021. And we expect a small rise in repayments, triggered by the recent fall in interest rates, to drive a slight decline in net advances from around £44bn in 2019, to 42 billion in 2020 and 40 billion in 2021. (See Chart 32.)

The Mortgage Market and Completed Sales (continued)

Chart 25: Owner Occupier Mortgage Advances
(% y/y)

Chart 26: Average Quoted Interest Rate 5-Year Fixed Rate Loan (%)

Chart 27: Lenders’ Reported Factors Affecting the Availability of Credit (% Balance)

Chart 28: Buy to Let Mortgage Advances (000s)

Chart 29: Lenders Reporting a Rise in Buy to Let Lending Spreads and Demand (% Balance)

Chart 30: Average Effective and Standard Variable Interest Rates (%)

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

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

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


House Prices

Two more years of sluggish house price growth

  • While the decisive election victory could lead to a modest pick up in housing demand, with prices already very high, we doubt that there is much room for a significant upturn in house price inflation.
  • House price growth was slightly stronger than we expected in 2019, but nonetheless subdued. On the Nationwide measure, house prices rose by a feeble 1.4% y/y. Admittedly, house price growth came in stronger on the refreshed Halifax measure, at 4.0% y/y. But with other measures of house prices also restrained, we suspect it is overstating the gain. (See Chart 33.)
  • Given Brexit-related uncertainty, it is perhaps not too surprising that house price growth was fairly weak in 2019. Then again, house prices managed to avoid an outright fall as both buyers and sellers were put off from the market. Indeed, our measure of months of unsold supply suggests that demand may still be outstripping supply. (See Chart 34.)
  • As we noted previously, there is some initial evidence of a so-called “Boris bounce”. Both the RICS new buyer enquiries balance and sales instructions balances jumped in December, suggesting a sharp pick up in both active demand and supply. (See Chart 35.)
  • But we doubt this will lead to a substantive increase in prices. After all, with house prices already high and mortgage interest rates close to their floor, these fundamentals limit how much further prices can rise. (See Chart 36.)
  • Meanwhile, increased competition among lenders drove down mortgage interest rates last year. Indeed, at 1.9% in November, mortgage interest rates were 25bps lower than the same month in 2018 and well below their five-year average. (See Chart 37.)
  • Of course, with CPI easing over the past few months, there is a growing possibility that the Bank of England cuts its key policy rate early this year, which could feed through to a decline in lending costs.
  • Yet any fall in Bank Rate would reflect a weaker economic backdrop. So, the boost to demand arising from that would be offset by a decline in economic growth and buyer confidence. What’s more, an interest rate cut would do little to change mortgage regulations, which would continue to constrain the maximum loan-to-income (LTI) available to borrowers. (See Chart 38.)
  • Although there is a real risk that Bank Rate is cut in the very near term, our hunch is that the boost to activity from the election result will tip the decision in favour of keeping rates on hold this year.
  • And further ahead we expect interest rates to rise, albeit by only 25bps in the first half of 2021. While we have previously noted that rates are a risk to house prices, such a hike is small by any standards. Indeed, by our measure of affordability, the one 25bps hike we expect in 2021 would rise mortgage payments by a meagre 2% of income. (See Chart 39.)
  • All told, we expect house price growth to accelerate modestly over the next couple of years. Our forecast is for house price growth to rise to around 1.5% y/y by the end of this year, before picking up in 2021 to around 2.0% y/y as the economy recovers. (See Chart 40.) The big picture, though, is that despite the pick up over the next two years, house price growth is subdued by past standards.

House Prices

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

Chart 34: Months of Unsold Supply and House Prices

Chart 35: New Buyer Enquiries and New Sales Instructions

Chart 36: House Prices (£000s)

Chart 37: Effective Mortgage Interest Rate (%)

Chart 38: New Mortgages at LTI ratios at or above 4 (%)

Chart 39: Take-Home Pay Required to Service a New Mortgage & Interest Rates (%)

Chart 40: House Price Forecast (% y/y)

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


The Regional Outlook

Too soon to call a London turnaround

  • London house price growth ended 2019 on a downbeat note. With prices already high and interest rates close to their floor, the fundamentals are not conducive to a recovery. But with survey measures for December showing a pick-up in demand and rising price pressures, the risks to our forecast are on the upside.
  • London house price growth saw a weak end to 2019. On the Nationwide index, prices fell by 1.9% during the year.
  • House prices fared slightly better on the official UK House Price Index, where they grew by 0.2% y/y in November. That was driven by the non-prime central boroughs, which saw price growth accelerate to 2% y/y. (See Chart 41.) Meanwhile, prices in outer London held broadly flat. And there was no sign of a surge in Prime Central London prices. Indeed, according to the official HPI, prime central London prices fell by 10.4% y/y.
  • That said, the timeliest data on London show evidence of a turnaround in December – probably in response to the result of the general election.
  • Firstly, both the RICS new buyer enquiries and new sales instructions data for London surged. (See Chart 42.) What’s more, London house price expectations – both in the near-term and long-term – rose to their highest levels since 2016. (See Chart 43.)
  • Also, our usual leading indicator for house price pressures – months of unsold stock – suggests that market conditions have tightened a little. (See Chart 44.) On past form, that would be consistent with house price growth turning positive in the first half of 2020.
  • The RICS measure of newly agreed sales suggests that the outlook for transactions in London has also improved a little as well. (See Chart 45.)
  • But more data is required to judge whether a “Boris bounce” will take place in Q1. And in any case, with more uncertainty likely to come alongside the Brexit trade deal deadline this year, we suspect that any pick-up in sentiment may prove short-lived anyway.
  • Indeed, we are sceptical that London house prices will see a sustained revival this year. Looking at the fundamentals, London’s house price to earnings ratio is still very high at 11.5 times. So even if sentiment seems to have improved, that enthusiasm isn’t backed up by higher wages or lower house prices.
  • Furthermore, mortgage affordability looks less favourable in London than in the rest of the UK, where prices are expected to rise this year. (See Chart 46.) Higher than average mortgage costs suggest that London buyers will remain reluctant to push up prices further.
  • On balance, we don’t expect London house prices to bounce back in 2020. We think prices will fall by 1% during the year, before holding flat in 2021. (See Chart 47.) In turn, this suggests that the gradual adjustment in London’s house price to earnings ratio and mortgage affordability will continue this year and next year. (See Chart 48.)
  • The risks to this forecast however, are to the upside. Already high prices largely rule out the possibility of a sharp rise in 2020 or 2021. But London price growth could outperform our expectations a little, and perhaps see low, single digit growth this year.

The Regional Outlook

Chart 41: London House Price Growth (% y/y)

Chart 42: London New Buyer Enquiries and New Sales Instructions (% Balance)

Chart 43: London House Price Expectations
(% Balance)

Chart 44: London Months of Unsold Stock and House Price Growth

Chart 45: Newly Agreed Sales and Transactions

Chart 46: Mortgage Payments as a % of Income
(% Diff. From LR Average)

Chart 47: London House Price Forecast
(% y/y)

Chart 48: London Mortgage Affordability and House Price to Earnings Ratio

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

The Regional Outlook (Continued…)

… or a fresh pick-up in the regions

  • Across the regions, buyer sentiment and activity improved at the end of 2019. But that doesn’t mean a pick-up in regional house price growth is on the way. Indeed, we expect house prices across the regions to grow by less than 3.5% p.a. out to 2021.
  • House prices outside of London have been rising at slow, single digit rates. And the South East, East of England and South West have tended to see the worst performance of all the regions. (See Chart 49.) In fact, prices in the South East have been falling.
  • That trend is unsurprising. On past form, house price movements in the South have tended to correlate particularly strongly with London. (See Chart 50.)
  • While it is too soon to be sure, there is some evidence that there has been a broad-based resurgence in buyer activity and confidence in the wake of December’s election result. With the exception of the East of England and Scotland, new buyer enquiries rose across every region. And in some regions, such as Wales and the North East, and the South East, demand seems to have risen very rapidly. (See Chart 51.)
  • Despite this rise, it’s too soon to call a fresh recovery in prices. For a start, the buyer enquiries data can be fairly volatile, and with demand looking very weak in previous months, it’s too soon to say whether any pick-up in demand will be sustained.
  • For example, even in the South East where house price pressures have been particularly weak, our measure of months of unsold homes suggests that the rise in demand has not come hand-in-hand with tightening in market conditions. (See Chart 52.) So, at least in the immediate aftermath of the election, the fundamentals do not suggest an abrupt pick-up in house price pressures.
  • In fact, given the already high level of house prices in the South of England, we are sceptical that a meaningful pick-up in house price growth could be sustained even if buyer confidence were to return. So in the South East, South West and East of England, we think house prices will rise by 0% to 1.5% a year in 2020 and 2021.
  • Admittedly, across the rest of the country, housing valuations appear to be less stretched. After all, loan to income ratios across the North, Midlands and devolved regions are much lower than in the South of England. (See Chart 53.)
  • But that doesn’t imply that a “Boris bounce” will happen. After all, over the last decade or so, house prices outside the South of England have been held back by comparatively weaker growth in the economy and employment. Looking at the PMI data for December, there is little evidence to suggest that this has changed following Boris Johnson’s election win. (See Chart 54.) And even if the regional economies were to start performing more strongly, it would at least be several months before any improvement could be seen in house prices.
  • On balance, we expect house price growth in the North, Midlands and devolved regions to grow by 1% to 3.5% per-year in 2020 and 2021. (See Chart 55.) That implies that the UK’s house price to earnings ratios will continue to converge over the next two years – reducing regional imbalances, albeit slowly.

The Regional Outlook (Continued…)

Chart 49: Regional House Price Growth
(Q4 2019, % y/y)

Chart 50: Regional House Price Growth Correlation
with London (1974 to 2019)

Chart 51: New Buyer Enquiries (% Bal., Dec 2019)

Chart 52: South East Months of Unsold Stock
and House Prices

Chart 53: Regional House Price to Earnings Ratio
(Q4 2019)

Chart 54: Regional PMI Points Below Long-Run Average
(December 2019)

Chart 55: Regional House Price Forecast
(% y/y)

Chart 56: Regional House Price to Earnings Ratio Forecast

empty cellempty cellempty cell

Sources: ONS, Nationwide, RICS, IHS Markit, Capital Economics


Residential Lettings Market

Rental market will gather pace in 2020

  • Rental growth is rising, and the gap between tenant demand and lettings supply widening. Indeed, the main take-away for property investors is that residential returns will beat those for commercial property across our forecast.
  • According to the IPHRP, growth in private rents ended 2019 at 1.4% y/y. (See Chart 57.) That was up from 1.1% y/y in 2018, and broadly in line with our expectations. Meanwhile, the rental component of the RPI recorded a similar rise in rental growth, from 1% y/y at 2018 end, to 1.2% y/y in November 2019.
  • Rising rental growth reflects strengthening tenant demand and weakening landlord instructions – a trend which has persisted over the last 12 months. (See Chart 58.) And looking ahead, this trend hints at even faster rental growth over the next two years. (See Chart 59.)
  • In all, the rise in rental growth reflects two factors. Firstly, the reduction in mortgage interest tax relief, which will be fully phased in this year, has reduced returns for many landlords. That has driven some to reduce their holdings, while discouraging others from entering the market, with the overall effect of tightening lettings supply.
  • At the same time, the economy has seen a pick-up in wage growth over the last year and a half. (See Chart 60.) Combined with record low unemployment, there is evidence to suggest that tight labour market conditions have boosted the ability of young adults to live independently – raising tenant demand.
  • Indeed, on past form, current rates of wage growth are consistent with even faster rates of rental growth than now. And looking ahead, with wage growth set to hold up over the next two years, that upward pressure on rents will be maintained.
  • Of course, many have argued that rents are high, and that may prevent further rental growth. But such an idea is a London centric view. Outside the capital, rents as a percentage of incomes are lower than they were before the financial crisis. (See Chart 61.)
  • The exception to this is London, where rents are elevated. But compared to the peak seen in late 2016, even rental affordability in the capital doesn’t look nearly as bad as it was.
  • All this sets the scene for a strong pick-up in rents across our forecast. We think rental growth in England will accelerate to 2.5% y/y by the end of the year, and 3.5% y/y by 2021. (See Chart 62.) That will in part reflect London, where a sharp rise in rental price pressures could push rental growth to a hefty 5% y/y by the end of 2021. (See Chart 63.)
  • Admittedly, the effect of rising rents will have only a modest upward effect on yields. Indeed, by 2021, we expect gross yields in England to edge up by only 10 or so basis points. With house price growth set to stay weak foreseeable future, that rise in rental yield is unlikely to bring buy-to-let investors back to the market en-masse.
  • That said, the comparison with commercial property is much more favourable. After all, residential capital values are set to hold up relative to commercial property. And as we argued in a recent Focus, total returns on housing investment are expected to beat commercial property across our forecast. (See Chart 64.)

Residential Lettings Market

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

Chart 58: Tenant Demand and Landlord Instructions

Chart 59: England Rents and Lettings Supply & Demand Balance

Chart 60: Rents and Income Growth (% y/y)

Chart 61: Private Sector Rental Affordability by Region
(Rents as a % of Full-Time Income)

Chart 62: England Rental Growth & Gross Yield

Chart 63: London Rents and Lettings Supply & Demand Balance

Chart 64: Total Returns on Property (%)

empty cellempty cellempty cell

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


Housing Supply

Construction will recede out to 2021

  • Housing starts fell sharply in the first half of 2019. And with HTB set to be pared back next year, the outlook for housebuilding in 2020 and 2021 is weak. Housing starts cooled sharply in the first two quarters of 2019, with MHCLG data showing falls of 10.9% y/y and 10.5% y/y respectively.
  • Admittedly we have some concerns around the data, as there are signs that starts are being undercounted by MHCLG. (See our Update: “Housing completions hit their peak”.) But even after adjusting for this, the big picture is that starts have passed their peak and are now in decline. (See Chart 65.)
  • Looking ahead, the housing PMI has continued to disappoint, and suggests that construction suffered a weak second half of 2019. (See Chart 66.) Based on what we already know, housing starts probably fell by 6% or more last year.
  • Falling construction seems to reflect waning demand. After all, during three of the last four quarters, 30% or more of home builders have reported buyer confidence as a major constraint on demand – a historically high proportion. (See Chart 67.) That is despite support from HTB and accommodative conditions in the mortgage market.
  • Meanwhile, a slightly higher share of builders reported production constraints arising from labour and materials shortages in Q3. (See Chart 68.) But, taking a step back, that metric has improved over the last few years, suggesting that capacity constraints aren’t the main factor driving the decline in construction.
  • Encouragingly, the timeliest data which covers the first three quarters of 2019, suggests that demand for new homes may be stabilising. (See Chart 69.) Indeed, the percentage of builders reporting a rise in net reservations and site visits trended upwards from the start of 2019.
  • Furthermore, while our working assumption is that HTB will be pared back in 2021 and fully phased out by early 2023, existing government funding commitments suggest that the scheme still has a lot more to give. (See Chart 70.) In fact, with cumulative HTB equity support funded to the tune of £29 billion by 2023, the scheme is set to nearly double over the next three years.
  • Admittedly, unless HTB is replaced after that, the planned end of the scheme will have an increasingly strong impact on housing starts towards the end of our forecast.
  • But for now, there are some reasons to be fairly optimistic. After all, with signs that the weakness in new home prices may be coming to an end and housing starts having already seen a sizable fall, we suspect that any further decline in construction across 2020 and 2021 will be modest. (See Chart 71.)
  • Taking all that together, improving confidence and measures of housing valuations suggest that housing starts might fall only 1% to 2% a year out to 2021. (See Chart 72.) That forecast implies that housing starts will fall into line with its long-run relationship with housing transactions by the end of our forecast. That will largely bring construction back to a pre-HTB level.

Housing Supply

Chart 65: Housing Starts (000s per Year)

Chart 66: Housing Starts and Housing Construction PMI

Chart 67: Builders Reporting Constraints Arising from Demand (%)

Chart 68: Builders Reporting Constraints on Production (%)

Chart 69: Builders Reporting a Rise in Net Reservations and Site Visits

Chart 70: Help-to-Buy Cumulative Value of Equity Loans and Projected Future Utilisation (£bn)

Chart 71: Builders Reporting a Rise in Sale Prices and New Home Price Index

Chart 72: Transactions and Housing Starts
(000s, Brexit Delay Scenario)

empty cellempty cellempty cell

Sources: MHCLG, ONS, 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
Gabriella Dickens, Assistant Economist, 020 3974 7421, gabriella.dickens@capitaleconomics.com