UK interest rates, lofty inflation, cost of living crisis.
They’re the pocket-hitting buzzwords dominating the year so far. And they aren’t just making stock market fans uneasy. Property investors are getting a bit worried the unwelcome triumvirate could mean the UK housing market will crash in 2022.
Given what the last housing market crash looked like during the subprime mortgage crisis in 2008, it’s no wonder the prospect of another big fall in house prices is a concern.
But has the pandemic really ushered in a housing bubble and are we right to expect a fall in UK house prices in 2022?
We’re not in the habit of scaremongering, so it’s worth pointing out no-one knows for certain if the housing market will fall. Even if it does, it doesn’t automatically mean it will plummet completely. It’s maybe the memory of the global financial crisis that makes us think that.
But the headline measures we mentioned up top are making some investors think a short-term drop in house prices is possible.
The Bank of England (BoE) expects UK inflation to top 10% by the end of 2022, which will inevitably put pressure on household spending as firms pass on costs to consumers where possible. That also means higher energy and fuel prices, something we’ve seen so far this year and could see more of, in light of Russia reducing gas supplies to Europe.
In an attempt to combat inflation, the BoE, US Federal Reserve and most central banks apart from China have already made it clear they will continue to raise interest rates. That’s a fairly normal strategy for countries during times of high inflation.
But, an aggressive tightening of monetary policy (raising rates) after over a decade of rock-bottom levels could mean homeowners suddenly face higher mortgage repayments at a time when they have less money to meet them.
That’s the big worry. Over the worst of the pandemic, UK banks had to set aside a lot of cash just in case any loans, including mortgages, went sour. Thankfully, it turned out ok. But has that unaffordability and mass loan default scenario just been kicked down the road instead?
Before we get into how the broader picture affects housing sentiment, let’s take a look at what the UK housing market looks like right now, starting with what it costs to get on the property ladder.
If we look beyond sheer house prices and factor in the wages buyers earn at the same time, UK buyers have been stretched for a long time.
According to the Office for National Statistics (ONS) the average house in England cost 9.1x the average salary in 2021. That’s compared to 7.9x in 2020 and around 3.5x in 1997.
In fact, house prices outpaced wage growth in more than 90% of areas in England and Wales last year. Only 16 local authorities in England and Wales had affordability ratios (house prices vs average earnings) of 5x or less, compared with 27 councils in 2020, and 270 in 1997.
All major house price indices reported significant rises in the year to June. But the affordability worry comes in when we see Statista reporting total inflation-adjusted pay fell by 0.9% in the UK in the three months to May 2022.
The main takeaway is that housing has been steadily drifting out of reach for the average earner, who has to work a lot harder to land that first home.
The National Housing Federation (NHF) estimates England needs about 340,000 new homes every year. That’s a big step up from the 300,000 the government currently targets let alone the 216,000 actually supplied in 2020/21.
That real lack of housing is one reason behind the rise of UK house prices over the past decade. When there’s a lack of supply and growing demand, prices are only ever going to go one way.
And they really have.
Nationwide data shows the price of the average UK house has nearly tripled since 2000 and is up over 60% in the last 10 years.
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More recently, the Help to Buy scheme, joint ownership programmes, stamp duty holiday and the government-backed 95% mortgage programme have made it easier to get into the market without bringing actual prices down.
But it’s not all about supply and demand.
Interest rates at record lows since the financial crisis were a significant tailwind for house buyers and the market as a whole.
And while the BoE lifting those rates off the floor this year doesn’t mean they’re instantly sky high, it’s the trajectory from here that might put people off buying in future. An increase in rates could also make repayments less affordable for those who already have.
Which brings us to the next question.
For property owners, such a sustained rise in house prices might not sound like a very bad thing at all. But it’s what hopeful buyers in a property-obsessed country do that might create problems down the road.
If buyers, especially those just starting out, feel like they need to take on a mountain of debt to get that elusive property, any further cost when they have already stretched their budgets could seriously hurt.
When the UK house price to income ratio went from 4.5x to 5.5x in the late 1980s, a huge spike in mortgage repossessions followed, from 15,800 to 75,500 according to the the EY Item Club. A similar pattern emerged in the 2000s when the ratio rose from around 5x to 8.4x. Repossessions went from 8,200 to 48,900.
More indebted households leave homeowners vulnerable to losing their houses. That might be particularly pertinent now as many rushed to take advantage of the government’s stamp duty holiday over the pandemic or moved out of London to upgrade to a house with a lockdown-friendly garden.
With rates rising and EY predicting property prices to be 26% more expensive in 2024 than they were pre-pandemic, investors are concerned another rise in the price to income ratio will foreshadow another round of mortgage defaults.
And this doesn’t seem to just be a UK problem.
Data from Goldman Sachs shows the ability to comfortably take on a mortgage has been diminishing across a lot of developed markets. The US, Canada, the UK and New Zealand also share that dearth in housing supply.
In the short term, that might be enough to prop up prices somewhat. But there are real concerns that a scenario will emerge where a lack of affordable housing tips the balance, at which point prices have to come down.
Rising interest rates will certainly put more pressure on household incomes and mortgage repayments but the adoption of fixed-rate mortgages should protect homeowners for the immediate future. If you’ve locked in a lower rate for the next few years, the current environment is unlikely to hit you hard all of a sudden, on the mortgage front.
But, if a trajectory of higher rates designed to combat high inflation sends the country into recession, that slowdown in the economy could provoke higher unemployment. That could set off a rise in mortgage defaults and a fall in house prices.
Markets are already starting to price in the fact that higher rates will stop people wanting to borrow money, which will decrease consumer spending. In line with central banks’ strategies, that could help bring down inflation but it could also end up stalling economic activity and lead to job losses.
Is that likely though? Well, the Centre for Economics and Business Research thinks a recession is on the cards, and says two straight quarters of negative GDP growth (the technical definition of a recession) are likely later this year. The consultancy predicts UK unemployment to rise to 4.3% by the end of 2022, up from 3.8% in April.
In this sense, it’s less about the rate rise narrative itself and more about how unemployment can serve as a leading indicator for the health of the housing market.
We can never definitively call a market correction before it happens, neither in terms of timing nor magnitude. That much has been made abundantly clear over the past few years.
What we can do is interpret what the data shows us and think about what might happen if things were to change, for better or worse.
In that sense, there are a few factors that could affect the UK’s housing market, which we should keep an eye on.
The first, as we’ve alluded to, has to do with how the trio of inflation, interest rates and general cost of living hit disposable incomes. Any sustained weakness in our ability to repay our mortgages or stump up more cash for a more expensive house could taint the stellar growth of housing prices over the past decade.
If we end up in a lengthy recessionary environment, a spike in unemployment could provoke a downturn in the housing market.
The broader, longer-term picture looks brighter though. A huge shortage of supply, coupled with a sluggish path to addressing the shortfall, will be a confidence booster for housing bulls.
A feasible result is that we see a slowdown in house prices, not a skydive, and not a sustained upward trajectory. We’re past the buying flurry induced by the stamp duty holiday and the Covid London exodus. A normalisation is probably warranted.
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