23 February 2017
House prices can also go down
There are forces at work to correct the value of your house
by Frank O’Nomics
Those living north of the Watford Gap may quite reasonably indulge in some schadenfreude on hearing that prime London property prices fell by 6.9% last year, and closer to 12.5% over the last two years. Given that the rise in stamp duty for properties valued at over £1 million was the real driver of this correction, most will assume that the trend will not permeate north or to cheaper properties in general. However, it seems that there are other forces at work that could drive a more pervasive correction in house prices. The OECD has described UK house prices as “dangerously high” and liable to crash. This is an important factor when looking at the UK economic outlook, given that housing transactions drive so much consumer spending, on both goods and services. The wealth created by rising house prices has long buoyed spending, and price falls could prompt widespread retrenchment.
Why might house prices be in for a broader correction? Well, first of all, they may not really have been as high as many estate agents made out. Some newly built properties on Highgate, North London were reduced in price from £9 million, to £7 million. That looks dramatic, but as none had traded at the higher level is this really a fall in prices? In a desperate effort to get properties onto their books estate agents have been overvaluing. This has the combined effect of causing a slowdown in transactions, and ultimately a significant fall in offering prices if people are keen to move. In some areas of the country homeowners are waiting for up to 10 months to sell, and transaction levels have been falling significantly in areas where prices have done well – notably Aberdeen, London and Bristol. In the last 3 months of last year, a price cut was needed to sell nearly half of the properties sold in London, usually of around 10%. Areas that have relied on buy-to-let or second home purchases have also seen price cuts following the increases in stamp duty.
A fall in the level of transactions might be regarded as a symptom rather than a cause of a property price correction. Prices are, after all, a function of the level of demand. In looking at what is undermining demand, the first and most obvious factor is economic uncertainty. The consequences of Brexit, in terms of jobs and interest rates, are still huge unknowns, and it is quite reasonable for homebuyers not to want to take on greater debt at such a time, given that it could take some years for matters to be resolved. This is particularly important when one adds in an affordability element; buyers are already stretching themselves to their limits. First time buyers’ house prices are over 5 times the level of average earnings, which is almost double the ratio of 30 years ago. Studies of house prices shows that they tend to match the growth in nominal incomes over the long-term, but they currently sit way above that trend line. There seems little prospect of significant earnings growth for some time (if there was, the Bank would have increased interest rates already) and in real terms the value of earnings is likely to fall short-term as inflation picks up.
Another good gauge of house prices is the rental yield which they offer. After the financial crisis, yields rose to a peak in 2011, but the rise in house prices means that they are now at their lowest level in 6 years, and exceptionally low in London. Prices have been rising faster than rents. For the prospective first time buyer this suggests that they are better off waiting, and for the buy-to-let investor the returns do not justify the risk. In addition to falling returns, the buy-to-let investor has been discouraged by the additional 3% stamp duty and the gradual reduction in mortgage tax relief that starts from this April.
All potential buyers (first timers, buy-to-let and those moving) are further constrained by changes in regulation. The authorities, concerned by increasing levels of indebtedness, are starting (via the Prudential Regulation Authority) to impose stricter criteria on lenders. It is estimated that these restrictions could remove some 50% of lenders from the market – in short, we are being saved from ourselves. The other factor that will impact potential mortgagees would be an increase in interest rates. For many such a move is way overdue – unemployment is at historic lows and inflation is forecast to exceed the Bank’s 2% target for a reasonable period of time. It seems very likely that the MPC will sanction an increase later this year.
The regular counter to all of the arguments that focus on the demand side is that supply constraints will always be greater. There are just not enough houses being built. However, this to some extent presupposes that everyone will want to own a house and it seems that the millennial generation is content to rent. Buy-to-let landlords selling, as 1 in 4 indicate that they will, will address some of the supply issues. Longer-term, government initiatives to allow building in green belt sites, together with tax breaks for pre-fab housing, could provide supply solutions.
The slowdown in transactions has not been uniform across the country, with those areas benefiting from government infrastructure projects, such as Manchester and Birmingham still seeing high turnover, but overall the impact on prices extends beyond just prime central London, so that the Land Registry has reported the first decline in outer London property prices for four years. The ripple effect should not be ignored and there is a danger that OECD fears could be realised. If that were to be the case, consumer spending could slow rapidly and post-Brexit complacency about the economic outlook for the UK could be short-lived.
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