Residential Property Focus

Residential Property Focus
 
Maintaining Balance

5 November 2015, by Lucian Cook

Affordability and accessibility are key to the prospects for the housing market.

 

Since the bank base rate fell to a record low of 0.5% just over six years ago, the affordability of monthly mortgage payments, historically the key driver of mainstream house prices, has been in a state of suspended animation.

Any price growth which has occurred since then has largely been absorbed by home buyers as mortgage rates have gradually but consistently fallen.

In this period the ability to accumulate the equity to obtain a mortgage has instead become the main consideration for the majority of buyers. However, as interest rates rise over the next five years, so the cost of servicing a mortgage will become an increasingly important factor in determining the prospects for the UK housing market.

Interest rates

The prospects for price growth are particularly sensitive to the timing and extent of interest rate rises, as is shown in our affordability matrix in Figure 1 below.

If rates rise quickly, which seems unlikely in the short term at least, prospects for price growth in certain parts of the market will be quickly curtailed. If they rise slowly, there is much more capacity for medium term price growth.

As appealing as that may sound to existing homeowners, there are risks if there is too much price growth while interest rates stay low, given the even tighter squeeze on affordability that would occur as and when rates move towards a new norm.

In light of this it is little wonder that the Bank of England has been so alive to the risk that a debt-driven housing market boom occurs before the brakes of affordability are applied to the market.

The Bank’s response has been the introduction of mortgage regulation, through capping the amount of lending at high loan-to-income ratios and requiring lenders to stress test borrowers’ affordability at higher interest rates. This has had the effect of limiting the amount they can borrow, while keeping mortgage deposits high in the absence of any drivers for prices to fall.

FIGURE 1

Affordability matrix – Assessing mortgage affordability at a national level based on potential house price growth and mortgage rate shifts by 2020

 
Figure 1

*Assumes a 25-year capital repayment mortgage. Currently stands at 17.5% at an effective interest rate of 2.9%
Source: Savills Research

Regulation implications

In itself this is likely to act as a drag on house price growth, limiting the prospect that prices will be forced into the danger zone of affordability but, as a side effect, also restricting market activity, as households enter the market later and move less frequently. This is expected to mean that mortgaged home ownership will continue to fall, whatever the stated ambitions of government to reverse the prevailing trend.

This adds another layer of complexity and is likely to mean a continuation of the trend most noticeable in the south of England, whereby prices become less and less dictated by what someone on the average salary can afford but instead what wealthier buyers and those on a good dual income are able to. Consequently, the earnings base on which house prices are supported increases faster than the underlying rate of salary growth.

Regional variation

This has been most evident in London, where price growth over the past 10 years and the extent to which even these more wealthy buyers have increased their borrowing relative to earnings leaves much less capacity for price growth generally. This outperformance of London has been much more marked than we have seen at similar stages in previous housing market cycles. This is partly because demand from relatively affluent aspiring homeowners has focused on emerging parts of the capital rather than the surrounding commuter zone.

As we have explored later in the publication, we expect this to continue though perhaps less aggressively. Instead we think that over the next five years London’s hinterland will benefit more strongly as the ripple effect gains greater traction.

In the areas beyond, much will depend on the degree to which regional economic growth and the performance of cities such as Birmingham and Manchester act as catalysts to reinvigorate their housing markets. Their prospects will be determined by the extent to which political talk of a Northern Powerhouse becomes a reality, taking advantage of their comparatively lower housing costs versus London, even as rates rise.

Mainstream Housing Outlook

Five-year regional house price forecasts and key drivers

 

 
Mainstream Housing Outlook

NB: These forecasts apply to average prices in the second hand market. New build values may not move at the same rate

Source: Savills Research

Cash Buyers & Buy To Let Investors

While not currently subject to the same level of mortgage regulation, the combination of increased costs of borrowing and reduced tax relief on those costs is also likely to temper the fervour of buy-to-let investors, who have a requirement for debt to retain or build up their portfolios.

For cash buyers, who continue to make up a much higher proportion of the market than was the case pre-credit crunch, these interest rate rises are not a constraint. Yet returns on cash and investments outside of property are expected to increase so the options available to them will widen.

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