Recent developments in the UK housing market
Recent statistics on the UK housing market have shown some improvement, giving an indication that the worst for the residential property market may be over and that some recovery may be starting to take shape.
The housing market went through its biggest slump last year since the early 1990s. The end of the credit era, following big losses on mortgage backed securities by global financial institutions, combined with a highly valued UK residential property market and rising interest rates in the face of increasing inflation, led to an end of the fifteen year long bull market in housing.
According to two of the main UK mortgage lenders, who compile house price statistics, UK property prices fell by over 20% since their peak in the summer of 2007. According to the Halifax, prices fell 22.5% from their peak, while the Nationwide pegs the decline at 21%. The Rightmove website also estimates the magnitude of the overall decline to a little over 20%.
Recently, the house price numbers have started to show glimmers of improvement, in some cases on a more significant scale. The Halifax showed prices rising in January and the Nationwide reported a price increases in March and May after over a year of continuous monthly declines. The RICS house price balance has also risen substantially over the past year, after reaching a low of -94 last April, gaining to -60 in April.
Mortgage lending data has also started to improve, even if at a slow rate. According to data from the British Bankers’ Association, 27.7k new mortgages were granted in April, which is a notable improvement from the 18k low seen last November. The numbers are still very low compared to normal market averages, which in the ten years to the end of 2007 were in excess of 60k mortgages a month, but the end of the deterioration in the lending market and signs of improvement are visible.
The degree to which the housing market can improve in the sense that prices stop declining and even begin appreciating again is related to the outlook for employment, interest rates and banks’ willingness and ability to extend mortgage loans. The true fundamental value of residential housing is hard to peg, but assuming a steady rate of population growth, and comparing the economics of buying versus renting by juxtaposing rental yields to the cost of servicing a mortgage, and it can be assumed that house prices should not have much further to fall. That is of course provided that mortgage financing is readily available.
In theory, mortgage lending should not be massively constrained now as the weak lenders have been taken over, or nationalised and recapitalised. Bank refinancing in the bond market has been insured by the State for the foreseeable future and the Government is taking a pro-active stance in trying to encourage lenders to add risk to their books, which should be less difficult where the Government is a major shareholder in a lending institution.
As long as banks remain in a messy position, having to undergo successive restructurings and to re-examine how risk is allocated and how much capital is set aside as a provision in case of losses, lenders will be less willing to be expansive in their practices and trading activities. So while lending has started to improve, banks are still proceeding on cautionary terms. There are significant uncertainties about the labour market, interest rates and even the outlook for house values for the lenders to weigh up, when deciding how much credit to extend. In this environment, it may even be argued that mortgage lending is not overly constrained in view of the prevailing uncertainties. The banks are also unlikely to ever go back to former lending practices, which made unrealistic assumptions about the future of the housing market, or the creditworthiness of borrowers. In that sense, it will take some time for lending to return to former cycle averages.
Some observers, including the Bank of England, have suggested that property price to income ratios are still quite high, implying that the housing market remains highly valued. This is true compared to past history, but it is possible that these ratios stay permanently higher, as lenders take a structurally different attitude towards loan-to-value and loan-to-income ratios. Lending attitudes will relax after the recession has ended and house prices start to rise again, although it is unlikely that those will ever return to pre-crisis levels. Not for a long time anyway.
The overriding conclusion is that lending availability and lending criteria are slowly moving in favour of the market and that demographics and the economics of renting versus buying have also shifted towards giving support to house prices and thus further lending and construction. It is just that it is still very early in the cycle to expect a pronounced turnaround. The recession is quite real and unemployment is likely to increase further, with repossessions also likely to continue to rise, despite the significant monetary and fiscal easing in place. The worst for the recession is over, but a sudden and rapid turnaround in activity is not likely as the crisis exposed a number of structural irregularities, the straightening out of which will prevent the economy from accelerating rapidly despite the unprecedented policy stimulus already in the system. Once the recovery has taken shape, employment will start to rise again, so demand for housing will increase, but interest rates will go up from near zero levels, which may to some degree act to counterbalance demand.
Overall, the housing market has gone through a notable correction and the outlook is much better than at any time in the past year, with actual statistical evidence also pointing to improving conditions. Whether the market improves rapidly is hard to call. The economics of it suggests that it may take a while for conditions to normalise fully and for prices to start rising on a trend basis, although a culture of home ownership and perceptions of residential real estate as a good investment vehicle, coupled with scarcity in the property market relative to demographics, cannot exclude the possibility of a rapid turnaround in the housing market, especially if dormant investment cash, possibly even from abroad, is put to work. What is clear is that the worst is over.
Nikola Mirtchev