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UK City HPI is running at 2.3%, with Liverpool and Edinburgh seeing growth of +6% and Aberdeen -5%. Looking at average house price growth versus growth in average earnings, we can see that affordability levels are starting to improve. Twelve cities are registering price growth that is lower than the growth in average earnings.
City house price inflation ranges from +6% to -5%
UK city house price inflation was 2.3% in the last 12 months. Edinburgh (5.8%) and Liverpool (5.8%) continue to register well above average price growth. Aberdeen remains the weakest growth city with prices 4.8% lower over the last 12 months.
Birmingham drops to 9th in growth rankings
Last month we highlighted that market conditions were weakening in Birmingham. The annual growth rate has slowed noticeably to 3.5% as demand fails to keep pace with rising supply. The city has slipped to 9th in the annual growth rankings (Table 3 – download report to view). Other cities with slower growth than a year ago include Leicester, Nottingham, Sheffield and Glasgow (Fig. 1).
12 cities with price inflation below earnings growth
This month we focus on housing affordability, as measured by the ratio of average house prices to average earnings. Twelve cities are currently registering house price inflation that is lower than the growth in average earnings (3.7% nationally). This means improving affordability in low growth cities where affordability has been stretched in most cases.
Large variance in price/earnings by capital city
Fig. 2 tracks the house price to earnings ratio for the UK compared to capital cities of the home nations. After a spectacular boom and bust in Belfast house prices, the price to earnings ratio has stabilised at 5x. Edinburgh (7.4x) and Cardiff (7.2x) have ratios that have tracked the UK average over time.
Affordability in London is slowly improving from its recent peak. The price to earnings ratio is currently 13.1x, down from a high of 14.1x two years ago (June 2017). This takes affordability, on this measure, back to the level last seen 4 years ago, in mid-2015. Despite this modest improvement, the London ratio remains relatively high, well above the 20-year average (9.9x).
Affordability slowly improves across southern England
Oxford and Cambridge have recorded a similar trend to London with the ratio falling back to 2015 levels off a high base (Table 2). The southern cities of Bournemouth, Southampton, Portsmouth and Bristol have the next highest affordability ratios of 7.5x to 9.7x. Here the ratio has started to slowly drift lower on weaker price growth. All other cities have ratios in line or below the 20-year average. Four cities have ratios that are still below the 20-year average – Belfast, Glasgow, Aberdeen and Newcastle (Table 2).
What is a sustainable price to earnings ratio?
House price to earnings ratios provide a consistent benchmark to assess the relative level and trend in the affordability of home ownership. The all-important question is ‘what is a sustainable level of affordability?’.
Affordability benchmarks are complex
A long run, 20-year average price to earnings ratio is a possible benchmark but this does not reflect the boost to buying power, and house prices, from lower mortgage rates over time. Today’s mortgage rates of c.2% are more than half the level recorded in 2007 (5.5%) and lower still compared to the mid-1990s.
In addition, the picture of affordability in London is complicated by its global city status and broad base of housing demand from international buyers, investors, second home-owners as well as residents living and working in and around the capital.
Benchmarking price to earnings ratios from the last market peak in 2007, reveals that there are eight cities where the current ratio is higher than in 2007 with the greatest differential in London, Oxford and Cambridge (Fig 4). The remaining 12 cities have ratios below 2007 levels with seven where the ratio is materially lower, typically in cities with lower capital values (Table 2).
Affordability will continue to adjust in southern cities
This analysis re-confirms the weaker outlook for house prices in the most unaffordable cities where the ratio between house prices and earnings needs to further realign. In the absence of any external shocks to demand, this is most likely to result from flat house prices and continued growth in earnings. Lower turnover has created a scarcity of housing and this has reduced the downward pressure on prices. This means the improvement in affordability is set to be drawn out over a period of time.
Room for price growth in most affordable cities
Housing affordability remains attractive in many cities across the UK, pointing to the potential for further price growth over the medium term as long as mortgage rates remain low and the economy continues to grow and create jobs.
How fast attractive affordability feeds into house price inflation depends upon consumer confidence and market sentiment. House price growth has slowed more recently on weaker activity and increased uncertainty over the near-term outlook. This is likely to build further over the autumn until there is greater clarity over the BREXIT process and the implications for the economy.Fig. 4 – Current price to earnings relative to 2007
UK city house price growth in February 2020 was +1.6%, higher than the +1.2% a year ago. That said, in recent weeks coronavirus has had a rapid impact on housing demand, which is 40% lower in the last week. Transaction volumes are set to decline by an estimated 60% in the next quarter with a further fall in sales volumes over Q3 2020.
This month's Cities Index is the second in a row to record a 3.9% increase year-on-year. This is taking average prices up to a nearly 3-year high. Prices have now also recovered across all English cities to pre-recession 2007 levels. Supply is still flat and outpaced by demand, at 2.6%.
This month’s Cities Index shows a continuation of the strong end to 2019. City house price growth is at a two-year high, at 3.9%. Coupled with a bounce in demand, which at 26% far exceeds the traditional new year boost, we see green shoots of returning market optimism. At a regional level, affordability of local stock is driving growth forecasts for Northern and Midlands cities, while in the South, the picture is more subdued.
Average UK city house prices have increased at an annual average rate of 4.4% per annum. While price falls in the latter part of 2018 suppressed the annual growth rate, these have dropped out of the annual growth calculation and explain the increase in the current annual rate of growth. The outlook for 2020 will be driven by affordability factors. We expect city house prices to increase by +3% over 2020 with above average growth in the most affordable cities and below average growth in cities across London and southern England.