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HPI runs at +1.8% as the rate of price inflation continues to lose momentum. Price growth weakens across southern England, hitting high priced cities more than others. These higher prices have resulted in fewer buyers. The net result is weaker demand, lower price growth and, in some areas, price falls. The income to buy across the three most expensive cities has fallen 5% since 2016.
Price growth weakens across southern England
UK city house price growth is running at +1.8% as the rate of price inflation continues to lose momentum. The annual growth ranges from a high of 5.0% in Liverpool to -4% in Aberdeen. Residential values continue to fall in London and Cambridge while the rate of growth weakens across southern England.
These trends are a result of market fundamentals. Specifically, evolving affordability dynamics and the impact of successive tax changes since 2015. Together, these have impacted buying power and demand for housing, hitting high priced cities more than others.
Income to buy average £54,400
This report examines the development of housing affordability for first time buyers. They are the largest group of buyers, accounting for 36% of sales. We find that the gross household income required by a first- time buyer to buy a typical city home has increased over the last 3 years by £4,500, or 9% to £54,400.
The income to buy ranges widely from a low of £26,000 in lower value cities such as Liverpool and Glasgow to a high of £84,000 in London (Fig. 2).
Income to buy falls across 4 cities
The income to buy across the three most expensive cities has fallen 5% since 2016 (Fig. 3). This is a result of a small fall in prices and a 0.5% decline in average mortgage rates since 2016. The income to buy in Aberdeen has fallen by 12% due to a sizable fall in average prices since 2015.
Affordability an important market fundamental
The income to buy has increased across all other cities since 2016 by as much as 20% in Leicester and 19% in Manchester. This is a result of above average house price inflation over the last 3 years.
Looking at the prospects for housing demand and house price growth moving ahead, it is more important to focus on the absolute income to buy. Fig. 2 shows this remains at or below the national average in all cities outside southern England, except for Edinburgh.
Higher prices result in fewer buyers
There is a clear link between the income to buy and recent developments in house price inflation. In simple terms, the higher prices rise, the greater the income to buy and this reduces the number of potential buyers. The net result is weaker demand, fewer sales, lower price growth and, in some areas, price falls.
It is no surprise that housing sales have declined across southern England and price growth has weakened. Price falls are concentrated in the highest value markets across south eastern England.
Mortgage regulations cap buying power
Low mortgage rates and new mortgage regulations introduced in the wake of the global financial crisis are capping buyer power and re-enforcing these trends. Over the last 23 years city house prices have increased at an annual average rate of 7%, well ahead of the growth in incomes. This out-performance is largely a result of lower mortgage rates which averaged 5.5% for first time buyers between 1996 and 2007 and are now 2.4%. The boosting effect of lower mortgage rates on house prices has largely run its course.
Furthermore, mortgage affordability tests and loan to income limits are also capping buying power. This has the greatest impact in high value markets and forces households to inject increasing amounts of equity to fund purchases. This further restricts the number of households that can buy. It is one reason Help to Buy has been an attractive product for new home buyers.
Deposit levels vary widely
Figure 4 shows the deposit for an average first-time buyer based on the average loan to value in 2007, before the global financial crisis, and the current level. We show a 15% deposit in all cities except London, Oxford and Cambridge where we use a 25% deposit. This larger deposit for high value cities allows for the impact of loan to income limits. We assume the borrower can only take a mortgage that is up to 4x their income. In the highest value cities this means buyers must either buy a cheaper property or find a larger deposit. It impacts in markets where average capital values are above c£300,000.
Weaker price inflation across southern England
The fundamentals of housing affordability and mortgage regulation mean we expect house price inflation to continue to slow across southern England. Our latest research report ‘How far have house price falls in London spread into regional markets – June 2019’ focuses in on these sub-regional trends where prices are falling across 40% of markets.
Buying power supports price inflation in regional cities
Our analysis shows that affordability pressures are less acute in lower value cities and prices are rising at an above average rate. We expect this to continue over 2019 with price growth running ahead of the growth in earnings.
House prices sensitive to mortgage rates
The analysis highlights the sensitivity of the housing market to higher mortgage rates. Short term movements in interest rates have typically impacted consumer sentiment and the demand for housing.
Lower mortgage rates have boosted household buying power over the last 25 years and it is hard to see rates moving any lower having plateaued at around 2.5% in late 2016. Modest increases in mortgage rates would increase the income to buy and impact housing demand, further limiting price inflation.
The good news for existing borrowers is that mortgage affordability testing means all recent buyers have had to prove they can pay much higher mortgage rates. The outlook for interest rates looks relatively benign at present but housing demand will remain sensitive to any material change in mortgage rates and housing affordability.
About the analysis
This affordability analysis uses the current average price of housing in each city. We use the average loan to value and mortgage rate for first time buyers from UK Finance to calculate annual mortgage repayments for a 30-year term. We assume 30% of net household income is spent on mortgage costs and the mortgage amount is capped at 4x income. For the latest data, we assume a 15% deposit in regional cities and 25% in London, Oxford and Cambridge.Fig. 3 – Change in income to buy 2016-2019
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.
UK city house price inflation is higher as prices start to firm up in London and Southern England. Large regional cities continue to post above average price growth on the back of rising demand and attractive affordability, supported by low mortgage rates. London is experiencing its highest rate of growth for 2 years and follows a period of modest price falls.
HPI is currently running at +2.4%, half the average growth over the last five years, and below average earnings growth. Time to sell has hit a 3 year high, while discount to asking price has widened across UK cities. Despite this, underlying market conditions still vary widely across large areas of the country.