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November 2015 and outlook for 2016 - City level house price inflation is now running in double digits once again at 10.1% but transaction volumes for the year as a whole look set to be 5% lower as fewer homes come to the market for sale causing scarcity of supply. We expect city level house price growth of 7% in 2016.
City house price growth ends year on the up
City level house price inflation has accelerated in the second half of 2015 and reaching double digits once again (Table 1 and Figure 1). Despite a stronger second half, transaction volumes for the year as a whole look set to be 5% lower, as fewer homes come to the market for sale.
Table 1- UK 20 city index summary, November 2015
Source: Hometrack House Price Indices
In the 12 months to November, the fastest rate of growth has been registered in London at 13.3% (14.7% in 2014) which equates to a £52,900 increase in the average value of a home (Table 2).
The weakest rate of growth has been recorded in Aberdeen where average house prices have fallen by 2.0% after a 12% increase in 2014 as the steep fall in the oil price since mid-2014 impacts demand.
The city with the strongest turnaround over the last 12 months has been Glasgow where house price growth has accelerated from 1.8% a year ago to 8.0% today as prices recover off a low base in one of the most affordable of the 20 cities tracked by the index.
Housing scarcity exacerbating price growth
The most important feature of the housing market over the second half of 2015 has been a chronic shortage of homes for sale. Housing supply comes from a variety of sources which change over time.
New homes starts have risen 5% over 2015 according to the NHBC but new homes comprise just 10% of all sales a year. Policies aimed at providing further support to demand such as Help to Buy and Starter Homes should encourage more supply in 2016. Evidence suggests that private landlords who own rented homes have been net buyers in recent years adding to their portfolios rather than selling. The balance of investment is set to shift in 2016 to a more neutral position as a result of recent policy announcements aimed at cooling investor demand.
The bulk of supply comes from existing homeowners who have been reluctant to move in the last few years - the share of housing transactions by mortgaged homeowners has fallen from 50% in 2007 to 33% today. Falling mortgage rates have reduced debt servicing costs for those with mortgages but this group appear to have limited appetite to take on new debt or incur higher moving costs from stamp duty, especially in southern England. Turnover rates for home-owners without a mortgage have always been relatively low which presents a longer term challenge as this group continues to grow in size.
We expect the scarcity of homes for sale to remain a feature of the housing market in 2016. This will only ease once we see greater levels of output from home builders, higher levels of activity amongst existing home owners and lower demand from buyers that have nothing to sell, in particular investors.
Scarcity reduces discount to asking price
Scarcity has resulted in a decline in the discount between asking and achieved sales prices for sales in the second half of the year. Our analysis shows the discount is down to just 1% across London City and 2.8% across all other cities in England and Wales as at September (figure 2). There is a narrowing gap between sales and asking prices which points to further prices rises in the first half of 2016.
Price rises against backdrop of low turnover - an indicator of increased risk?
The growth in house prices, on rising scarcity, is against the backdrop of a 5% drop in open market housing transactions over 2015. This is down to a weak first-half of the year together with lower stock for sale in the second half of 2015.
While transactions levels have bounced back from their 2009 lows the general levels of housing turnover remains well below the long run trend. Just 5% of private homes are turning over each year compared to a long run average of over 7%. A range of structural and market factors such as low inflation and higher moving costs in the south of England mean we expect housing market liquidity to remain constrained for the foreseeable future.
While turnover looks set to be 5% lower in 2015 it has fallen further in the high price, less affordable cities where high housing costs are impacting demand as well as willingness and ability of household’s to move. Turnover is set to be 15% lower in Cambridge over 2015 and 12% lower across London City.
Questions over the sustainability of house price growth are being raised as house prices accelerate on growing scarcity and lower sales volumes, especially in the high growth markets such as London. The greatest focus is on the influence of investor buyers, who we estimate account for one in every five buyers nationally. This group don’t need to buy homes and could react differently to home owners in the face of changing market or economic conditions.
In the most supply constrained markets, changes in demand can feed quickly and dis-proportionately into prices. Any sudden decline in demand from one or more groups of buyers could result in a rapid slowdown in house price inflation and potential price falls in local markets which is the fear amongst policy makers. Speculation over a major London-wide house price correction are over-done in our view but the risks to pricing at a localised level from material changes in demand are real.
We do not need to look far for a city that has suffered the impacts of an external shock. The collapse in oil prices since mid-2014 and resulting impact on investment in the oil and gas industry in North East Scotland and the knock on effects for market sentiment has resulted in house price inflation across Aberdeen slowing rapidly from 12% to -2% today.Table 3 - Affordability (3.5x income loan & 76% LTV)
Affordability levels unchanged across many cities
Looking ahead, the impetus for house price growth is set to come from regional cities which have recorded relatively lower levels of house price growth in the last few years and where the local economy is adding jobs and affordability levels are far less stretched.
House price to earnings ratio are well ahead of the long run average in London, Oxford and Cambridge (figure 3) yet across all other cities affordability on this measure is in line with or below the average over the last 12 years.
Across the 20 cities covered by the index the average income to afford a home with an average mortgage at 3.5x income is £49,700, up from £45,200 a year ago (see table 3).
Perhaps more importantly for mortgage reliant borrowers, debt servicing costs continue to fall with the average mortgage rate on outstanding mortgage debt down to just 3.1%. UK mortgaged households have seen interest payments fall by £1.1bn over 2015. Yet while mortgage rates are low it is the challenge of passing tougher affordability stress tests that is likely to be supressing a proportion of demand for homes. The full impacts of tougher mortgage regulation on the housing market are yet to play out.
That said, businesses operating across the residential sales market will be hoping that a greater proportion of the 8m households who own a home with a mortgage will be looking to take advantage of record low mortgage rates, an improving economic outlook and rising house prices to move home in 2016.
Rising house prices will push down loan to value levels and create more capacity for household to find cheaper finance as well as boosting sentiment. Only time will tell whether households in the regional cities see 2016 as an opportunity to move ahead of a possible rate rise later in the year and ahead of more house price inflation.
Fig 3 - City level house price (single) earnings ratio
Source: Hometrack House Price Indices / ONS
The wider housing market has seen a wide range of policy interventions as the Government looks to reduce welfare costs and build more homes. The most recent announcements targeting new housing and investors are set to have a mixed market impact.
We expect investor demand to weaken over the course of 2016 as a result of stamp duty and tax relief changes announced earlier in the year. The tax relief changes are likely to result in some modest levels of dis-investment as investors look to de-leverage portfolios. Despite these changes, the buy to let market is far from dead. Private investors will remain an important feature of the housing market but the recent scale of investor demand will slow which is important for a more balanced and sustainable housing market.
Policies to support demand for new housing supply such as Help to Buy and Starter Homes will support pricing levels of new homes. Once up and running these schemes could account for up to 16% of first time buyer activity but the impacts of the schemes will be localised with a limited impact on the wider housing market in 2016.
Outlook for 2016
We expect 7% growth in city level house prices over 2016 with a 1% increase in housing transactions. This is based on a slowdown in the annual rate of growth across London City to 8% as affordability pressures and lower investor demand reduce the upward pressure on house prices. It is worth noting that the London City index covers 46 local authority areas and we expect house price growth to come from the more affordable outer areas as central areas have already seen growth slip into low single digits.
This is all predicated on interest rates rising in late 2016. Earlier and faster rate rises would negatively impact the level of house price growth more rapidly as this would further impact investor decision making and mortgage affordability for home owners.
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.
With HPI moderating at 1.9%, it appears the slowdown in house price growth is an indication of a return to a more sustainable pace of price growth. However, a change in buyer mix from cash buyers to those with mortgages, plus wide variance in the recovery of house prices is sending mixed signals about current housing market activity.