Crisis? But which housing crisis?

Features

Property market

Richard Northedge explains why there are various different crises in the property market and suggests ways to solve some of them

Expect the housing crisis to feature strongly in next year’s UK general election. But, to adapt the headline that paraphrased former prime minister James Callaghan, “Crisis? Which crisis?” Is it that property prices have soared – or that they’re falling? Is it insufficient housebuilding – or is the green belt being concreted over? Is it that mortgage rates have rocketed – or that they’re still historically low? Is bank lending too lax – or too strict? Does buy-to-let deprive would-be owner-occupiers – or boost rental supply? Why are rents rising? Has helping first-time buyers pushed up prices, making buying harder? Indeed, is home-ownership an asset or a liability?

Measures meant to help the housing market frequently exacerbate the problem they hoped to solve

The first step to fixing the housing crisis is to decide which crisis to fix. Property is important in both national and personal finances. It supports £1.7tn of mortgage debt, can absorb more than half of homebuyers’ disposable incomes and is increasingly seen as a pension pot. But instead of being a stable investment, the housing market is highly volatile, lurching from boom to bust and back.

House prices can yo-yo, rising 29% one year then falling to 7% the next, before declining another 11%. And they fluctuate as wildly between decades as between years, soaring 180% in the 1980s, just 21% in the next decade, 117% in the 2000s, only 33% over the following ten years and are now falling.

And while residential property has outpaced inflation over the long term, it has been a poor hedge over many medium terms. A 37% fall in real terms, that is adjusted for inflation, from 1989 to 1995 and a 26% real fall from 2007 to 2013 offset much of the gain in between, when general inflation was minimal. And now, with consumer inflation high and property price inflation negative, real values are falling sharply again.

Yet housing is still regarded as expensive. So, who sets prices? Not sellers or estate agents – they can ask what they want but buyers don’t have to pay. The same for housebuilders. Their annual output is declining rapidly but it comprised only a fifth of sales in the good years and added 1% to the housing stock. Demand, not supply, has driven the market, with an increasing population still aspiring to home ownership. But demand can be satisfied only if would-be purchasers have finance.

When banks lend five-times income and 100% of value, they allow buyers to bid up prices. Deposits are first-time buyers’ greatest hurdle but when the Bank of Mum and Dad chips in, the young can pay more. Cutting stamp duty and other incentives inflates the market further. Measures meant to help frequently exacerbate the problem they hoped to solve.

Overheated markets tend to correct naturally but the notorious September 2022 mini-Budget applied a sharp pin to a housing price balloon that might otherwise have deflated gently. Trebling mortgage rates will hit existing owners over time but quickly deters prospective first-time buyers. So, in a self-tightening vicious circle, demand drops, banks toughen lending criteria and prices fall. Why buy an asset falling in value? Or why build, or buy land? And with savings rates so much higher, already squeezed mums and dads have less reason to invest in property. State aid for buyers has also ended.

Meanwhile, buy-to-let landlords, hit by tax changes and red tape as well as higher mortgage rates, are now net sellers, increasing the stock of property for sale but decreasing the supply of rented accommodation, thus pushing up rents.

Forecasts are that prices will fall about 10% from their recent peak, home sales this year will decline from 1.2m to under 1m, new mortgage lending will drop nearly 25%, equity-release loans have halved and housebuilding – already well below the government’s 300,000 target – could also halve to 120,000 units.

Lower house prices to the rescue?

Won’t lower house prices solve several elements of the housing crises? As described above, prices have often fallen in real terms, but high consumer inflation in the 1970s and 1980s permitted that without sticker prices declining. The lower inflation since means real falls become absolute falls and that causes problems for all parties.

Long-term owners can absorb a 10% fall in prices but still show a profit on their purchase, but if they’re less inclined to move, the market stagnates. Anyone buying since 2020 with a 90% mortgage would see their equity completely wiped out and they would be unable to move. That would also eliminate the banks’ collateral, justifying even higher mortgage rates. Housebuilders won’t build if they can’t cover construction costs that continue increasing. And if the threat of negative equity and less choice of new or existing properties does not deter would-be buyers, why would they purchase a property that will be worth less in future?

What to do?

So what can be done to alleviate the various crises? It’s worth observing that intervention has often been ineffective, counter-productive or had unintended consequences. Help-to-Buy inflated builders’ profits. The Lifetime ISA gives only a £1,000 bonus a year and its house price limit is less than many first-timers pay. Right-to-buy increased ownership at the expense of rental property. Stamp duty concessions inflated prices, fuelled a buying spree to beat deadlines, then caused a crunch when withdrawn. Meanwhile, the Bank of England’s use of monetary policy to curb inflation is hitting mortgage holders hard but missing those without home loans.

A reliable rental marrket would reduce the pressure to buy, especially for a generation happy to lease

Buy-to-let boomed as small entrepreneurs filled a hole in the market, encouraging banks to adapt their products, but is now shrinking because the government changed the tax regime and imposed onerous environmental demands. Policymakers’ role should be countercyclical, gently cooling overheating markets or thawing them when frozen – not pouring paraffin onto the fire. Loan leverage exaggerates price fluctuations for borrowers: reducing the volatility would remove many of the problems, but political and housing cycles do not always coincide.

However, non-government parties can take the initiative. Lenders can resist competing to raise loan-to-value and income-multiples in rising markets, for instance. The Mortgage Charter should make them more sympathetic to customers’ hardship than they were in the 1990s, when repossessions exacerbated a weak market. Longer loans and interest-only mortgages temporarily reduce costs. Guarantees from family or friends help both lender and borrower. Perhaps legislation could allow buyers to use their pension pots to reduce deposits, although all extra finance inflates prices.

Builders have been carrying landbanks equivalent to about four years’ output. As sales plummet, those landbanks extend to six or seven years, financed at rising interest rates while land values collapse far further than house prices. Planning permissions are slowing even faster than housebuilding. Granting more consents sooner is essential: rather than building handfuls of homes in Nimbys’ backyards, perhaps this is the time to repeat the post-war new towns, putting thousands of homes, with infrastructure and jobs, on suitable greenfield sites.

Reducing demand is harder: people need homes. But a reliable rental market would reduce the pressure to buy, especially for a generation happy to lease, rather than own, phones and cars. There is also a need for more council housing. Building to let is an opportunity for banks and pension funds to create long-term income-yielding assets. Housebuilders could divert current unused capacity to constructing rental property, either as developers or contractors for housing associations or institutional landlords.

There is no silver bullet for fixing housing, but address one crisis and the other crises can fade away. And fixing housing will reduce many wider economic problems. Smoothing out the volatility would be a good starting point.

Richard Northedge

Richard Northedge is a former Banking Journalist of the Year and has spent the past decade at a leading investment bank