United Kingdom: Price History

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Last Updated: Apr 14, 2008

UK house prices softening

In March 2008, a flat in central London sold for a price generally believed the most expensive apartment the world, with a sale price exceeding £115m. The off-plan flat was in St James’s Square, equidistant from 10 Downing Street and Buckingham Palace.

Nevertheless, UK house prices are softening. After many false alarms, the long-lasting boom seems over. Exotic headlines about highly priced London residences seem emblematic now of past excesses, not the expected future. UK house prices fell by 2.5% nationally in March, the biggest monthly decline since September 1992, according to the Halifax Building Society. House prices were still 1.1% up on the year, but both the Halifax and Nationwide now say they expect a decline in prices over the course of this year – a significant change of view, in contrast to recent optimism.

Savills, the property agency, has warned that sharp price falls for multi-million-pound Central London flats and houses are likely this year and next, reversing its forecast last autumn that upper-market prices would rise by 5% in 2008.

These downgrades are based on fears that City banking bonuses for the coming year will be a fraction of last year’s, in view of the credit crisis, the collapse of Bear Stearns, and the earlier collapse of Northern Rock. Changes to non-domiciles’ taxation rules have also impacted foreign buyers.

Mortgage lenders have greatly reduced the amount of loans they are prepared to make. Council of Mortgage Lender (CML) figures indicated that in the 3 months to February, lending to first-time buyers was at its lowest since early 1975. 100% mortgage loans are now no longer offered. Higher deposits are being demanded, and interest rates on mortgages are rising, with the average two-year fixed mortgage at 6.29% in late March. In late March, the National Association of Estate Agents reported the number of potential homebuyers on its members' books had fallen to a record low.

"Borrowers looking for new mortgages are being thrown into complete chaos as deals they have agreed with their broker disappear from the market just hours before applications were to be signed," reported the Financial Times in March 2008. "Many are now facing unaffordable increases to mortgage payments."

Ed Stanford, property economist at Capital Economics, has said it is possible that the credit squeeze, the financial markets' turbulence and sliding consumer confidence could lead to house prices falling by 25% in the next two years.

The Centre for Economics and Business Research predicts that the London market will now trail the rest of the country, with falls of 2 per cent across the country to be overshadowed by declines of up to 3.5 per cent in the capital.

To add extra weight to the message, Mervyn King, the Bank of England’s governor, said in March that he would be “surprised if in a few years, house prices were markedly above where they are now.” in early April, the bank reduced base interest rates from 5.50% to 5.25%. The IMF followed by warning that UK house prices could fall in Britain by as much as 10% in the coming year, and said that Britain was particularly vulnerable to the economic slowdown.

The upside – rising rental yields

Despite the distinctly ‘end of cycle’ feeling, there are areas of light. Average rental incomes increased 16.7% over the past year, according to the buy-to-let specialists Paragon Mortgages. Paragon Mortgages find London’s rental yields to be 5.7%. Terraced houses generate the highest rental returns (6.8%), they report, followed by detached (6.5%), semi-detached (6.3%) and flats (5.5%).

The Association of Residential Letting Agents (ARLA) finds average returns for both rented houses and flats to be lower, at around 5%, with London having the highest gross rental yields, at 5.2%.

For the last three months the proportion of ARLA members saying that they have more tenants than properties has been at its third highest level since quarterly ARLA surveys began nearly six years ago.

Increased demand is being driven in part by immigration. Across the country, the average proportion of properties taken by immigrants through ARLA members is 20%. More than 16% of these are from the European Union. The UK continues to suck in immigrants and has an extremely tight labour market. In addition the economy remains strong. Retail sales in the year to February rose by a stronger-than-expected 5.5 per cent.

Are UK houses overvalued? One useful measure of affordability is the ratio between house prices and earnings. House prices are now 7.0 times earnings in London, 5.7 times in the South West, 4.6 times in the Midlands, 4.5 times in Yorkshire and Humber, and 4.0 times in Scotland. This suggests that UK house prices are more overvalued now than ever before in post-war history (see chart).

However, a less alarming conclusion can be drawn from using yields as a valuation yardstick. Yields in the UK have fallen over the past decade because of the rapid rise in house prices, combined with only a modest rise in rental levels. Yet yields are not dramatically low. Gross rental yields in the UK now (Q1 2007) stand at 5.0%, according to the Association of Residential Letting Agents (ARLA). Prime London gross yields are up at 5.2%. Global Property Guide research produces similar results. Gross rental yields in London range from 4% to 5.4%. Mid-sized flats (100 – 150 sq. m.) in prime luxury areas in the centre of London have the highest rental yields, reaching up to 5.36%. Flats in other luxury areas in London have slightly lower yields, at 4.5% to 5.2%.

Note also that mortgage payments in London are relatively low as a percentage of take home pay (110%), compared to some other areas of the UK, including N. Ireland (218%), and the West Midlands (146.7%).

Housing shortage

UK house prices have been continually on the rise since 1995. From Q4 1995 to 2008, average UK house prices have risen from £50,930 to £179,363, according to Nationwide. This is an overwhelming 252% increase in nominal terms.

UK house-building has largely failed to respond to booming house prices for the past decade, largely because of building regulations. Increases in population, immigration, and decreases in unemployment, have all added to the pressure, as have changes in household sizes.

The Barker Review (HM Treasury) concluded that to reduce the trend in real price inflation to 1.8%, the rate of new home building would have to increase by around 70,000 homes per annum, to around 195,000 per annum. Government figures show that homebuilding stagnated at 148,000 new units annually between 1989 and 2005. In 2006, 180,000 new homes were built, still low compared to 425,000 units in 1968.

Over the past five years planning policy has swung towards emphasizing the development of high-density housing on brownfield land. Over the past five years, apartment completions have grown from just 15% of annual completions to almost 45%. Most city centres have seen a rapid expansion in the supply of new apartments, many of which have been bought by investors. Yet despite the high media profile of buy-to-lets, the private rentals sector is still quite small, and has remained stable over the last decade, at around 10% (16% in London). And only around half of that is available of the open market (the rest is either protected tenancies or in corporate hands).

Conclusion: softening

In conclusion, constraints on new supply (planning controls), and the current low interest rate environment, do seem to have increased the long-term equilibrium price of housing in the UK.

This means that the UK market may be different from that of the U.S., where there are serious regulation-induced supply constraints only in a few areas, notably California and New York.

Yet the UK housing market is surely vulnerable. Above all, there seems to have been a shift of mood in the wake of the credit crisis. Several city economists are talking, Soros-like, about how the mutual feedback of City optimism and easy credit fed into higher salaries and therefore higher house prices during the boom times. The feeling is that this may all unwind, leading to several years of poor growth.

In the context of an economy which has indeed been growing above-trend since 1992, and which shows signs of capacity constraints, problems of inflation and central government over-spending, caution is now in order.

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