UK: No housing market recovery until after 2010

As the UK’s economy teeters on the edge of recession, two questions arise for the housing market: By how much will house prices fall? How long before the market recovers?

UK house prices fell by more than 10% during the year to end Q3 2008 (-10.3% according to Nationwide and -12.4% according to Halifax). This is the biggest annual decline since the housing crash of 1992.

The economy is grinding to a halt. There was negligible 0.3% GDP growth in the year to Q3 2008. The UK is expected to go into recession in 2009, with the economy contracting by 1.5%.

Investors are holding on to their cash, waiting for the crisis to pass. The collapse of Iceland’s banking system, which led to substantial losses for around 250,000 British depositors, has exacerbated the situation.

To address the crisis, the government recently slashed transaction taxes, while the key interest rate was cut by the Bank of England. However, the moves will only soften the impact of the crisis on the housing market, not push it toward recovery.

However house prices may bottom in 2010. Then, the big hope is that construction spending for the 2012 London Olympics may help propel the economy and the housing market to recovery.

House price crash

During the great British housing boom, house prices rose more than 200% from 1996-2007.

• Prices in Northern Ireland rose most, by 458.6% (361% in real terms) from Q3 1996 to Q3 2007.
• Prices in London rose 310% (238% in real terms) during this period.
• The national index rose 259% (196% in real terms), over the same period (all figures from Nationwide).

Property prices peaked in Q3 2007. Higher interest rates then pricked the housing bubble.

During the year to end-Q3 2008:

• The average house in Northern Ireland has fallen 29.8% in value, during the year to end-Q3 2008.
• The national average price fall has averaged 10.3%.
• London house prices have fallen 9.4%.

How much will house prices fall? This is, of course, a matter of debate.

Ed Stanford, property economist at Capital Economics – which has an excellent track record - has said that the credit squeeze, the financial markets' turbulence and sliding consumer confidence could lead to house price declines of 25%, over the next two years.

The International Monetary Fund recently warned that UK house prices were overvalued by 20% to 30%. It added that the correction will take place “over several years,” emphasizing that Britain is particularly vulnerable to the economic slowdown.

Government boosts economy

To soften the impact of the economic crisis on the housing market, the government has suspended stamp duty on houses costing less than £175,000. The suspension is in effect for year until Sept. 3, 2009.

The stamp duty levy table is now:

Broad measures to help first-time house buyers and families include:

• A mortgage rescue scheme, helping vulnerable families at risk from repossession;
• A shared equity scheme, helping first-time buyers (“Home Buy Direct”). The government and developers contribute up to 30% of the loan value;
• Millions pounds are being fast-tracked for social landlords and councils, to build affordable home.

Bank rescue plan

In October 2008, the government injected £400 billion into the UK’s banking system. The main points of rescue package are:

• Banks must increase their capital by at least £25bn, and can borrow from the government to do so.
• An additional £25bn in extra capital will be available in exchange for preference shares.
• £100bn will be available in short-term loans from the Bank of England, on top of an existing loan facility worth £100bn.
• Up to £250bn in loan guarantees will be available at commercial rates to encourage banks to lend to each other.
• To participate in the scheme banks will have to sign up to a Financial Services Authority (FSA) agreement on executive pay and dividends.

The Bank slashes rates

The Bank of England has drastically reduced key interest rates. In November 2008, it reduced the key rate by 1.5% to 3%, the single biggest rate cut in the bank’s modern history, and the lowest rate since 1954.

From 2002 to 2006, the key rate fluctuated from 3.5% to 5%. In 2007 the key rate was raised three times by 25 basis points, to reach 5.75% in July 2007.

In December 2007, the rate was reduced by 25 basis points to 5.5%, then further reduced in April and October 2008, by 25 basis points at a time, before the dramatic cut this November.

The magnitude of the cut and the historic low level highlights the severity of the current crisis.

Despite the reduction in the key rate, interest rates on mortgages are still rising, with the average mortgage rate at 6.11% in September 2008.

Trackers rule the mortgage market

The house price boom was powered by rapid mortgage market expansion. Since 2001, net secured lending outstandings rose by more than 10% annually from 55% of GDP in 2000, to 85% of GDP in 2007.

In 2005, lenders introduced tracker mortgages, i.e., variable rate mortgages that “track” the Bank of England’s base lending rate. Tracker mortgages were 20% of all loans in 2006. The proportion fell to 14% as the base rate rose (July 2006 to July 2007), but they now account for 34% of all loans (as of September 2008), boosted by the base rate cuts.

Since April 2005, the proportion of fixed rate mortgages has always been above 50%. It rose to more than 75% of all loans between late-2005 and mid-2007.

Meanwhile mortgage lenders have become much more cautious, greatly reducing the number of loans they are prepared to make. Banks no longer offer 100% mortgage loans. Higher down-payments are also being demanded.

First-time buyers took only 13,400 loans in September 2008, significantly down from the average of 31,000 loans approved monthly from 2005 to 2007, according to the Council of Mortgage Lenders (CML)

2012 London Olympics

While 2009 is expected to be an unpleasant year, some economic recovery can be expected as early as 2010. Massive infrastructure projects for the 2012 London Olympics may be catalysts for economic recovery.

Total spending for the venues, facilities and other related expenses is estimated to be around £9.3 (US$13.8) billion. However, the organizers of the London Olympics have downplayed expectations, after the flamboyant US$42 billion 2008 Beijing Olympics. The organizers of the London Olympics have promised that there will be no white elephants left after the event.

There will be two major beneficiaries of the 2012 games:

• London’s crumbling mass transport system;
• East London, where the Olympic Stadium, the Olympic Village and other major facilities will be located.

To accommodate the massive numbers of people moving across the city, major improvements to the transport system include the expansion of London Underground's East London Line, upgrades to the Docklands Light Railway and the North London Line, and the new "Javelin" high-speed rail service.

East London was the site of the city’s early industrial development. As the economy shifted to more service-oriented industries, it became one of the poorest areas in the city. The Olympic Delivery Authority has allotted £3.1bn for the construction of the Olympic Park and venues and £1.7bn for regeneration and infrastructure. The budget includes £1 (US$1.5) billion for the Olympic Village and £400 million for the media center.

Buy-to-let

Immigration has played a big role in the demand for housing over the past decade. Immigrants rent 20% of Association of Residential Letting Agents (ARLA) members’ properties. More than 16% of these are from the European Union. The UK continues to suck in immigrants and has an extremely tight labour market.

Meanwhile public anxiety over the (already high) level of immigration is rising, and the government is being forced to be more restrictive, which is likely to impact the housing market. But foreign workers are needed for the Olympics construction projects. Olympic-related activities will likely also accelerate demand for foreign workers in hotels, restaurants, and tourism.

Temporary workers and new immigrants generally will continue to push rents up in London. Combined with falling house prices, rental yields are expected to improve within the next few quarters.

Compared to the same quarter last year, ARLA finds rental yields to be generally lower in Q3 2008. The average yield for UK was 4.89%, down from 4.99% a year ago.

In Prime London, average rental yields were 4.89% in Q3 2008, down from a peak of 5.25% in Q1 2008. For rest of London, average yields were 5.08% in Q3 2008.

Rental yields were highest in the combined areas of Scotland, Wales and Northern Ireland at 5.45% in Q3 2008, albeit still a lower kevel than their peak 6.9% in Q3 2004.

Housing shortages

UK house-building has largely failed to respond to booming house prices during 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 an average of 186,000 new units annually between 1991 and 2003.

From 2004 onwards, new homes built exceeded 200,000 annually (222,490 in 2007), but this is still low compared to more than 300,000 annually in the 1960s and 1970s.

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).