If House Prices Fall…

Changes in average house prices are a favourite topic for headline writers. In 2020, UK newspapers were full of articles commenting upon what was widely regarded as an astonishing performance by the housing sector. Despite Covid, Brexit and a host of other challenges, and after dire predictions at the start of the year, average values defied all expectations. They just kept on rising.

In January 2021, the Office for National Statistics (ONS) published its November figures, which found that average house prices had risen, year on year, by 7.6%. This drove values to a record high of £250,000, and it represented the fastest rate of annual growth since June 2016.

Drivers of Price Growth: Supply & Demand

Looking back, it seems clear that this growth was the result of at least four important factors. One was simply the continuing imbalance between housing supply and demand. For years now, rates of house-building have failed to keep pace with demand for homes, and whenever large numbers of buyers are competing for a scarce commodity, its value always tends to rise.

The under-supply of homes is nothing new, of course. It has been a feature of the economic landscape for decades. Nor is it set to change. In 2020, rates of construction fell even further behind target, and there are no signs of any new surge of activity in 2021. The shortfall in supply has been Britain’s status quo for years, and many argue that it is one of the main foundation stones that underlie the buy-to-let sector’s success.

Drivers of Price Growth: Interest Rates

Another important driver of price growth has been interest rates and, more specifically, the historically low cost of borrowing. Never has it been cheaper for investors to borrow, and this has effectively helped to make property more affordable. When buyers feel that they have more purchasing power, price competition typically follows, and this ultimately manifests in rising prices.

Again, there are no signs of any significant impending increase in the base rate. In fact, the reverse may be true: just this month (February 2020), the Bank of England warned lenders to start “getting ready for negative interest rates”, a move that could reduce the cost of borrowing even further. The Bank was careful to add that its warning “shouldn’t be taken as a signal that the policy is imminent,” but it does at least suggest that any sharp rise in interest rates is out of the question.

Drivers of Price Growth: Changing Preferences

A third driver of growth was, paradoxically, the Covid pandemic itself – or at least, that is what some economists have argued. Estate agents have reported that when faced with the realities of lockdown, large numbers of people with homes in big cities have sought to move. They have reportedly been seeking homes with better access to open space – whether in the form of bigger gardens or better access to parks, countryside or coastline. More transactions, coupled with a greater desire to move, amount to a recipe for price competition and rising values.

It’s impossible to know whether this trend will continue, once the changing weather and the vaccination programme start to have an effect. Unlike the previous two factors, the ‘race for space’ may not be a lasting influence on the UK residential market.

Drivers of Price Growth: Stamp Duty Holiday

The decision to suspend stamp duty until March 31st has certainly had a more time-limited effect on prices. Initially, it prompted a surge in demand, transaction volumes and prices, as people sought to complete before the deadline. However, that excess demand also resulted in administrative bottlenecks and by January, many were realising that their sales were not going to go through in time.

At the time of writing, some government sources have been suggesting that the Chancellor is considering a short (perhaps 6 week) extension to prevent buyers falling into what The Telegraph described as a ‘completion trap’, but even if that happens, it will affect only those who are in the final stages of their transactions. It would be unlikely to have a more widespread or lasting effect on prices generally.

The stamp duty holiday can therefore be considered an artificially imposed, short term factor that has little to do with the more fundamental operations of the market. For a while, prices rose as demand rose and now, with thousands pulling out of sales, we’re seeing early signs that prices might be dropping back again.

The Halifax House Price Index

One of the earliest indicators of this came through on 5th February, when Halifax reported that average prices had fallen by 0.3% between December and January. Its January House Price Index noted that “On a monthly basis, house prices in January were 0.3% lower than in December” but added that they were up 1.6% overall for the quarter, and 5.4% higher than at the same time last year.

This is only a modest drop and, by any usual standards, an annual gain of 5.4% might be cause for celebration. With ONS reporting an annual rate of inflation of only 0.8%, this is a strong real-terms gain. However, the greater significance of that 0.3% fall lies in what it might foreshadow. The question is whether it marks the beginning of a long-term decline, or merely a temporary dip. Most industry sources seem to be interpreting it as the latter, and there are some strong grounds for holding that position.

Commentators have long argued that the stamp duty holiday created an ‘artificial horizon’ that was always destined to skew prices, and that once it was over, there would be a sharp decline in transactions. Back on 9th January, The Telegraph warned that “The share of agreed sales falling through jumped from 17% in July to 28% in December,” and in early February, MPs warned that thousands of residential property transactions could collapse if the Chancellor refused to extend the holiday.

In practice, that decline in transactions already seems to be happening. That’s quite clearly because there is now little or no realistic chance of sales completing before the March deadline. Those who rushed to take advantage of the holiday are now realising that the opportunity has gone, and the artificial stimulus to the market has gone with it.

In the same week that Halifax identified a 0.3% fall in average values, Robert Gardner, Nationwide’s chief economist, said: “To a large extent, the slowdown probably reflects a tapering of demand ahead of the end of the stamp duty holiday… While (it) is not due to expire until the end of March, activity would be expected to weaken well before that, given that the purchase process typically takes several months.”

As a result of the end of the stamp duty holiday and other factors, including continuing fallout from Brexit and the expectation of rising unemployment, several industry groups are now forecasting a short-lived dip in prices. For example, a survey for the Royal Institute of Chartered Surveyors (RICS) found that a majority of its members expected prices to fall in the next three months.

Yahoo Finance reports that “many estate agents and surveyors said they expected the looming end to temporary stamp duty … to hit sales in months to come.” Significantly, however, “several said they expected current sales to be renegotiated but not fall through if they miss the deadline and buyers face higher tax bills.”

The prospect of ‘renegotiation’ is important because that would typically result in lower average values, and might account for some of the recent dip. Crucially, however, it suggests that the market won’t necessarily experience the sharp ‘cliff edge’ that some had feared. Transactions will continue, but as buyers re-examine their finances to factor in the added tax cost, so prices may fall by a corresponding amount.

House Price Forecasts to December 2021

There is considerable disagreement between different lenders and industry bodies about how prices might change over the course of the year. This is illustrated below.

  • Rightmove             +4%
  • Chestertons         +1.5%
  • Zoopla                     +1%
  • Savills                      0%
  • Halifax                     Between -2% and -5%
  • OBR*                       -8%

* (Office for Budget Responsibility)

This 12% difference of opinion points to the difficulties of forecasting during a period when Britain is facing both the biggest public health challenge in a generation and the biggest change to the terms of its international trade. At a time when exports are falling dramatically and unemployment is rising, some pessimism might seem justified. However, it’s equally important to point out that few, if any, of these sources believe that the price-dip will last much beyond the end of the year.

Longer Term Expectations

Looking again at those predictions, it’s telling to note that even the most downbeat forecaster, the OBR, expects “a steady recovery from 2022 onwards.”

For investors, and particularly those who invest primarily for capital gains, a short-term dip in prices matters very little. What matters much more is the longer-term trend. The market has seen dips before – most notably in 2008 – but the overall trend has always been upward.

The 2008 financial crisis presented a much greater challenge than today because the fall in house prices stemmed directly from a financial cause. There was a clear correlation between access to finance, market confidence and average property values. Today, with respect to Covid, prices are being affected much less directly; as a result of issues relating to health, not economics. Once that underlying health issue resolves itself, most likely through international vaccination programmes, there is little to stop the housing market returning to growth.

Making house price predictions is no exact science, of course, but a glance at some of the UK’s most widely-quoted organisations would seem to hint at a broad consensus: that average values will rise steadily after this year.

House Price Predictions to 2024

Source

2021

2022

2023

2024

Savills

0%

+4%

+6.5%

+4.5%

Statista

-1%

+3%

+5%

+5%

JLL

-1.5%

+2.5%

+4%

+5%

Seven Capital

+2.5%

+4%

+3.5%

+3%

Knight Frank

+1%

3%

NA

NA

2021: Different Impacts for Different Investors

Clearly, not everyone expects a price dip this year but enough consider it a possibility that it should be taken seriously. So if it does happen, what does that actually mean? How would that affect investors?

For those who intend to keep hold of their properties, which will probably be the majority of landlords, a dip would have minimal impact. Capital values matter most when an investor comes to sell and, until that point, on-paper values are little more than notional. A small drop in 2021 would quickly be counteracted by stronger gains in 2022 and, thereafter, conditions are expected to look good. Logically, those who can hold on to their properties in 2021 should do so. In the meantime, with rental demand still sky high, and average rental values still rising, landlords can still expect a healthy regular return in terms of rental yields.

For those who are forced to sell later this year, a dip is unwelcome but unlikely to make a serious dent when set against the astronomic gains of 2020. A gain of 7.6% followed by a drop of, say, 1.5% still amounts to a very respectable 2-year return.

For those investors who want to expand their portfolios, a price dip will actually be welcome news. We are used to thinking about average values in terms of capital gains – i.e. from the perspective of investors who already own property – but it’s equally valid to adopt the perspective of an investor looking to make a new acquisition. In that case, it makes sense to think of house prices as the average cost of a new investment. For such people, a year of static or falling prices represents the perfect opportunity to buy, not least because there is a strong expectation of price growth thereafter.

The graph below uses data from Statista* to show how average values have changed since 2007. Note how far average house prices have risen since the global financial crisis in 2008.

*Source: Statista. (2021 house price data from ONS)

Summary

Not everyone agrees that prices will fall in 2021, but it is certainly a possibility, and one that needs to be considered. However, few seriously believe that values will fall for any extended period. Unlike in 2008, the forces that could cause a dip are not directly related to any structural weakness in the housing market itself. The forces of supply and demand still broadly favour investment and once the immediate impacts of Covid have passed, those forces can be expected to drive values up again.

In the meantime, if prices do fall in 2021, investors will be able to buy more cheaply that they otherwise could, so any dip would constitute an opportunity to make money work harder and to achieve better yields, year on year. Moreover, if history has shown us anything, it’s that the property market is capable of weathering out severe storms and returning quickly to positive growth, delivering respectable capital gains in both the medium and longer terms.

* * *

For more information about investment opportunities in 2021, please call our advisory team on 01244 343 355 or email sales@residential-estates.co.uk 

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