Not that many years ago, but long enough to fall outside the adult memory of a large number of today’s homeowners and would-be buyers, the blight of negative equity struck Britain. The condition – where the value of your house or flat falls below the value of your mortgage and well below the price you paid for the property – caused untold misery for millions of people. Prevented from either moving or remortgaging, they were trapped in their homes, burdened with often unaffordable mortgage repayments.
The crash of the late 1980s happened swiftly and brought about a slump the magnitude of which had not been seen since the 1930s. Almost overnight, easy credit and generous mortgage multiples vanished as interest rates climbed and the rip-roaring boom in house prices – which had seen annual growth peak at over 20 per cent in 1988 – came to an abrupt end. Confidence drained out of the market and property values nosedived. Repossessions soared, as did the numbers of people voluntarily handing keys back to their lenders and walking away from the problem, unable to cope with the strain any more. Woolwich Building Society figures showed that by 1993 the number of households in negative equity had hit 1.7m, up from just a few thousand at the end of the previous decade. Thatcher’s property owning democracy had run into a brick wall.
However, the past is easily forgotten, and in 1996 prices began to rise again. And rise. And rise. And rise. By the eve of the financial crisis in 2007, the average house price had risen 260 per cent from its mid-90s nadir. Even the credit crunch could only induce a temporary slowdown – the 18 per cent price drop of 2008 was fully reversed in 6 years, and by 2017 prices had soared another 15 per cent above their pre-crunch highs.
The obvious question after such a powerful run, arguably driven by accommodative monetary policy that has led many investors into residential property as a way of replacing lost income, is whether the market has now peaked. And if that is the case, have the armies of first time buyers still entering the market, attracted by government-backed incentives such as Help to Buy (see this week's Sector Focus), put themselves in a position where they are now sitting on a ticking negative equity timebomb?
There are already signs that the market is cooling – price growth is slowing again, led by the London market which, according to the widely followed Nationwide house price index, has experienced five consecutive quarters of declines. Transaction volumes have slumped by 40 per cent over the year – a similar level to the 38 per cent fall during the 1988 and 1991 crash. Brexit uncertainty is commonly presented as a culprit, and concerns are mounting that the increasingly likely possibility of a no-deal Brexit could inflict a mortal wound on the UK housing market. Those fears were stoked further by widely circulated reports that Bank of England governor Mark Carney had suggested that such an outcome could presage a crash in UK house prices. As the BBC reported his presentation to the government, “his worst-case scenario was that house prices could fall as much as 35 per cent over three years… mortgage rates could spiral, the pound could fall and inflation would rise, and countless homeowners could be left in negative equity”.
As is now de rigeur in journalism, fact checking of this deliberately leaked statistic reveals a slightly different picture – what Mr Carney was in fact reporting to the cabinet is how resilient the UK’s banks would be to the very worst outcome a disorderly Brexit may bring; the so-called ‘stress testing’ that has taken place regularly in the aftermath of the credit crunch. As the BBC put it deep into the same article, it was “not a forecast [but] an apocalyptic test where the Bank deliberately sets the parameters beyond what might reasonably be expected to occur”. A test, incidentally, which all UK banks passed.
But crises often come when least expected. And the febrile political environment in the UK now means that it is becoming difficult to distinguish economic fact from fiction – a negative, misreported news story can be half way around the country before anyone has a chance to correct it. And in our property-obsessed county, where the threat of a serious housing market correction is for many the biggest worry of all, that can be dangerous. How many people will consider buying a house if they think that in a year or two its value will have fallen and the cost of the mortgage has risen?
What’s more, a downward shift in house prices could more broadly undermine the UK’s economic confidence and create a downward economic spiral. As the Bank of England explains, rising house prices make consumers feel better off and spend more money, often by borrowing against their home equity.
Separating housing fact from fiction
So what is really going on in the UK’s housing market? Let’s start with a very basic statistical observation: there is no period in modern history where house prices have been lower than 20 years earlier. And Mr Carney’s worst-case scenario of a 35 per cent fall over three years is around double the short-lived decline seen in the wake of the financial crash a decade ago, or the 1990s crash.
There are other more tangible forces at work to explain the fall in demand. In some parts of the country such as London, house prices have been falling for the simple reason that they have risen too much, underpinned to some extent by overseas buying interest and subsequently undermined by higher stamp duty and other measures to deter foreign buyers.
And, in fact, although price growth is slowing, the overall trend is still up – 3.7 year on year in August to an average of £230,000 according to the latest Halifax figures. On a more granular level, there are still pockets of steady price growth across the country, often in areas that did not, like London, bounce back so sharply from the crunch. Nationwide’s latest figures show that even the London price slide is starting to slow, and it, too, is hardly a homogenous market either – recent figures from estate agency group LSL show some boroughs still seeing high single digit (Redbridge and Lambeth) and even double digit price inflation (Merton and Kensington).
Indeed, history tells us that the UK housing market is, when it comes to long-run returns, a pretty resilient investment that has shaken off all manner of political and economic concerns over the years. According to the 2018 Credit Suisse Global Investment Returns Yearbook, housing has returned a real (ie post-inflation) return of 1.8 per cent a year since 1900 – worse than equities, but better than bonds (see Chris Dillow’s view on housing as a portfolio diversifier on page 16).
Indeed, that’s a fair return that backs up residential property’s ‘safe as houses’ moniker – but, as the study’s authors point out, “residential property should not be purchased with an exaggerated expectation of a large risk premium”, a job they suggest is best left to equities. In other words, if you are buying property for the supernormal returns that have been witnessed at some points in various property cycles, the next few years may be disappointing.
Stretched affordability
One indisputable truth about UK homes is that they are much more expensive than they once were – in fact, according to the Bank of England, around three times more expensive than they were in the 1970s. This means that the price of the average property has risen at three times the rate of the average salary. Buyers are now being asked to find around 8.5 times salary on average.
Nevertheless, affordability is stretched and this could act as another tangible deterrent for future purchases. According to data compiled by Hometrack, the income that first-time buyers need to get onto the housing ladder in the UK’s 20 largest cities has risen by nearly a fifth in the past three years, with the average income requirement ranging from £25,000 in Liverpool to £82,000 in London. However, while this means buyers may have to rein in their urban aspirations, it is not keeping them off the housing ladder altogether.
Indeed, broad affordability statistics belie the fact that the UK residential property market is not a homogenous entity, with many regional variations in the rate of price growth and affordability.In fact, there still eminently affordable homesfor private sale within travelling or commuting distance of the big cities, and while travel costs will be higher, they are not means tested as are mortgages. (Typical example: two-bedroom ground floormaisonette in Gillingham, Kent £150,000. Travel time to London 50 minutes, annual season ticket £4,124 per annum).
ONS data also reveals a disparity between the affordability of new and existing homes – with buyers being asked to pay 10 and 7.5 times salary, respectively. The explanation: Help to Buy, which critics suggest has simply enabled housebuilders to add a premium to their houses, and make supernormal profits funded through government largesse and at the expense of buyers for whom the scheme is often the only way to get on the housing ladder.
The scheme, which has helped to fund 158,000 home purchases so far, is due to run until 2021, but as we explore more fully on page 58, it has become so integral to the health of the UK housing market that it seems likely that it will be extended further – the methadone of the housing market as it were. Indeed, Help to Buy has helped offset the post-credit crunch caution of banks and major lenders, which in a decade have moved from being profligate mortgage issuers to somewhat abstemious (see page 28 for more on what current housing trends mean for UK banks and insurers).
The rate question
Anyone who has taken on a new mortgage in the past few years will be well aware of the increased scrutiny to which banks now subject borrowers. A key test is whether mortgagees will be able to afford their mortgage commitments in the event of a rise in interest rates towards ‘normal’ levels.
By normal we mean mid-single digit mortgage rates – but the likelihood is that this isn’t going to happen any time soon, and it may well be that the current situation is in fact the new norm. That seems all the more likely given the reaction of the housing market to the MPC’s rate hike in August – according to the month’s RICS survey, new buyer enquiries and sale instructions slipped back sharply. Rate setters will have been watching closely and will be mindful of further weakening the market further.
Thus, the only prospect of higher rates is if inflation and economic growth rise significantly. Weak economic growth currently rules out any material shift in rates, and the idea of protecting the pound after a run precipitated by Brexit chaos or a Labour government doesn’t wash any more.
Conversely, house prices are unlikely to crash at all unless there is an economic collapse or a drastic increase in unemployment, neither of which any serious economic pundit is predicting. Indeed, the UK homebuyer is still in largely good health. According to the IHS Markit Household Finance Index, households confident in their future finances turned positive in July for the first time since 2016, supported by strong employment trends, and although sentiment slipped sharply in August current finances are generally strong, with earnings continuing to climb sharply.
Indebtedness remains an issue for UK households – according to ONS figures, household debt stood at £1.7tr at the end of 2017 – up from £1.4tn at the credit crunch took hold in 2018 – with mortgage debt accounting for 78 per cent of all lending to UK households. However, beneath the headline figures the picture is far less alarming. As a percentage of disposable income, at 133 per cent, current household debt is lower than in 2007 when it approached 147 per cent. And as economists at Pantheon Macro note, mortgage payments are historically low thanks to low interest rates, and borrowers have been able to take on bigger loans by lengthening mortgage terms. It’s hardly surprising that UK remortgaging activity hit a 10-year high as borrowers lock in low rates.
It is also telling that the number of first time buyers is continuing to rise, up 3 per cent in the first six months of 2018 to 175,500 according to Halifax figures. That’s just 8 per cent below the peak of the last boom, in 2006, and more than double the credit crunch nadir in 2009. First time buyers now account for more than half of all mortgage-financed purchasers, and 81 per cent of all Help to Buy funded purchases. The dream of home ownership is alive and well.
Conclusion: don’t forget the 90s
Of course, the dream of home ownership was equally strong in the late 1980s, fuelled by Thatcher’s Right to Buy reforms. But that dream alone did not prove enough to prevent a market blowout that financially scarred many young property owners.
Indeed, while it’s fair to say that talk of UK housing’s demise has been greatly exaggerated, it is not misplaced to suggest there are some red flags that we should continue to monitor – slowing activity, stretched affordability and the risk of unsuccessful political tinkering that accompany this key industry, particularly given the intensifying pressure to increase supply. Even the rush by remortgagers to lock in low rates could be interpreted as a sign that confidence in continuing benign economic conditions is shaky.
But it is possibly a wise response. A 1997 government survey conducted to understand the impact of negative equity found that householders had become much more aware of the risks related to home ownership. Housing is resilient, but the short-term risks of buying at the wrong time remain. As another contemporary study published by the Royal Geographic Society put it: “Even if there is a recovery, it is important not to revert to thinking that negative equity is something that happens to other people in other places at other times. It has happened before and could happen again”. If it does, its effects will be felt widely.
