OPPORTUNITY KNOCKS ON THE DOOR OF UK RESIDENTIAL PROPERTY

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Policymakers have clearly targeted the log-jam in the UK residential property market with a series of new initiatives this year, which we think will be a catalyst for house prices to rise. In this document we look at how these policies should drive residential property prices higher in the short term. We focus on the longer-term outlook, opportunities and pitfalls of investing in the UK residential rental market and set out the key factors every potential landlord should understand before investing.

Broadly Risks

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Key opportunities and risks
• House prices could rise by 8% per annum
• Already-high prices depend on cheap funding for more gains
• Population growing four times as fast as housing stock
• High deposits keep would-be first-time buyers renting
• Growing number of renting households supports market
• Rental income is capped by affordability; vulnerable to economic weakness
• Low rates exacerbate investment traps

OUR VIEW
We believe that UK house prices are now set to rise after a couple of years where gains were focused in London and most other regions experienced declines. Recent government measures to make new mortgages cheaper and more accessible will support the housing market and the UK economy is forecast to improve. However, the key caveat is that prices would be rising from an already-expensive level, and advances would only be driven by the continuing availability of ultra-cheap finance.
It is generally agreed that UK residential property stands at more than fair value by most measures. Our preferred approach is to look at the relationship between nominal gross domestic product (GDP), which is the total value of income produced in the economy including inflation, and the price of houses. House prices have broadly kept track with the growth of nominal GDP over the past 60 years, and have reverted back to trend following both booms and busts. By this measure house prices have been above average since 2002 and are currently 9% above their average value against nominal GDP.

So how has the UK housing market sustained such ‘overvalued’ levels and proved so resilient through the global financial crisis compared to other countries and asset markets? One important factor is the scarcity of dwellings in the UK relative to households, compared to other countries. What’s more, this availability didn’t increase significantly during the preceding boom.

In the US, the stock of new dwellings outstripped the increase in households by 4% during the house-building boom in the decade since 2000. In contrast, the increase in the UK was less than half that and started from a much lower base. While dwellings outnumber households in the UK, the surplus is in the wrong places, with a shortage in London and the south-east. This constraint on availability has helped UK rents hold up and continue to rise throughout the period.

Nonetheless, being above average has not stopped UK house prices from rising further. A key factor is affordability, which has improved as interest rates have fallen to record lows. But despite the low cost of borrowing, the problem of raising the required deposit to obtain these affordable mortgages has proved a barrier for many, especially first-time, buyers.

Government to unblock log-jam in mortgage market

This issue has been targeted by the Government’s new Help to Buy scheme, which provides loans or guarantees for first-time buyers with a 5% deposit. The Coutts measure of affordability, which takes into account the total cost of purchasing a house by incorporating an inferred cost for the deposit, has fallen to its best level for nine years. The expansion of the Bank of England’s (BoE’s) Funding for Lending Scheme will also increase the supply of cheap finance to the UK residential property sector. So-called “buy-to-let” mortgages will qualify for a bonus whereby lenders can receive funding at 0.25% from the BoE for up to 10 times the amount of new loans made.
As a consequence of these measures, the cost of mortgages to buy houses will be back to very affordable levels that have historically been associated with house prices rises of around 8% per annum. However, this is likely to require a further improvement in consumer confidence. But provided the economy continues to improve, as we forecast, we expect many people currently renting will look to buy, supporting prices.

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