EY ITEM Club Special Report on Housing
No bubble to burst at a national level…
2013 saw a robust pickup in UK housing transactions and house prices, driven by a powerful blend of government support schemes, improved credit conditions, rising employment and an accelerating recovery in the wider economy. But despite the strength of the rebound in prices, the main indicators suggest that fears of a renewed housing bubble are unfounded across most of the country. House prices in most regions are still well below their previous peaks, both in real terms and in relation to average incomes. And household debt is at much more manageable levels than before the financial crisis.
…but the warning-lights are flashing in London
The exception to this benign scenario is Greater London, where limited supply and strong demand have combined with rising employment to push both the price-to-income ratio and average income multiple back to pre-crisis highs. London house prices surged by over 11% in 2013; without the ‘London effect’, the average UK house price rise of 5.4% during the year would have been only 3.5%. There’s also increasing evidence of the price acceleration spreading beyond central London prime properties to the rest of London’s residential market. All of this marks London out as a special case demanding particular vigilance from policymakers.
Continued modest growth in average UK prices…
Over the next five years, a combination of improving economic conditions and ongoing support from Help to Buy should ensure that demand for houses continues to strengthen across the UK, fostering further growth in transactions. These conditions should give house-builders the reassurance they need to further ramp up building plans, in turn boosting the supply of housing and helping keep a lid on price growth. Given these balancing forces, we expect prices to rise by a UK-wide average of 6.5% per annum over the next five years.
…but with stark differences at the regional level
However, London is once again the exception, with differing economic factors across the UK regions leading to wide variations in house price inflation. Employment and income growth is likely to be strongest in London and the other southern English regions. Given that this is where the housing shortages are most acute, we expect these areas to see the strongest price growth. London is set to lead the way with annual rises averaging over 7%, though the increase will be limited by poor affordability. But greater exposure to public sector spending cuts will limit employment and income prospects for the northern and devolved regions, where supply restrictions are also less serious. As a result, the gap between prices in London and most other regions will continue to widen: by 2018 we project the average price in London will be just below £600,000, some 3.5 times the average in Northern Ireland and more than 3.3 times the North East.
Help to Buy: keeping a steady hand on the tiller
Recent expressions of concern over the risk of a UK-wide housing bubble have been accompanied by calls for the government’s Help to Buy (HTB) scheme to be scaled back or dropped. The Treasury has provided funding for HTB to guarantee around 550,000 mortgages over the next three years, and it’s true that it will play a role in boosting prices and transactions in most regions. However we do not see a case for changing the terms of Help to Buy, especially since the the most likely source of a bubble is London, where the impact of HTB is likely to be small. This is because the main constraint on buyers in London is not loan-to-value ratios but income multiples, which HTB does not address.
Policy options: one rule for London…?
The most immediate challenge facing policymakers is how to ensure the London market remains under control without choking off the nascent recovery elsewhere. This means any intervention to cool the market should be of a macro prudential nature and focused specifically on London. The best option would be to police income multiples in the capital while allowing market forces (and HTB) to hold sway in other regions. The most likely cause of a housing bubble at the national level would be that the supply of housing fails to keep pace with rising demand. So, alongside its policies to support demand such as HTB, we believe the government should also implement measures aimed at increasing housing supply, including planning reforms and public sector house-building.