THE UK HOUSING MARKET ANALYST

Transcription

1 THE UK HOUSING MARKET ANALYST Q Lack of homes for sale will drive house prices higher in House prices resume their upward trend, as recovering demand comes up against low levels of homes for sale. But beyond, very high valuations and a gradual rise in interest rates will weigh on price gains. Mortgage lenders increase their share of lending to BTL. Housing starts set for period of steady growth.

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3 THE UK HOUSING MARKET ANALYST Q Economic analysis for UK housebuilders, developers, mortgage lenders, surveyors and investors Executive Summary The Economic Backdrop Valuation and Affordability Housing Market Activity House Prices The Regional Outlook The Regional Outlook (continued) Residential Lettings Market Housing supply and land prices Demographic indicators The UK Housing Market Analyst Q

4 Executive Summary The UK economic backdrop has strengthened over the past three months, with revisions to Q GDP suggesting that growth was faster than initially assumed. Despite a rise in unemployment in May, wage growth has picked up. Looking ahead, a broad range of surveys suggest that the economic recovery s momentum is set to be maintained. Active housing demand appears to be responding to the strong economy. Measures of consumer confidence in making a major purchase have risen sharply in recent months, and the RICS new buyer enquiries balance is close to a -month high. Demand has also been supported by mortgage rates, which have seen further falls over the quarter. With mortgage availability likely to improve in the coming months, lending will continue to support activity and prices. That said, strong demand will probably have a greater impact on prices than transactions. Stocks of unsold homes on the market are extremely low. So while activity in the housing market has risen slightly, there aren t enough homes for sale to allow strong buyer interest to drive an increased level of transactions. Consequently, we expect a total of around. million transactions this year, only marginally more than the figure. Instead, the imbalance between active demand and supply will put upwards pressure on house prices. Admittedly, Nationwide reported a further decline in the annual rate of house price inflation in June to.%. But we expect this to increase over the latter half of the year, and prices to rise by % during. In and 7, increasing interest rates and low affordability will act to slow the market, with annual price growth falling to %. Driven by high demand and limited stocks of homes for sale, house prices in London saw the largest quarterly rise out of all the regions bar Northern Ireland in Q. That said, the rate of annual price growth in London has slowed considerably over the past year. We expect that to continue, cumulating in flat prices for, before rising slightly by % y/y in 7. The share of mortgage loans going to the buyto-let (BTL) sector has risen sharply in recent months, which will partly reflect the fact that BTL loans are not affected by tougher mortgage regulations. Investors are also being attracted by strong tenant demand, which has put upwards pressure on rents. We doubt the cut to tax relief announced in the Summer Budget will trigger a sudden rise in rents, but longer term the cut in yields will dissuade some investors from entering the market, and that drop in supply could lead to higher rents from 7 than otherwise would have been the case. Housing starts jumped in Q, reflecting both a catch-up after a surprisingly weak end to and also a rebound in demand for new-build homes. Furthermore, constraints around the supply of labour and materials, which have been holding back production, have also started to ease. After such a strong start to the year, housing starts might dip slightly in the second quarter. But in the medium term we expect them to rise steadily, in line with our forecast for transactions. The UK Housing Market Analyst Q

5 Main Forecasts TABLE : NATIONAL HOUSING MARKET FORECAST Year-end, unless stated otherwise 7 Nationwide house prices, % y/y House price to earnings ratio Transactions, mns, total for year.... Transactions, % y/y.... Land prices, % y/y.... Rental growth.... Rental yields....9 Total gross returns to landlords (net of RMD and financing costs) Sources Thomson Datastream, Capital Economics, Nationwide TABLE : REGIONAL HOUSE PRICE FORECASTS Year-end, % y/y 7 London South East East Anglia South West East Midlands.... West Midlands.7... North East.... North West.7... Yorkshire and Humberside Wales.... Scotland.... Northern Ireland Sources Nationwide, Capital Economics TABLE : SUMMARY UK ECONOMIC FORECASTS % y/y, year average, unless stated otherwise 7 GDP.... Household spending.... Real household disposable income.... Average earnings.... CPI inflation.... Unemployment (ILO measure, mns) Unemployment rate (ILO measure, %).... Employment (%y/y)...7. Base rates (%, end-year).... Average new mortgage rates (regulated lending, % end-year).... Sources Capital Economics, Thomson Datastream The UK Housing Market Analyst Q

6 The Economic Backdrop Strong real income growth will fuel recovery in We remain generally optimistic about the outlook for the economy. Recent revisions to the data suggest that the slowdown in economic growth at the start of the year has been largely temporary. The provisional estimate of GDP for Q has already been revised up to.% from.%, and if past experience is anything to go by, this may be further revised upwards in the future. (See Chart.) Surveys are also painting a relatively positive picture of economic activity. A weighted average of the Markit/CIPS surveys fell a little in June but remain consistent with quarterly GDP growth of about.%. (See Chart.) Surveys from the Bank of England s agents, British Chambers of Commerce and the CBI also remain strong, further suggesting that the economic recovery has not lost pace. Job vacancies are high and employment intentions are robust. (See Chart.) Furthermore, with inflation set to remain at zero for the rest of the year and nominal pay growth rising, real average earnings are now growing robustly. Admittedly, unemployment did increase in May, but strong economic growth should mean that this is only temporary. That said, over time, we expect the main driver of GDP growth to shift from employment to productivity. As a result, jobs growth is unlikely to beat recent highs, but the outlook for wages should roughly make up the difference. (See Chart.) Interest rates on new mortgage borrowing have fallen to fresh record lows, which should support mortgage activity. While the risk of a rate hike has risen, we still think that they will stay on hold until next year, and even when they do rise, we expect it to happen only gradually. (See Chart.) Admittedly, the outlook is not all rosy. For a start, fiscal consolidation is set to continue. Although the Chancellor smoothed the UK s fiscal path in the Summer Budget, this brought forward the timing of some cuts, making policy more of a drag this year than in previous plans. (See Chart.) Then again, while we note that GDP growth slowed sharply when the first part of the fiscal squeeze really got going in /, a stronger economic backdrop now makes the situation much more favourable this time around. A number of external threats loom, but we believe the UK should have little trouble dealing with them. The US Fed is soon set to raise rates but, importantly, it will be doing so because the US economy and therefore its demand for UK exports is strong. As for Greece, the UK s direct exposure via exports and bank loans are limited and contagion to other euro-zone countries has so far been small. (See Chart 7.) As a result, the impact of a potential Grexit on the UK economy, and on the banking sector, would likely be limited. Overall, we expect GDP growth to slow only modestly, from about % this year to.% in. (See Chart.). Looking further ahead, as some of the constraints on demand ease, there is the potential for economic growth to rebound to rates of % or higher for several years, as productivity makes up some of its lost ground. The UK Housing Market Analyst Q

7 The Economic Backdrop : Real GDP Growth : Markit/CIPS Composite PMI & GDP Growth %q/q (RHS) %y/y (LHS) CIPS/Markit composite PMI (LHS, quarter average) GDP (%q/q, RHS) : Vacancies per Employee Jobs : Employment, Productivity & Real GDP (% y/y) Employment Productivity GDP Forecasts Av : Expectations of Bank Rate (%) : Change in Cyclically-Adjusted Net Borrowing (% of GDP) Consensus Forecast Capital Economics Forecast Implied by markets OBR Forecasts Fiscal stance looser Jul- Jan- Jul- Jan-7 Jul-7 Jan- - - Mar. Jul. Fiscal stance tighter / / / / / / /7 7/ /9 9/ / - - 7: The UK s Direct Exposures to Greece : Real GDP Growth UK goods exports to Greece (% of total). UK banks' exposures to Greece (% of GDP) % q/q (RHS) % y/y (LHS) Forecasts: =.% =.% 7 =.% Sources Thomson Datastream, Bank of England, Bloomberg, OBR, CIPS/Markit, ONS, Capital Economics The UK Housing Market Analyst Q

8 Valuation and Affordability Further fall in mortgage rates improves affordability Mortgage rates have seen further falls over the past quarter. Average quoted rates on a twoyear fixed rate, 7% loan-to-value (LTV) mortgage dropped to just.% in June. For those with just a % deposit, the rate has fallen by bps over the past year to.%. (See Chart.) The drop partly reflects an earlier fall in wholesale rates, as expectations of when the MPC would start raising Bank Rate drifted further into the future. But more recently the downward trend in wholesale interest rates has reversed. For example, since the start of the year two-year swap rates have risen by bps, and five-year swaps by bps. (See Chart.) Alongside developments in the wholesale debt markets, mortgage spreads have continued to narrow. (See Chart.) Spreads are likely to fall further. The higher levels of capital that banks are now required to hold will mean that spreads are likely to remain somewhat higher than they were prior to the financial crisis, but even so we estimate they could absorb at least the first bps of any rise in Bank Rate. The Help to Buy scheme appears to be losing momentum. While take-up of the generous equity loan component for new-build homes has held steady, the mortgage guarantee scheme has tailed-off. (See Chart.) The cost of the loans, and the strict affordability test required by the MMR, help to explain its waning popularity. The decline in take-up of the Help to Buy mortgage guarantee scheme has led to a reduction in the share of mortgages advanced with small deposits. The share of loans with a LTV of over 9% has fallen from.% in Q to.9% in the first quarter of. Given that, it is not surprising that the median deposit for first-time buyers (FTBs) is still close to %. That represents over % of earnings for an average priced FTB property. (See Chart.) Average loan-to-income (LTI) ratios have eased back since the Financial Policy Committee (FPC) introduced a tougher interest rate stress test and cap on the share of loans with an LTI of over. in the middle of last year. (See Chart.) But the latest Credit Conditions survey showed lenders were planning on increasing maximum LTIs over the third quarter, so we doubt they will fall much further. The slowdown in house price inflation and return of modest earnings growth has led to a period of stability in the house price-toearnings ratio, which has held at.9 for the past year. (See Chart 7.) We expect it will rise slightly over the next six months given our forecast for stronger price gains, but is then set for a period of gradual decline as earnings growth outpaces house price growth. Rising earnings will also help to cushion the eventual gradual rise in interest rates. As will the fact that, for those first-time buyers who have got a mortgage, mortgage payments as a share of income are at their lowest since records began in. (See Chart.) And a one percentage point rise in mortgage interest rates would leave payments at a manageable level. So while rising rates will certainly slow house price gains, we doubt they will cause a sharp downwards correction. The UK Housing Market Analyst Q

9 Valuation and Affordability : Average Quoted Mortgage Rates (%) : Interest Swap Rates (%) Two-Year Fixed 9% LTV.. 7 Two-Year Fixed 7% LTV Two-Year Discounted 7% LTV year swaps -year swaps. Jan- Apr- Jul- : Spread of New Effective Mortgage Rates Over Bank Rate (%) : Help to Buy Loans As Share of Mortgage Approvals for House Purchase (%) 7 Equity Loan Mortgage Guarantee Jun- Aug Oct Dec Feb Apr Jun- Aug Oct Dec Feb Apr : Average First-Time Buyer Deposit as Share of Income (%) : Median Loan-to-Income Ratio (%).. First-time buyer Homemover Introduction of FPC interventions.. 7: House Price-to-Earnings Ratio : First-Time Buyer Mortgage Payments as Share of Income (%) 7 7 After rise in mortgage rates of percentage point Forecast Sources Thomson Datastream, Bank of England, Capital Economics, Nationwide, CML The UK Housing Market Analyst Q 7

10 Housing Market Activity Housing demand responding to strong economic backdrop Active housing demand is finally responding to Housing demand look set to remain strong. the strong economic backdrop. The new buyer Measures of consumer confidence in making a enquiries balance is close to a -month high, major purchase have risen sharply in recent and has now been in positive territory for the months. (See Chart.) Indeed, the GfK past three months. (See Chart.) measure rose to its highest level since in June. Rising employment and earnings will be New buyers can also expect a bit more support supporting confidence, while the trouble in from the mortgage market. Although mortgage Greece does not appear to have dented approvals for house purchase fell back in May, consumers economic sentiment. that was not enough to reverse a very large rise in April, and approvals are up.% compared The reform to stamp duty did not raise overall to a year ago. (See Chart.) Remortgaging transactions as much as we expected in fact activity is also making a comeback, as transactions have been surprisingly flat so far borrowers have been tempted to switch to new in. But transactions just above the old fixed mortgage interest rates which are now thresholds of,,, and lower than average existing variable rates. million have increased, reflecting the removal of price distortions created by the old slab That improvement in the supply of mortgage structure. (See Chart 7.) Meanwhile, at the top lending is expected to continue. The latest end of the market, sales volumes of homes Credit Conditions survey reported that lenders worth over million fell by 7% y/y, plan to raise the availability of secured loans in reflecting both increased stamp duty costs and the third quarter, and approve a greater share concerns over a possible mansion tax. of applications. (See Chart.) With active housing demand set for further Recent signs of a rise in housing sales are growth and mortgage lenders looking to boost therefore set to continue. According to RICS the availability of credit, both mortgage surveyors newly agreed sales edged higher in approvals and transactions will see further May and June, and they expect that gradual gains. But a lack of stock on the improvement to accelerate over the next three market will act to prevent a rapid recovery, months. (See Chart.) and with no pre-election slump in activity, there is limited scope for a post-election jump. Transactions are also being supported by a rise Overall, we expect transactions to total. in cash buyers. We estimate there were around million this year, marginally higher than the, cash buyers in the year to the first total. (See Chart.) Beyond that, sales quarter of, the highest number since should be able to rise steadily, although at records began in. (See Chart.) But as.m by the end of 7 they will remain mortgage lending gradually recovers, the share below pre-crisis levels. of cash transactions should start to fall. The UK Housing Market Analyst Q

11 Housing Market Activity : New Buyer Enquires (% Balance) : Mortgage Approvals (s) Remortgage House Purchase : Availability of Secure Credit and Share of Mortgage Applications Approved (% Balance) : Newly Agreed Sales and Sales Expectations (% Balance) Credit availabilty rising/ approval rate up Expected in Q Applications approved Availability of credit Agreed Sales - Sales Expectations : Transactions by Buyer Type (Rolling -Quarter Sum, s) : Measures of Confidence in Buying a Home (% Balance) 7 Cash Buyer Mortgage Home Mover Mortgage First-time Buyer Mortgage Buy-to-Let Confidence in making a major purchase (LHS) Buy home in next months ( RHS) : Transactions by Value (March, % y/y) : Completed Housing Transactions and Mortgage Approvals (Rolling -month Total,s) Under k k-k k-k k-k k-k k-k k-k k-k k-k k-k k-m m-.m.m-m Over m Transactions Mortgage approvals for house purchase Forecast Sources - Bank of England, RICS, HMRC, Halifax, Eurostat, Land Registry, Capital Economics The UK Housing Market Analyst Q 9

12 House Prices House prices set to rise further this year According to Nationwide, house prices fell by months of unsold stock per surveyor falling.% in June. But this only reversed a gain of a throughout the period. (See Chart.) similar magnitude in May, and on an Admittedly, the new sales instructions balance underlying basis, prices rose by a respectable increased from May, but at minus.% in % m/m. (See Chart.) June, there are few signs that stock levels will rise in the short term. Some other measures also pointed towards a pick up in price growth. The Halifax recorded In part reflecting this low level of stock, house a.% m/m price rise in June the highest price expectations rose to a -month high. it has been in five years. Similarly, the Land While not a perfect indication of the future, Registry recorded a.9% m/m price rise in this recovery in expectations does point to its estimate for June also stronger than the accelerating house price gains. (See Chart.) month before. (See Chart.) Only the ONS recorded slower underlying price growth in its One potential drag on price growth is the BTL latest data, although note that this is a lagging sector, which has become increasingly indicator of the market. important over the last year. In the Summer Budget, the government reduced the There are few signs to suggest that the general generosity of tax relief on rental income, election impacted house prices nationally. resulting in potentially lower returns on BTL Looking at the Halifax, Nationwide, Land investments. We doubt the change will trigger Registry and ONS measures of house price a rapid downward price adjustment, but growth, there is little sign of a pattern in prices suspect that it will deter some landlords from around the vote. (See Chart.) Indeed, looking entering the market or expanding their across all the indices reveals that prices rose portfolios. While some of this slack will be by an average.% m/m in the two months taken up by first-time buyers, the change will both before and after, suggesting that election add to the headwinds facing house prices uncertainty had little impact. beyond. Growing mortgage activity has been In the short term, low stock levels, falling supporting house prices. Mortgage approvals unemployment and strengthening wage growth for house purchase rose by.% m/m in will facilitate a fairly strong house price rise of May, considerably faster than the.% growth % this year. But given the high level of house seen three months prior in February. (See Chart prices, such a pace cannot be maintained..) This growth is likely to continue in the near Indeed, house prices have now exceeded their term, as interest rates remain low and banks pre-crisis peak on all the main measures. (See look keen to expand their lending. Chart 7.) Consequently, we expect house price inflation to slow considerably over and A historically low number of unsold homes on 7. (See Chart.) the market has also supported prices, with The UK Housing Market Analyst Q

13 House Prices : Growth in House Prices on Nationwide Measure : Underlying House Price Growth on Different Measures (% m/m) % m/m (RHS) % m/m (LHS)... Halifax Land Registry Nationwide : Growth in House Prices Before and After the General Election (% m/m) Apr-May Average May-Jun Average May Data Only Flat Land Registry ONS Nationwide Halifax : Growth in Mortgage Approvals and Annual Change in Mortgage Rates Mortgage approvals (%y/y, LHS) Annual change mtge rate (pp, adv. mths. inv. RHS) Mtge rates down/ Mtge appvs up : Unsold Stock per Surveyor and New Sales Instructions : House Prices Growth and Future Price Expectations Unsold Stock Per Surveyor (LHS) New Sales Instructions (% Bal. RHS) Surveyors Expecting Higher Prices, Next m (% Bal. Adv. m, LHS) Nationwide House Prices (% m/m, RHS) : House Price Indices Difference from Pre-Crisis Peak (%) : House Price Forecast (% y/y) Forecast Land Registry ONS Nationwide Halifax Sources T Sources Nationwide, Land Registry, Halifax, ONS, Bank of England, RICS, Capital Economics The UK Housing Market Analyst Q

14 The Regional Outlook For how long can London prices power ahead? According to Nationwide, London recorded Activity has continued to decline, as low stock the second fastest rate of price growth in Q at levels limit the chance that buyers will be able.% q/q, behind only Northern Ireland. (See to find a suitable home. The Land Registry Chart.) The Land Registry also reported reports that London sales volumes fell by strong price growth in London compared to 9.9% y/y in March, bringing them nearly the rest of the regions, with 9.% y/y growth in % below their pre-crisis average the worst May, putting the capital in joint top place performance in the UK. (See Chart.) With no alongside the South East. sign of active demand and supply rebalancing, activity will likely remain subdued. Strong growth may be explained by the solid performance of London s economy. Within London itself, prices in Prime Central Admittedly, employment growth slowed London (PCL) have been growing at a slower sharply and unemployment rose in April. (See rate than in the rest of the capital. Indeed, PCL Chart.) But earnings in the capital have price growth was.7% in May, while prices performed well, growing at % y/y, and elsewhere in London on average grew at over London s PMI rebounded in June to rank first twice that rate. (See Chart.) Indeed, amongst the regions, pointing to nominal GVA Kensington & Chelsea and Westminster have growth of 7%. been amongst the slowest growing boroughs. (See Chart 7.) But even though wages are now growing at a robust pace, prices are rising even quicker, The recent slowdown in prime property may meaning that affordability continues to be be related to fears of a mansion tax in the run stretched. Indeed, with prices % above their up to the election. With that threat now pre-crisis peak and the price-to-earnings ratio removed, we may see a small rebound in at around, affordability will constrain future prices later in the year, as spooked buyers price growth. (See Chart.) return to the market. That said, with PCL prices far higher than elsewhere in the capital, there House prices in London are being supported is less room for prices to grow as quickly as in by a large imbalance between active demand recent years. and supply. The RICS new sales instructions balance for London has lagged behind the new The annual rate of London price growth has buyers enquiries balance since April. (See slowed over the past months, though at Chart.) While this imbalance has not 7.% y/y growth is still quicker than expected. translated to falling stock levels, conditions But record low affordability suggests that price have been tight for some time now, as stocks growth should ease further. We see London began very low compared to historical prices rising by % this year, flat lining in averages. This strong demand and limited and then growing by % in 7. (See stock has increased competition between Chart.) buyers, putting upward pressure on prices. The UK Housing Market Analyst Q

15 The Regional Outlook : House Price Inflation by Region on Nationwide Measure (% q/q) NI LN YH SE WA SW WM NW EA EM SC NE : Employment Growth (% y/y) London UK : London House Price-to-Earnings Ratio : Difference between London RICS New Instructions Balance and New Buyer Enquiries Balance (% Bal) Demand exceeds supply : Change in Land Registry Sales Volumes (% y/y, Mar ) : London House Price Growth (% y/y, Jun ) Ldn SE E NE SW EM NW Y&H W WM - PCL C. Ldn C. Ldn excl. PCL Outer Ldn Ldn E&W 7: London Borough House Price Growth (% y/y, Jun ) : London House Price Forecast (% y/y) Newham Croydon Top Bottom Lewisham Enfield Sutton Wandsworth Camden K+C Hammersmith Westminster UK London - - Forecast Sources ms Sources Nationwide, ONS, Land Registry, RICS, Capital Economics The UK Housing Market Analyst Q

16 The Regional Outlook (continued) House price gap between regions will start to close While annual price growth across the South of England continued apace, June data from Nationwide shows that, on an annual basis, prices in most of the North, Scotland and Wales have either barely grown or have fallen. The Land Registry paints a similar picture, showing comparatively weak annual price performance in the North East and Wales, but a slightly better performance in the North West. (See Chart 9.) Poor performance in the North East is not surprising given its weak economic performance. The employment rate, despite recent improvements, is still the worst in the UK. (See Chart.) But with a relatively strong PMI reading in June, and house prices still % below their peak according to the Nationwide, there are reasons to be optimistic about the future. (See Chart.) In Wales, where employment has performed relatively poorly but wages and output according to the PMI survey have done relatively well, subdued house price growth may be explained by a comparatively large amount of unsold stock held by surveyors, resulting in more bargaining power being handed to buyers than in other regions. But with stock levels now falling, house prices in Wales should be able to grow slightly faster than the UK average over the next couple of years. However, the North West s sluggish price growth has been somewhat unexpected. Its economy has done relatively well unemployment and wage growth are both around the national average, whilst employment has been growing at close to the fastest rate in the UK. (See Chart.) Additionally, stock per surveyor in the region is further below its pre-crisis level than anywhere else, indicating tight market conditions. (See Chart.) With prices still % below the pre-crisis peak, we believe the region has plenty of room for growth. But the North West is not the only region with tight market conditions. Unsold housing stock levels have continued to fall, with the RICS survey showing months of unsold stock per surveyor falling in 7 of regions between March and June. Stock per surveyor is now at or below its pre-crisis average in all the regions, as the rate of home sales exceeds the number of new homes coming onto the market. (See Chart again.) Furthermore, there are few signs that the trend of falling stocks will reverse soon. In June, the new buyer enquiries balance exceeded the new instructions balance in nearly every region, indicating that active demand continues to outstrip active supply. (See Chart.) Consequently, the trend of falling stocks will likely continue in the short term, putting further upward pressure on prices. We expect prices will rise in every region of the UK in. (See Chart.) This is in line with RICS future prices expectations balance, which has been strengthening for the past three months across nearly every region. (See Chart.) Longer term, with affordability constraints biting harder in the south, northern regions are set for a period of outperformance. The UK Housing Market Analyst Q

17 The Regional Outlook (continued) 9: Land Registry House Price Index by Region (% y/y) : Regional Employment Rate (%, Apr ) - Ldn SE E SW WM NW EM Y&H NE W - LO SE EE SW EM SC NW YH NI WM WA NE : Nationwide Regional House Price Difference from Pre- Crisis Peak (%) LO SE EA SW EM WM YH NE WA NW SC NI : Regional Employment Growth (% y/y, May ) - WA NW SC SW EE WM EM UK YH LO SE NE NI - : Months of Unsold Stock per Surveyor, Difference from Long Term Average : Difference Between New Buyer Enquiries and New Sales Instructions Balances (% Bal) More new active demand than active supply Market Conditions Tight/ Upward Pressure on Prices Mar Jun N W E Ldn WM SW SE EM Y&H NW SW Ldn WM Y&H E NW N EM W SE Scot : House Price Growth Forecast by Region (% y/y) : Price Expectations Balance (% Bal) 7 7 Apr May Jun SW Ldn WM Y&H E NW N EM W SE Scot Sources Nationwide, RICS, ONS, Capital Economics The UK Housing Market Analyst Q

18 Residential Lettings Market Lenders boost share of loans to buy-to-let sector The share of new mortgages going to the non- So far, new letting instructions have not kept regulated sector, % of which are buy-to-let up with tenant demand, and that has pushed (BTL), reached just over 9% in the second up rent expectations. (See Chart.) But looking quarter the highest level since records began ahead, the rise in BTL mortgage lending should in 7. (See Chart.) That will partly reflect mean that the supply of rental property picks- the fact that tougher mortgage regulations up over the next few months. (See Chart.) introduced last summer do not apply to the BTL sector, and lenders may therefore be The cuts announced in the Summer Budget to trying to boost lending volumes by targeting the tax relief that higher rate taxpayers can investors. claim on their mortgage interest payments will hit post-tax rental yields. Landlords may try to The rise in the share of lending going to the recoup the difference by pushing up rents, but BTL sector has not gone unnoticed by the with rents already high as a share of earnings, Bank, which highlighted its potential risk to we suspect their ability to do so in the short financial stability in the latest Financial term will be limited. Stability Report. And new tools for the FPC, such as limits on interest coverage ratios, are We also doubt, given the change takes place due to be consulted on later this year. We gradually over four years from April 7 and expect the threat of tougher regulation will the substantial upfront costs to a BTL weigh on lenders willingness to further investment, that the cut in relief will trigger a increase their share of BTL finance. wave of landlords selling up. But it will deter some new landlords from getting into the Lenders reported that demand for BTL market, or existing landlords from expanding mortgages recovered in the second quarter, their portfolios. and they expect it to increase further over the next three months. (See Chart.) Investors are That drop in supply may mean that, in the being tempted by a recovery in tenant longer term, rents rise faster than would demand, which is keeping void periods low. otherwise have been the case. However, the (See Chart.) In turn, higher demand could picture is complicated by the fact that reduced reflect the earlier dip in mortgage lending, demand from investors may allow more first- which would have increased the number of time buyers into the market, cutting the need households looking for rental accommodation. for rental homes. That rise in tenant demand is feeding through But overall, we are edging up our rental into stronger rental growth according to most growth forecast in 7 to.%, following measures. (See Chart.) For example, the gains of.% in and. That will private sector rent series from the ONS keep rental yields steady. (See Chart 7.) But recorded growth of.% y/y in March, up beyond, weaker house price gains will from.% a year earlier. weigh on total returns. (See Table.) The UK Housing Market Analyst Q

19 Residential Lettings Market : Share of Non-Regulated Lending in Total Mortgage Lending (% New Advances) : Demand for Buy-to-Let Mortgages (% Balance) Introduction of MMR Expected : Tenant Demand and Average Void Period : Measures of Rental Growth (% y/y). Average Void Period (Weeks, LHS)..... Tenant Demand (% Balance, RHS) Change in void period survey methodology - - LSL Property Services BTL Index ONS Private Sector Rents Rent component of RPI : Demand and Supply Balance in Rented Sector and Rent Expectations - - Tenant Demand Minus Lettings Inst. (%Balance, LHS) Rent Expectations (% Balance, RHS) Market conditions tightening - - : Mortgage Advances for BTL House Purchase and New Lettings Instructions Lettings instructions (% balance, LHS) BTL mortgage advances for house purchase (roll. q total, s, adv. qtr, RHS) : Gross Rental Yields (%) : CE Forecasts of Annual Residential Property Returns for Landlords, 7%LTV Interest-Only Mortgage, (% House Price) Forecast Annual average figures Landlords 7 Capital value growth... +Gross Rental return...9 =Total Gross Return...9 -Running, management costs & depreciation (RMD)... - Mortgage Interest Payments... =Total pre-tax tax return as % initial house price... % initial outlay...9 Sources RICS, ARLA, ONS, Bank of England, Capital Economics The UK Housing Market Analyst Q 7

20 Housing supply and Land Prices Housebuilding set for steady rise Housing starts jumped up in the first quarter of on land prices. Indeed, builders have reported. Starts totalled,, up almost, that the growth in land values has tailed off in on the previous quarter and the highest level recent months, and Savills report that annual since the end of 7. (See Chart.) That rise growth of urban residential land eased will partly reflect some catch-up after a marginally from 9.% in the final quarter of surprisingly weak second half of. to 9.% in Q. (See Chart.) But building has also been supported by a The earlier slowdown in house price inflation rebound in the demand for new-build homes. may also have contributed to the recent easing Homebuilders have reported that site visits in land values. As such, the more recent have recovered since the start of the year. (See acceleration in prices, and our expectation that Chart.) With more new homes being they will finish the year % higher, suggests reserved, builders view their current level of the cooling in land value inflation will be stocks as inadequate to meet expected limited. We expect an overall increase in demand, which has encouraged them to break values of % this year. (See Table.) ground on more sites. Beyond that, it is possible that reforms to the Furthermore, the labour and material shortages planning system for brownfield land which have been holding back production announced after the Summer Budget will have started to ease. The share of builders increase the supply of land, bearing down on reporting that materials availability is a its price. But given that house prices have constraint on production has dropped back returned to their pre-crisis level, but land from 7% in Q to % in the first prices are still around % below their peak, quarter of. (See Chart.) That said, over there remains scope for land to outpace house half of builders see labour shortages as a prices for a couple of years yet. problem, and that will weigh on activity. After such a strong start to the year, housing The improvement in materials availability has starts may dip slightly in the second quarter. contributed to an easing in construction cost But in the medium term, strong underlying inflation in recent months. (See Chart.) demand will help starts to make further gains. Barring a small uptick in the first quarter of Indeed, the strength of that underlying demand, the ONS measure of annual cost can be seen by the fact that builders have been inflation has been on a downwards trend since cutting back on sales incentives in recent the start of. And the ABI measure shows months. The housing construction PMI is also a reduction from.% y/y in the third quarter above, indicating that output is expanding. of to.% y/y in Q. (See Chart 7.) Overall, we therefore expect a steady rise in starts, in line with our forecast for Other things equal, lower construction cost transactions. (See Chart.) inflation should reduce the upwards pressure The UK Housing Market Analyst Q

21 Housing Supply and Land Prices : Housing Starts by Sector (s) : Site Visits and Adequacy of Stock Levels to Meet Demand (% Balance) Private RSL & LA Site visits compared to a year ago (LHS) Level of stock adequate to meet demand (Inv. RHS) Site visits up/ Tightening stock level : Material and Labour Shortages a Constraint on Production (% Respondents) : Construction Costs (% y/y) 7 Materials Availability Labour Availability 7 ABI Rebuilding Cost ONS Total New Housing : Measures of Residential Land Values : CE Forecasts of Land and House Price Inflation Builders reporting a rise in land values (% Bal, LHS) Agents estimates of urban land values (%y/y, RHS) %y/y Residential land values House prices Q.7 -. Q.7. Q. 7. Q.. Q.. 7 Q.. 7: Use of Sale Incentives and Construction PMI (% Balance) : Private Sector Starts and Housing Transactions (Four-Quarter Total, s) 7 Construction Activity Rising/ Use of Sales Incentives Falling Housing Construction PMI (LHS) Sales Incentives (RHS, Inverted) - - -,,,,,, Transactions (LHS) Starts (RHS) Forecast Thomson Datastream, O D Sources Home Builders Federation, CIPS/Markit, ONS, DCLG, ABI, HMRC, Savills, Capital Economics The UK Housing Market Analyst Q 9

22 Demographic indicators : UK Population, 99 : Projected Drivers of UK Population Growth, - (s).. ONS projections Millions (RHS) % y/y (LHS) Net migration Births less deaths : Age Distribution of the UK Population, % of Total : Projected UK Dependency Rates Children, Retirees and All Dependents (per, working age) 7 Children (LHS) Total (RHS) Pension age (LHS) & over 9 : Trend in Tenure (England and Wales, % of Total) : Tenure by Region (-, % Total) Owner Occupation Private Renters Social Renters 7 Owner Occupiers Social Renters Private Renters NE NW Y&H EM WM E Ldn SE SW 7: Average household size, 97 (England, Persons) : Share of Households by Type (England, % of Total)... DCLG Projections One person Couple and no other adult Couple and one or more other adult Lone parent (with or without other adult) Other Sources DCLG, ONS The UK Housing Market Analyst Q

23 Capital Economics Ltd Capital Economics is an independent economic consultancy based in London, Toronto and Singapore. We specialise in macro-economic analysis and the relationship between the macro economy and individual business sectors. We are retained by both financial and industrial & commercial companies to provide regular analysis and advice on the state of the world s leading economies and the economic prospects facing business sectors. Our clients range from some of the world's largest banks to boutique property investors. They include retailers, pension funds, insurance companies, fund managers, merchant banks, stockbrokers, housebuilders, property developers, construction companies, building societies and specialist lenders. In addition to our retained relationships we also undertake research projects commissioned by companies, government agencies, and trade associations. Recent research projects have included studies on personal finances in an era of low inflation and low interest rates, VAT and the construction industry, the use of property in business, the impact of the euro on the UK savings market and the impact of deflation on pensions and pension funds. If you would like more information about Capital Economics and what we could do for you, then please contact us at the addresses given overleaf. About Roger Bootle, Managing Director One of the City of London s best-known economists, Roger Bootle runs the consultancy, Capital Economics, one of the world s largest independent economics consultancies, which he founded in 999. Roger is also a Specialist Adviser to the House of Commons Treasury Committee and an Honorary Fellow of the Institute of Actuaries. He was formerly Group Chief Economist of HSBC and, under the previous Conservative government, he was appointed one of the Chancellor s panel of Independent Economic Advisers, the so-called Wise Men. In July, it was announced that Roger and a team from Capital Economics had won the Wolfson Prize, the second biggest prize in Economics after the Nobel. Roger Bootle studied at Oxford University and then became a Lecturer in Economics at St Anne s College, Oxford. Most of his subsequent career has been spent in the City of London. Roger has written many articles and several books on monetary economics. His latest book, The Trouble with Markets, analyses the deep causes of the recent financial crisis and discusses the threats to capitalism arising from it. Like his previous book, Money for Nothing, which correctly anticipated the financial crisis, it has been widely acclaimed. This follows the success of The Death of Inflation, published in 99, which became a best-seller and was subsequently translated into nine languages. Roger is also joint author of the book Theory of Money, and author of Index-Linked Gilts. Roger appears frequently on television and radio and is also a regular columnist for The Daily Telegraph. In The Comment Awards he was named Economics Commentator of the year.

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