Market Insight - April 2015
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How Times Have Changed

Framing the debate.
Who’s paying for forty years of growing house prices?

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The housing market has experienced large tenure shifts in recent years. According to the English Housing Survey the private rented sector grew by 421,000 households over the last year alone. At the other end of the spectrum the number of households owning a home without any debt overtook those with a mortgage.

These shifts in tenure are a focus of the intergenerational fairness debate. Where the lifestyles and wealth the baby boomers born between 1945 and 1960 enjoyed are compared and contrasted against the experience of generation Y, born between 1980 and 2000. The boomers seem to win out as they benefitted from huge real increases in house prices, creating the kind of wealth which generation Y can only dream of.

A simple comparison of house prices over the last 40 years shows prices have increased 17 fold since 1975. But taking inflation into account changes this substantially. A property in 1975 cost about £10,500, but in today’s money that’s £86,000. So after inflation, the value of a property today is on   2.2 times higher than 40 years ago. A fraction of the 17 times simple prices have increased, but more than enough to have serious ramifications for affordability and access to home ownership.

To illustrate the effect of rising house prices on affordability and purchasing power, we’ve calculated how much space a typical buyer could afford today versus what they could have bought in 1975. A first time buyer today with a household income of £40,000 and a 20 per cent deposit could purchase about 650 square feet of space at average prices, roughly the size of a small two bedroom flat, where as in 1975 they could have stretched to a 3 bedroom terrace at 1,060 square feet.

In practice the difference in purchasing power manifests itself in more ways than simply how much space purchasers are able to buy. For generation Y many would- be buyers simply can’t afford to buy due to high house prices, instead they’re either renting or living at home with parents. Others at the start of their ownership journey, who can affo   to buy, may be balancing compromises on location, space and quality of property.

On the other hand many of those that have owned homes since the 70s have benefited from prices growing above inflation. Their purchasing power has increased, with their wealth often reinvested into the housing market through buy to lets, second homes or assistance for young family members trying to buy their first home.

There’s no quick fix available for the political parties currently campaigning in the run up to the general election. Managing the interests of the older generations, more likely to be property owners against the younger, less likely to own, generations is something no mainstream party has yet to get right. What does seem to be clear is that delivering new homes into the markets that need them most is likely the best long term solution.

Rising Standards
Living standards are rising - at last.

The UK economy has grown consistently for two years now, and the pace of growth is picking up. At 2.8 per cent the annual rate of growth throughout 2014 is the strongest since 2006, but in the final quarter the economy was three per cent bigger than in Q3 2013. This is the highest rate of growth among the most developed economies in the world.

Living standards are better too, although they have recovered slowly since the recession, largely because of slow wage growth. Better living standards bode well for confidence among consumers – and potential home buyers. Much of this is to do with the fall in oil prices and the rising value of Sterling, both of which reduce the cost of imported goods. In the long run, policies that boost productivity, and so increase real earnings, are likely to have the biggest impact on future living standards, rather than changes to the tax and benefit systems that the politicians quarrel about.

While overall living standards are better, in general, younger people have not benefitted  s the economy has recovered, which has implications for the health of housing transactions. Analysis from the Institute for Fiscal Studies shows that those who are over 60 are much better off than they were, but those under 30 are much worse off. The group in the middle are now beginning to feel a little better off. So, movers are perhaps beginning to be in a better position, but first time buyers still have a lot of making up to do.

Even so, the UK’s economic performance is definitely improving and with inflation now at zero per cent any rise in wages will translate immediately into higher living standards. That’s really good news, though we shouldn’t be too impatient. These improvements are starting from a low base so it will still be sometime before people feel as rich as they used to. Low interest rates will help, especially as credit conditions loosen, because mortgage lenders are increasing their risk appetites as economic conditions improve. Overall once the uncertainty of the election process is out    the way, there is definite room for further improvement.

Emerging seven figure markets?
The million plus market spread further in 2014

2014 was a record year for £1millon plus sales, 14,000 homes worth a total of £26 billion traded hands for £1million or more. That’s a third up on the 11,000 sales in the £1million plus price bracket in 2013 and two thirds more than the 8,900 in 2007.

Growing prices, particularly in London and the South East have put more homes than ever into seven figure territory in 2014. The growth of transactions above £1million in local markets points us to emerging and growing prime areas. In 2014 there were 16 local markets in particular that saw £1million plus markets emerging. Those that saw an increase from just one sale above a million pounds in 2013 to five or more in 2014.

There are three distinct groups on the list. Areas on the fringes of Inner London that are currently on the up, there aren’t many areas like this without £1million plus markets already, so New Cross and Bethnal Green stand out. Markets in Outer London boroughs, some less established, such as Brentford, Harrow and Edgeware which are benefitting   om a flow of demand from more expensive central areas. And towns in the commuter belt, currently seeing an influx of London leavers, cashing in on prices in the capital while making life stage moves.

The only area on the list outside of London or the commuter belt is Sudbury, in Suffolk. Sudbury is benefitting from a mix of spill over from Cambridge, and the seemingly constant advance of London leavers looking further afield to get more for their money. Sudbury’s stock of classic Georgian buildings seems to be proving particularly popular with incoming buyers.

While the upcoming election and the threat of a mansion tax makes it difficult to chart the path of the more expensive £2million plus markets over the rest of 2015, it is likely that we’ll see the emerging £1million plus areas continuing to grow. House prices are forecast to rise in 2015, albeit at a slower pace of 4%, and we expect the tide of London leavers to continue to push demand into prime markets across the rest of the country. The result will likely be more areas outside of the traditional London commuter belt, like Sudbury, making an appearance in next year’s list.

Adding Up
Rental yields are likely to make up a greater proportion of total returns for landlords in 2015.

Returns from buy to let investments fall into one of two categories. Income from rent paid to the landlord by tenants and capital appreciation from growing house prices, adding these two together gives the total return for any given year. While these figures are gross, so don’t account for a landlord’s costs, they provide a useful way to understand how landlords’ returns are made up and how they will likely change in future years.

2014 saw average total returns increase to 12 per cent, from 9.3 per cent in 2013. The increase was driven by accelerating house price inflation, prices in 2014 grew by 6.7 per cent across England and Wales versus 4.3 per cent in 2013. Gross yields on the other hand fell slightly as house price growth outpaced rental growth. Average gross yields in 2014 were 5.3 per cent versus 5.7 per cent in 2013.

Given total returns were driven by price growth in 2014, the areas with the most price growth saw the highest total returns. Despite yields in London being lower than any other region, a  4.7 per cent, total returns in 2014 were the highest of any region reaching nearly 20 per cent. Total returns were lowest in the North West, at 8.5 per cent, the area with the second highest yields.

Hamptons International forecasts house price growth to slow in 2015, so total returns will likely fall. House price growth and rental growth is forecast to be roughly equivalent, which means yields should remain stable over the next two years. Total returns in 2015 are forecast to average 9.3 per cent, down from 12 per cent in 2014.

With lower house price inflation forecast, income generated from the tenancies, will make up a much greater proportion of total returns in 2015 and 2016, shifting from less than half of the total return to nearly two thirds. This means managing income by keeping voids and arrears low will be particularly important areas of focus for landlords over the next two years. But with wage growth picking up against the backdrop of a growing economy, the risk of arrears is falling and the overa   outlook is strong for incomes.

Sharing ownership
Starts of new affordable homes are starting to lag behind.

The latest NHBC data on house building show that in the last three months private sector housing starts were up 7 per cent compared to the previous year. Public sector starts, of affordable housing, were down a third in the same time period compared to the previous year though. Most of this fall seems to be coming from housing associations, DCLG numbers show starts by housing associations down 40 per cent in the final quarter of 2014 compared to 2013.

The fall in delivery of new affordable homes is worrying given the context of increasing right to buy sales and the proposed extension of right to buy to housing association homes by the Conservative party. 11,261 local authority homes were sold through right to buy in 2013/14, whereas only 1,572 replacement homes were started by councils. While starts of replacement homes are likely to increase, the lag between starting and finishing a build means it’s unlikely we’ll see the one for one replacement promised on the original scheme any time in the near future.

Affordable homes also include intermediate tenures like shared ownership. Shared ownership was introduced in the late 1970s to help people unable to afford a home on the open market get onto the property ladder. Predominantly provided by housing associations, the scheme allows the purchase of a share in a property, typically between 25 and 75 per cent, while paying rent to the housing association on the remaining share. Demand for shared ownership outstrips supply, with housing associations approving around 85,000 applications a year, against government funding for the development of just 11,000 homes. The tenure has the advantage of giving part owners security of tenure similar to outright ownership, not always available in the private rented sector.

Building more homes is only part of the answer to solving the problems in the UK housing market. Given high house prices relative to incomes and other affordability issues, attention must also be paid to the variety of tenures. While we have seen significant demand  ide stimulus from the current government, particularly in the form of the various help to buy schemes, we have seen less success on the supply side. We can only look to the next parliament in the hope that housing supply issues will be tackled in a more meaningful way.

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