Property Market Forecast 2023

PROPERTY MARKET FORECAST

Conditions for property investors will not be the easiest in 2023. Numerous factors will act to suppress growth in capital and rental values, not least cost-of-living constraints, which look likely to persist for the majority of the year ahead. Consequently, investors shouldn’t be expecting the same sorts of growth rates that we experienced in 2021 and in the first quarters of 2022.

On the other hand, there are signs of improvement in some important areas of the economy. In this article, we’ll offer our interpretation of the latest reports and forecasts, and show why investment prospects look much better in the medium term than they do for the coming year alone.

Inflation and the Cost of Living

When it comes to prospects for growth in capital values and monthly rental returns, one of the most influential factors is affordability. It’s certainly true that demand for housing greatly exceeds supply, and that’s been a key driver of rising prices over many recent years, but that demand only really has the power to affect average values when people have the money to back it up. This is why affordability matters: the more strains there are on ordinary people’s household finances, the less room there tends to be for price growth.

In 2022, tenants and house-hunters found their budgets stretched for a variety of reasons. First, the global recovery after the Covid pandemic prompted a surge in demand for fuel and materials as industries returned to full production. It has taken time for those commodities to be replenished after lockdown, and the temporary imbalance between supply and demand pushed prices considerably higher.

This was compounded by Russia’s invasion of Ukraine, which put further constraints on the supplies of gas, oil and certain important foodstuffs such as wheat and vegetable oils. Nations and businesses competed to secure their share of scarce commodities and this had a further inflationary effect.

At the domestic level, the UK has also had to contend with a weakened Pound, which has made imports more expensive, together with rising wage costs, substantial tax rises and – for a variety of reasons – a steadily rising base rate, which has made mortgage payments more expensive.

All of these – and other factors besides – have contributed to the current cost-of-living crisis. Most people are materially poorer now than they were last year. The costs of simple essentials such as food, fuel and energy have risen faster than growth in average earnings and, at the same time, any savings that people have amassed have tended to be eroded by high rates of inflation.

Against this background, it’s easy to see why many forecasters expect average property values to fall over the course of the coming year.

House Price Forecasts

Various agencies have predicted a contraction in house prices in 2023. Below are listed just a selection.

• Knight Frank -5.0%

• OBR -6.1%

• Rightmove -2.0%

• Savills -10.0%

• Zoopla -5.0%

Longer-term Trends

It’s always worth reiterating that property investment is a long-term business, so temporary dips in the market matter much less than the broader, longer price trends. For example, despite the fact that average house prices fell by as much as -15% at the time of the global financial crisis, they are now substantially higher than they were in 2008/2009. Values recovered steadily, and those who bought homes or buy-to-let properties during the downturn would subsequently have enjoyed impressive capital gains.

Month / Year

Average

• January 2008 £185,782

• March 2009 £154,452

• January 2018 £224,544

• March 2019 £227,104

• October 2022 £296,422

House Price (UK)

These figures, provided by HM Land Registry, show that despite the biggest house price fall in living memory, someone who bought a typical residential property in January 2008 (i.e. before the financial crisis) would have seen a temporary dip in values but they would still have seen substantial capital growth in the longer term. Specifically, they would have seen growth of +20.8% (+£38,762) after ten years, and a total gain of over +59.5% if they had continued to keep hold of their property to the present day.

Looking back at those price forecasts for 2023, it’s clear that the market is facing another dip, but it is not expected to be anything like so severe as the global financial crisis. Consequently, some of the agencies listed above expect average house prices to return to positive growth in 2024, or at least shortly thereafter. Savills, for example, gives a decidedly downbeat forecast for 2023 but expects 2024 to deliver average growth of +1.0%, followed by +3.5% in 2025 and +7.0% in 2026. Others expect the dip to be longer. For example, the Office for Budgetary Responsibility expects values to dip by a total of -9% over 2023 and 2024 before they start to recover.

Importantly, however, there is a widespread expectation of a return to growth, whether that occurs towards the end of this year or some time in 2024. In the next section, we’ll consider why that is so.

Indicators of an Improving Market

Perhaps the biggest difference between this recession and the global financial crisis of 2008/2009 is that the current difficulties are not directly related to the housing market. Then, part of the problem was due to the way that banks (particularly in the United States) were lending money for property purchases. Homes were often over-valued and mortgages were often agreed without adequate checks on applicants’ ability to make regular payments. This led to growing insolvencies and repossessions. It was a poisonous cocktail but, crucially, none of those elements are present today.

In 2023, banks are much more tightly regulated and the challenges faced by the sector are largely about affordability. As we noted earlier, household budgets are being strained by external, global factors such as post-Covid inflation and the war in Ukraine. It’s impossible to know how long Russia’s invasion will last but it is to be hoped that it is very short-lived. In any event, we are already seeing evidence that some inflationary pressures are abating.

Energy Costs

For example, wholesale gas prices have fallen back steadily. Western nations have been able to stockpile supplies, assisted by a relatively mild winter and the growth of renewable power generation, so supply constraints have eased. That, in turn, has allowed global fuel prices to come down again and these should eventually translate into lower energy bills for consumers.

This won’t happen immediately, of course. Energy prices are still likely to rise over the next few months, which is one reason why 2023 is expected to be so challenging. The government will be reducing its support via the Energy Price Guarantee from April, at which point, average household energy bills could rise to around £3,000 per annum.

In the longer term, however, those lower wholesale prices should percolate through to the domestic market and bring costs down to more normal and sustainable values.

That should ultimatly leave homebuyers and tenants with more to spend.

CPI Inflation

Something similar is happening with respect to many other important commodities. As global production has recovered after the pandemic, so supplies of many products have improved and the gap between demand and supply has started to close. Again, it will take time for this to have a marked impact on everyday living costs but it’s encouraging to note that the most recent inflation data (ONS, November 2022) showed the Consumer Prices Index (CPI inflation) slowing to +10.7%, which compares against 11.1% in the previous month.

The Bank of England has predicted that inflation will “fall sharply” from the middle of 2023. It offers a number of reasons for this, stating that:

• the price of energy won’t continue to rise so quickly, and could turn negative from Q2 2024

• it doesn't expect the price of imported goods to rise so quickly

• it expects global price inflation to turn negative in 2023, meaning that import prices should gradually fall

• lower disposable incomes should mean that there is less demand for goods and services in the UK, which means less upward pressure on prices

• higher base rates will make borrowing more expensive so money supply will tend to contract, and this tends to have a slowing effect on inflation

As a result, the Bank expects CPI inflation “to fall some way below the 2% target in years two and three of (its) projection.” That is to say, in 2024 and 2025. It has even speculated that inflation could turn negative – a view which the OBR supports in its own forecast. It believes that inflation has already peaked (Q4 2022) and predicts that:

“Inflation then falls rapidly, and temporarily goes negative in mid-2024 as energy bills fall back and some global supply pressures reverse. We expect inflation to return to the 2 per cent target by the end of the forecast as the large swings in energy prices fall out of the annual CPI calculation and output grows broadly in line with the economy’s productive potential.”

Mortgage Rates

The Bank of England uses the base rate of lending as a tool to help control the rate of inflation. Making it more expensive to borrow money usually means that households are willing to spend less, so prices (of property and all kinds of other goods) will not rise so quickly.

In recent months, with CPI inflation running well ahead of its 2% target, the Bank has introduced a succession of rate rises, and there will almost certainly be more to come. In December 2022, the BBC’s economics editor Faisal Islam predicted that “the final resting level of interest rates in the UK will be closer to 4%. It will likely be reached in the middle of next year (i.e. 2023), and stay there for some time.”

A higher base rate inevitably means higher costs for those on variable rate mortgages and for those seeking to make new purchases. This limits buyers’ spending power and acts as a brake on price growth. The prospect of further rises in the base rate is one key reason why property prices are expected to fall this year.

However, the Bank of England won’t want to keep the rate elevated for longer than it absolutely must. That’s because a higher base rate also acts as a disincentive to business borrowing and tends to reduce investment for economic growth. Consequently, the Bank is likely to reduce the rate as soon as it believes it is safe to do so.

A falling rate of inflation is therefore good news. The sooner and faster it starts to diminish, the sooner the Bank will feel comfortable about reducing the base rate. This, in turn, would make borrowing cheaper again and should drive renewed activity in the property market. This is important because a growth in transactions typically goes hand in hand with a growth in average values.

A Trend Towards Normality

It would be wrong to suggest that things will be easy in 2023. Affordability pressures will persist for most of the year. It will take time for prices to come down and, even then, the UK will be subject to some of the highest borrowing costs and the highest rates of taxation that we have seen for many years. However, some of the principal forces that have been creating these difficult conditions are now easing, and they should continue to do so as the year progresses. In time, market conditions should therefore begin to normalise.

It's also worth remembering that “normal” conditions have supported strong capital growth for well over 50 years. In January 1970, the average home sold for just £3,920, according to the Land Registry, whereas its latest figures (October 2022) put the average at £296,422. That makes today’s house prices almost 75 times higher than they were – a figure which is massively ahead of the rate of inflation and represents a substantial real-terms gain. “Normal” conditions certainly shouldn’t be feared.

This excellent record of long-term growth has been at least partly the result of a continuing imbalance between supply and demand. There simply aren’t enough homes available to satisfy the needs of families and individuals, so in most years, Britain has been a seller’s market.

There is no credible prospect that the imbalance will change in 2023 or in any of the next few years. That suggests that usual market conditions should gradually reassert themselves and, consequently, that investors can expect capital values to recover strongly. It won’t happen immediately, of course, but those who buy in 2023 can reasonably expect to see good growth in subsequent years.

Combined Returns

We have talked mainly about capital values in this article, but it’s also important to note that, whatever happens to asking prices, residential property will continue to produce regular rental returns.

In recent months, the imbalance between supply and demand has driven strong growth in rental values. Recent estimates vary between +8.7% (Goodlord, England only) and +12.1% (Hometrack, all UK.) The December Rental Index from Homelet suggests a midway figure of +10.8% for the whole of the UK.

It’s likely that affordability pressures will constrain rental growth in 2023, but not to the same extent as they affect house prices. The latter will likely turn negative this year, whereas rental values should stay resolutely positive. Moreover, as inflation starts to drop towards 2%, so the real-terms returns from rent should improve steadily. Those alone may be enough to justify property investment in 2023, even without the prospect of longerterm capital gains.

2023...

Summary

At Residential Estates, we expect 2023 to mark a turning point. In itself, it won’t deliver great returns in terms of capital values, but over the course of the year, we should start to see a weakening in the forces that have been acting against that growth. There are good reasons to expect inflation to come down, and that will open the door to lower interest rates, lower mortgage costs and, consequently, an eventual upturn in activity and market confidence.

Once those immediate affordability pressures start to ease, the continuing gulf between demand and supply should begin to exert its influence once again, putting upward pressure on both capital and rental values.

We expect rental values to remain positive and relatively strong, though we don’t expect them to grow at the same exceptionally high rates as they did last year. Similarly, whether we see a return to capital growth in late 2023, in 2024 or even a little later, we don’t expect values to rise at the rates that we saw in 2022. That’s simply because household budgets will have been hit hard, savings will have been depleted and high taxes will remain a heavy burden well into 2024.

However, we do expect a reasonably rapid return to growth and to the sorts of steady, sustainable market conditions that have made property such a reliable investment asset for so many decades.

To find out more about investment opportunities in residential markets across the UK, please call our advisory team on 01244 343 355.