PROPERTY AND MARKET RESILIENCE
ECONOMIC RISKS
At the start of July, two notable companies published house price indices that seemed to suggest that annual growth rates might finally be returning to more usual and sustainable levels.
How long this will remain the case is harder to predict. Certainly, recent economic reports from the UK Government’s Office for Budgetary Responsibility (OBR) and the pan-governmental Organisation for Economic Co-operation and Development (OECD) make for less than cheery reading.
Nationwide’s June index cited year-on-year growth of +10.7%, which was down half a percentage point from its May figure of +11.2%. It also reported a monthly gain of just +0.9%. Similarly, Zoopla and Hometrack’s index (for May) indicated that average residential values had risen by +8.4% over the last 12 months. That was unchanged from the year-on-year figure in April, and represented a monthly gain of just +0.1%. Taken on their own, these findings might well be seen as confirmation that the oft-quoted ‘headwinds’ now rising against the UK economy are beginning to have a slowing effect on price growth. That is, after all, what almost everyone has been predicting since the start of the year. So it came as something of a surprise when the latest price index from Halifax indicated that values were once again accelerating. The Halifax data show that average prices rose by +13.0% in the year to June 2022. That covers a more recent period than Zoopla’s May index, which makes the higher figure even more surprising. For context, the May index from Halifax put annual price growth at +10.5%, which means that the increase seen by the lender has also been fairly substantial (up by 2.5 percentage points). It points out that +13% is the fastest rate of appreciation that it has recorded since 2004. Halifax’s managing director Russell Galley said: “The UK housing market defied any expectations of a slowdown, with average property prices up +1.8% in June, the biggest monthly rise since early 2007. This means that house prices have now risen every month over the last year, and are up by +6.8% or +£18,849 in cash terms so far in 2022, pushing the typical UK house price to another record high of £294,845.”
Drivers of House Price Growth His explanation for the continued strength of the residential market is a familiar one: “The supply-demand imbalance continues to be the reason house prices are rising so sharply. Demand is still strong – though activity levels have slowed to be in line with pre-Covid averages – while the stock of available properties for sale remains extremely low.” The commentary accompanying Nationwide’s data makes a similar point. The company’s chief economist Robert Gardner said: “The housing market has retained a surprising amount of momentum given the mounting pressure on household budgets... Part of the resilience is likely to reflect the current strength of the labour market… Furthermore, the stock of homes on the market has remained low, which has helped to keep upward pressure on house prices.” The reference to the labour market is noteworthy. Currently, UK unemployment rates are very low by historic standards and this situation, coupled with the fact that many families saved more than usual during the pandemic, could be helping to maintain positive sentiment amongst prospective buyers. Although real earnings are falling as a result of inflation, if people feel relatively secure in terms of their incomes, that factor alone could help to keep the market energised and active.
The OBR estimates that, post-Brexit, the UK’s new trading arrangements with the EU will reduce its Gross Domestic Product by about -4% over the coming years (i.e. a loss of approximately £100 billion per annum), and notes that international trade could fall by around -15%. It adds that the UK already “appears to have become a less trade-intensive economy, with trade as a share of GDP falling 12 per cent since 2019; two and a half times more than in any other G7 country.” Similarly, the OECD indicates a pronounced gulf in economic performance between the UK and other developed nations. In 2023, it predicts that the UK will see zero growth – the lowest rate in the G7 group of developed nations, and lower than any country in the G20 except sanctions-hit Russia. Over time, a widening performance gap between Britain and its trading partners could begin to constrain growth and deter commercial investment in the UK, neither of which would be good news for domestic employment figures. And if, in time, unemployment were to rise, then some of the positive sentiment in the housing market could erode. That said, current job forecasts aren’t especially dramatic: CBI is predicting only a small rise in unemployment (to +4.1% by the end of 2023), which may not be enough to change market perceptions a great deal. The Bank of England’s outlook is rather more sombre, but it’s contingent on inflation; it has said that if the Bank is forced to keep raising borrowing costs in an effort to tackle inflation, that could ultimately lead to over half a million job losses. Inflation could have a similar effect on sentiment if it were to continue at anything like its current high rate; it would undermine people’s sense of financial wellbeing and perhaps prompt buyers to be more cautious when considering the cost and timings of their next moves.
PRICE MODERATION For these and other reasons, most commentators are expecting the rate of house price growth to moderate; that is to say, to return to more usual patterns. Growth of around +10% is unusual by historical standards and, since it seems very unlikely that earnings will rise at anything close to the same pace, such rapid gains cannot continue forever. In a sense, a return to normality is essential for the market. When ‘price’ becomes too far removed from ‘value’ and when affordability is stretched too far, this is when a market begins to look like a bubble. No one wants the risk and volatility associated with that, so it would be no bad thing for the market to start to lose at least some of its heat in the second half of the year. Happily, this is more or less what industry insiders are predicting. Savills is forecasting average gains of +12.9% by 2026, while Knight Frank has opted for a more optimistic +16.9%. Over 5 years, that would equate to average gains of roughly +2.5 to +3.0% per annum.
PRICE GROWTH AND INFLATION Investors might not welcome such a prospect at a time when prices are rising by almost +11% a year, but many economists seem to regard the present high rate of inflation as a temporary phenomenon. It’s true that international markets for energy, food and basic materials may take a little while to rebalance after the exceptional disruption caused by Covid but, once the dust has settled, there are few lasting ‘structural’ reasons why very high inflation should persist at a global level. One caveat to that is, of course, the war in Ukraine, which – for so long as it lasts – is likely to fuel inflation by constraining supplies of gas, oil and grains. That’s an imponderable for now, but most modern economies are looking for work-arounds and we might ex pect some partial solutions that begin to limit the inflationary effects. In any event, the Bank of England appears confident that it can wrestle inflation down to a much more manageable figure, “close to” its +2% target by 2024. In such an environment, capital gains of +2.5% or +3.0% begin to look rather healthier, particularly when they are accompanied by a steady rental income.
RENTAL RETURNS On which subject, prospects for rising rents continue to look good. The June Lettings Index from Homelet finds that average monthly returns rose by an average of +10.6% year-on-year. And that’s not an isolated figure; the rental platform Rentd reports that average UK rents have risen +9.8% since the start of the pandemic, while the most recent UK Rental Report from Hometrack indicates annual growth of +9.1%. Again, the main drivers of rising values are strong demand and limited supply. In its May PRS Report, Propertymark writes: “The great rent rise continues. While we have seen an increase in availability of properties to rent since February, demand from prospective tenants has also risen… Our members reported having ten properties on average per member branch that were available to rent in May. (However,) an average of 113 new applicants were registered per member branch in May. This is up since February when 78 new applicants were registered on average… As rises in demand match increases in available homes, pressure on rents is set to continue.” This is a view that Savills appears to share. Its 5-year rental forecast estimates that average rents will rise by +19.9% by 2026, an annual growth rate of approximately +4%.
SUMMARY Property has an excellent track record of producing good rental incomes and strong, long-term capital gains. According to Nationwide (which has the UK’s longest-standing records of house price data), a typical UK residential property grew in value from £11,288 in 1975 to £271,100 by the end of 2021. That’s something like a 2,300% increase over 46 years, and although that doesn’t quite match up to the old maxim that “property doubles in value every 10 years”, it’s undeniably impressive. Analysis by Barclays suggests that, in real terms, house prices since 1995 have outperformed inflation by +3.8% per annum. Over the full history of the index (that is, since 1952) residential property has delivered +2.2% of real-terms growth per annum. Real-terms rental incomes are harder to quantify because rents vary so greatly by property type, tenure and location. Nevertheless, if capital growth alone is tending to exceed inflation over the long term, then any rental returns can only improve overall profitability for investors. That’s all retrospective, of course, and there are no guarantees that future performance will reflect the past. However, all the most important market forces are still working in the investor’s favour: demand remains exceptionally strong, supply remains low and even if the base rate were to reach 3%, that would still make borrowing relatively cheap by historic standards. In the long term, then, property as an asset class looks set to remain as rewarding and as resilient as ever.
To find out more about investment opportunities in residential markets across the UK, please call our www.residential-estates.co.uk advisory team on 01244 343 355 reservations@residential-estates.co.uk