The European Commission Warns on UK Housing

In a review of the UK economy released earlier this week, the European Commission offered advice on the state of the UK housing market, and what should be done to address some of its problems.

Suggestions to cool down the market include adjusting the help to buy scheme and raising council tax on more expensive property. The property tax on smaller properties is significantly higher than larger ones from a relative standpoint. The property roll, which records property tax levels, has not been updated since 1991, and therefore doesn't reflect existing price differentials. Nor does it take into account price increases overall.

The UK was urged to monitor house prices and mortgage indebtedness, and take action as appropriate. To meet increasing demand, the supply of new houses was also encouraged.

This sage advice comes on the back of the latest Nationwide Price Index report showing an 11% price increase in May over the same month last year. According to Nationwide, the continued rise in property prices in areas showing strong economic recovery has not been influenced primarily by Help to Buy. In London only 4% of purchases in quarter 1 of this year were Help to Buy assisted. In fact, the majority of Help to Buy mortgages were granted to those buying in the North of the country, and 45% of those were on properties valued at around £125,000 or less.

Instead Nationwide suggests that continuing low interest rates and an improving economy is driving the boom in house prices. First time buyers are getting on the ladder, accounting for 48% of purchases in March. The same report notes that the ratio of prices to earnings for first time buyers was now at 4.7, which it last reached in 2008. The average house price is now £186,512, at its highest since October 2007.

The first quarter has seen a moderating influence, in the shape of a reduced number of mortgage approvals. According to the Bank of England just under 63,000 mortgages were approved in April, the lowest figure since July 2013. This is credited to lenders changing their criteria in advance of the introduction of the Mortgage Market Review, which came into effect at the end of April.

The Mortgage Market Review (MMR) puts the emphasis on lenders to ensure that applicants take out a mortgage they can genuinely afford. Not only must you prove your income, you also need to confirm your spending and show that you can still make repayments on interest rises up to 7%. Lenders no doubt vary in the amount of detail they want, but a close assessment of 3 months of bank statements seems to be part of the standard criteria going forward. This new and more ruthless assessment of applicants is an antidote to the carefree lending seen not so long ago, and will in all probability dampen the market to an extent. But as the regulation has just arrived, its effectiveness as a 'cooling' agent remains to be seen.

The European Commission's 'interventionist' comments on the state of the UK market led Business Secretary Vince Cable to remark that although the country had a problem with house price inflation, he felt that 'we don't need the EU to tell us what's going on here.' The perception that the Commission is dictating UK economic policy may only fuel the anti EU sentiment so recently demonstrated by UKIP's strong results in the European Parliament elections.

From the Bank of England's perspective the housing market is the highest risk to financial stability, and it is prepared to take action to maintain that stability with all the means at its disposal. This could include introducing even higher capital requirements for mortgages, insisting that the government change Help to Buy, or simply raising interest rates (a debateable option, as it may have a negative impact on other parts of the economy). The Bank's Financial Policy Committee will meet in June, and is expected to discuss tougher mortage criteria along the lines of loan to value and affordability ratios.

What is the government doing to build more houses? Successive governments have failed to address the shortfall in new housing, it's an historical issue. In 2009 only 115,000 new houses were built. You have to go back to the 1920's to find a figure that low. Of course the financial crisis hobbled lending to house builders and exacerbated the situation further.

Now the government is pushing forward with initiatives like the 'Get Britain Building' investment fund. This is a £570 million fund to kick start building on existing development sites and those either stalled or on hold. Surplus public sector land will be sold to make way for another 100,000 new homes. Grants are being made available to local councils to encourage home building, and to bring empty homes back into occupancy. There are reportedly over 250,000 homes in England that have stood empty for more than 6 months. There is also a move to ease building regulations in order to make the house building process a little easier. Bodies like the Chartered Institute of Housing and the National Housing Federation are being actively involved in creating a go ahead housing policy.

Back in 2007 a target of 240,000 new homes per year by 2016 was set. The financial crisis obviously dented this aspiration, and it's only perhaps now as we emerge from the economic doldrums that the numbers can start to climb again. In 2013 a total of 122,590 homes were started, but only 109,370 completed. In the first quarter of this year the homes started comes in at 36,450, and those completed at 27,670. Still some way to go then before we get anywhere near meeting the demand. But until that demand is met, the rules of the market will apply, meaning that scarcity will continue to drive ever higher prices. And I think we could have probably worked all of this out well before the European Commission shared it with us.

Interest Rates in the UK

Interest rates are a tool that central banks use to implement monetary policy. They represent the percentage rate at which interest is paid by a borrower for the privilege of using money that has been lent to them and the interest can be paid at various time intervals. Higher interest rates will have an impact upon inflation and employment and could lead to a reduction in consumer spending and investment. The Bank of England meets every month to set the UK bank rate. There are nine members of the Committee and they are appraised of all the latest data on the economy and business conditions. Their task is to keep inflation below 2% but above 1% in the following 2 years.

In the UK the current rate of interest, also known as the base rate, as set by the Bank of England, is 0.5%. This is an historically low level which has been in place for the past 5 years in order to aid the country's recovery from the recession brought about by the financial crisis. It is anticipated that interest rates will have to rise sooner rather than later, although there is much speculation about the date of the first rate rise which is anticipated to be in the first half of next year. The new normal level for rates is expected to be 2 to 3%, well below the 5% from the late 1990s to the financial crisis. In 1976 interest rates hit 15% and double digit interest rates were not uncommon between 1975 and 1991.

Mark Carney, the governor of the Bank of England, and Charlie Bean, the outgoing Deputy, have both indicated that rates will peak at around 3% in 3 to 5 years time, below the pre-crisis average of 5%. There have been indications that rates may start to rise in the next 12 months and in the latest minutes of the Bank of England's meeting it seemed that a decision was now more finely balanced than in recent years. It is essential that the Bank of England raises rates slowly so that it does not choke off the recovery that is beginning to come through. Britain's economy is growing faster than any of the other Group of Seven countries at an annual rate of 3% and it is not clear what impact an interest rate rise would have on the economy after the long recession.

Charlie Bean has suggested that any rises are in "baby steps" in order to avoid making mistakes. In other words he thinks the Bank should be cautious - this could entail raising rates soon - but at a smaller rate than has been implemented in the past, for instance at a rate of increase of 0.1% instead of the previous normal rate of 0.25%.

It is generally accepted that low interest rates are inflationary and the Bank will be watching for early signs that this is happening and try to move interest rates up early to forestall it. Generally they would raise interest rates if they were concerned that inflation was on the increase in order to reduce demand and slow the rate of economic growth. At the present time there are no signs that inflation is picking up with the latest CPI figure coming in at 1.8% which may be attributable to the output gap.

Interest rate movements have the largest impact for individuals on savings, mortgages and annuities, whilst for businesses it impacts the level of demand, interest on loans and the present value of assets and liabilities.

Over the last 5 years savers have been badly hit by the low level of interest rates. This has been particularly hard for pensioners with savings. Higher interest rates would make it more attractive to save cash in deposit accounts as the level of interest received would be higher than at present, thus reducing the need to take on extra risk to earn a decent reward.

At the same time interest payments on credit cards and loans would increase making them more expensive to use and would act as a disincentive. Those who have existing loans may find them harder to finance due to higher interest payments and this could reduce their spending in other areas.

In Britain there have been concerns about the housing market recovery and the possibility of a bubble forming, particularly in London. The Bank of England will be more concerned about the risks of a large increase in debt than about price growth due to a lack of supply. If interest rates rise mortgage payments linked to the variable rate will also rise and new mortgages will also be issued at a higher rate. This would also have the impact of a brake on spending as disposable income would be reduced. For instance a 0.5% rise in interest rates would increase the payments on a £100,000 mortgage by £60 a month.

Annuity rates have been very low during the financial crisis as they are linked to interest rates via the 15 year gilt or government bond yield. When interest rates rise annuity rates should also improve. Those retiring in the coming years should be able to secure a higher income. A half a percentage rise in interest rates could see yields on the 15 year gilts rise by 50 basis points which could result in a 5% rise in annuity rates whilst if interest rates reach 1.75% annuity rates could be 12.5% higher.

The value of sterling would increase if interest rates rose. International investors would be more likely to use British banks for their savings if the interest rates in the UK are higher than in other countries.

A strong pound also makes British exports less competitive which could have the effect of reducing exports and increasing imports thus reducing the overall demand in the economy.

Interest rate rises also have the general effect of reducing confidence both for the consumer and business which has the effect of discouraging risk taking and investment.

Predicting when rates are likely to increase is difficult. One indicator that may help to predict when interest rates are likely to rise are the overnight swap rates which often influence the market rates of fixed mortgages and fixed rate savings bonds.

Darren Winters

The UK Housing Market - where is it going?

Owning your home is something of a British obsession. It is not just somewhere to live (though that's important), it's also the biggest investment most people make in their lifetimes. And if you already own one you're fortunate - the prices seem to be going nowhere but up.

Last month, figures from the Royal Institute of Chartered Surveyors suggest that on average we can expect a 6% rise in prices for the next five years. In the last year alone we've seen a 17% rise in London prices, arguably driven by an influx of wealthy foreigners who see London as a good investment, and the ability of London as a centre of economic growth to attract ever more people. But the price rise in London tends to distort the overall pattern, and if we remove London from the equation we get a national price rise in the last year of 5.8%.

The Office for National Statistics has produced a chart showing price changes expressed as percentages. You can see below that we had a substantial drop into negative figures with the financial crash in 2008, and by contrast now we're seeing a steep upward movement.

Figure 1: Annual house price rates of change, UK all dwellings from January 2004 to February 2014

(12 month percentage change)

The ONS puts the average UK house price at £250,000, while Nationwide have it lower at around £175,000. The Land Registry has it lower again at £165,000. This variability is down to the way the organisations calculate the figures, Nationwide using its own mortgage lending data, while the ONS uses data from a number of lenders, and makes certain adjustments. The Land Registry uses property ownership registration data. It all leads to an £85,000 difference between lowest and highest figures, which tends to confuse the issue.

London of course leads the pack, with the average house price now around £458,000. And if things move as predicted that will be £567,000 by 2020. 

So what's driving this resurgence? Low interest rates are a factor, as is the Help to Buy Mortgage guarantee scheme.  Then there's the funding for lending scheme, which was launched by the government in conjunction with the Bank of England in 2012. Its purpose was to provide cheap money to banks and building societies, thereby encouraging them to increase mortgage lending. This seems to have worked too well, as it was withdrawn in November 2013, supposedly to cool the market down. Another significant factor is the lack of new housing being built. This is a problem stretching back many years, and it seems the political will to address it has been woefully lacking. So we've had a long period where demand exceeds supply.

This seemingly relentless increase in prices creates issues of affordability, especially if you're a first time buyer. If we use a simple example to demonstrate the problem: - let's assume you want to buy an averagely priced London house at £468,000. You actually have a deposit of £40,000, and your net income per month is £2,500. At a mortgage term of 25 years and an interest rate of 4.75% you're only looking at a monthly repayment of £2,440! Which is 97% of your monthly income. Walk in the park then. This example may be extreme, but for younger people living in London (many of whom won't have a £40,000 deposit), it effectively excludes them from home ownership.

Intiatives (as mentioned above) have been launched to address the problem. The most significant one from the buyer's point of view is the Help to Buy scheme. This comes in two flavours. The first is an equity loan. This allows a prospective buyer with a 5% deposit to take a government loan for up to 20% of the price of the house. That loan is fee free for five years, then you will be charged an annual fee of 1.75%. With this arrangement in place you can then apply for a mortgage up to 75% of the property's value. Flavour two is the mortgage guarantee option. Again, you need 5% deposit, but this time the government guarantees the mortgage with the lender, so if you default they'll get their money back. Both these options are open to first time buyers and those moving home, on a property with a value up to £600,000.

There's no doubt that this scheme has made it possible for people to get on the housing ladder. But along with the funding for lending scheme it has been criticised in some quarters for stoking up the housing market.

The crazy multiples of income that were on offer before the last recession in 2007/8 (up to 6 times salary in some cases) are no longer the norm, though some lenders still offer them. And although income multiples are still a factor, as a result of the recent Mortgage Market Review lenders are moving towards pure 'affordability' as a criterion. This means that during your mortgage application your finances will come under close scrutiny, a kind of 'stress test' for consumers. This is an effort to curb the tendency of borrowers to overextend themselves when they had the opportunity pre-2007. Interest rates are currently at a historic low, but when they go up, as they inevitably will, your lender wants to be confident about your ability to keep repaying the loan. For many people this kind of scrutiny will make it yet harder to get a mortgage.

So the alternative for those young people priced out of the market is either to rent or stay at home with Mum and Dad. The stay at home generation aren't doing it by choice, they have the issue of first getting a decent paying job, which is proving problematic for many well qualified young people, the jobs just aren't there. And assuming they are working, the average rent for a one bedroom flat in London is £1200 a month. Admittedly that figure is only around half that outside the capital, but it's still a significant slice of a salary. And rents are only predicted to rise going forward.

There's a school of thought that says the UK housing market is a bubble that will one day burst, and compared with other countries Britain's housing stock comes out as 30% overvalued. But apart from the 2008 dip, there seems no sign of the bubble bursting anytime soon. Even if in the near future salaries rise, and more housing stock becomes available, it will still be a challenge to get your foot on that ladder. 

Darren Winters