House prices: The only way is up
News about the low number of new homes being built means the only way is up for property prices, says Chrstina Jordan.
The level of construction going on in your local area is often a good indicator of the state of the economy. When times are good you see scaffolding, cranes and building work filling city skylines, towns and villages. It may not be pretty but it's a sign of investment and optimism.
But with the roots of the recession in the mortgage and housing markets it's not surprising that construction and house building was one of the worst hit industries in the country last year. The number of applications from house builders to start new homes in the UK fell by almost half during 2008 compared to 2007 -- just under 107,000 applications were made, and that's the combined private and public sector figures, according to the National House-Building Council (NHBC).
Construction work on many city centre apartment blocks and mixed use schemes literally halted halfway through, as the money dried up.
Unfortunately this massive slowdown in new home building sits against a long-term backdrop of insufficient housing supply to meet the needs of the country, which has a growing number of households. In its Comprehensive Spending Review of 2007 the Government said that three million new homes would be built by 2020. That was already a stretch but it now looks extremely unlikely.
Within that target was the aim to be building at least 240,000 new homes a year by 2016 -- Government figures show that in 2007/8 the number of net additional homes reached 207,500 dwellings, and numbers have fallen since. It's worth pointing out that the Government has recently claimed that the three million homes was an 'ambition' not a target.
So if there are not enough homes for the number of people who need them, the laws of supply and demand says that prices will rise. OK, people need to be able to afford to buy and mortgage lenders (more than ever) need to limit the amount they will lend, which will provide some restraint. But there is still real concern that prices will rise above and beyond the reach of many, but not, of course, the rich or existing property investors.
The good news
However, there is some good news from the latest new build figures released by the Government last week. New build starts are rising and it looks like we have turned a corner. In quarter three of this year there were an estimated 25,820 housing starts in England, up 18% on the previous quarter and the third successive quarterly rise in (seasonally adjusted) housing starts. This is an encouraging sign.
Plus, just focusing on private enterprise housing starts shows even higher increases -- they increased 21% in quarter three compared to quarter two.
It's a step in the right direction, but the annual figures are still woefully low.
The not-so-good news
According to the Department for Communities and Local Government, annual housing starts for England totalled 83,080 in the 12 months to September 2009, down a substantial 35% compared with the 12 months to September 2008, and a massive 55% below their 2005/06 peak of 178,000. That's a big drop when we need to be building more, not fewer homes.
Annual housing completions are also down 21% to just over 122,000 over the last 12 months.
According to homelessness charity Shelter, if compared with annual calendar year figures, the last time house building dropped below 122,000 was in 1947 when the official number of homes built was 120,860.
It says that we are simply not building enough homes to meet the huge growing need, adding that there are a quarter of a million households being formed every year, and more than 1.7 million households on council waiting lists. In other words, demand is far outstripping supply.
The Royal Institution of Chartered Surveyors also noted that despite the recent rises in housing starts, the figures are still historically weak. It suggests that the total starts for this year will struggle to pass 90,000, "barely a third of what is required over the coming years given trends in household formation".
So, what about prices?
Many people believe that property prices may stutter or even fall in the next year or so, as the huge Government stimulus we have seen over the last year is reversed in the next 18 months, and as the impact of unemployment really takes hold.
But the shortfall in new properties has been referred to as a ticking time-bomb for first-time buyers over the medium term because of the danger that house prices will be squeezed higher by the lack of supply. If this happens property could become unaffordable to large sections of the population.
RICS is in agreement with Shelter that prices are in real danger of rising out of the reach of many first-time buyers in the medium term.
What next?
The house building industry clearly needs continued Government support to boost the number of housing starts, and the upcoming Pre-Budget Report will hopefully paint a clearer picture of Government intentions. The industry needs the current support schemes to be maintained to underpin the recent signs of recovery. This might include extending the Stamp Duty holiday up to £175,000 (due to end next month) to further encourage first-time buyers for example, and maintaining funding for the HomeBuy schemes already in place.
Labour and the Tories have both pledged to increase house building if elected next year, albeit via different methods. Whatever you think about house prices and which way they should go, there is the real possibility of a future shortage of homes for UK families if the three million target is not reached, and that's a situation nobody wants to see.
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For all the talk of supply and demand, I don't see the practical aspect of demand being discussed, i.e. affordability. Whatever the mortgage market is quoting on LTV and income mulipliers, you will have to service the debt once it is successfully obtained. Can people actually afford houses at current prices? Let's assume a relatively well-to-do London couple with individual incomes of £40k buying a home together. With a combined income of £80k they obtain a 85% LTV mortgage for 4x their income = £320k in mortgage for a £377k home. Let's also assume for argument's sake that this means they have the £68k in savings required to pay the 15% deposit plus the 3% stamp duty. With the lowest mortgage rate that is on offer on the Lovemoney tables, they pay 2% floating to start off with (1.5% above BOE base rate that is currently at 0.5%). I used the lovemoney calculator and determined that a 2% interest rate on a £320k 25-year mortgage costs ~£1,300 per month. The couple has a take home pay of £2700 x 2 = £5,400 so spending £1,300 per month of a mortgage seems feasible (24% of take home pay), leaving £4,100 per month for food, insurance, household bills, transportation, savings. I estimate essentials to be around £1,300 per month minimum => £600 food (£10/person/day) + £200 home insurance, £150 council tax, £150 utilities (gas, electricity, water, landline), £200 transport (tube to work £4x20daysx2 + some allowance for taxis) £5,400 - £1,300 - £1,300 = £2,800 (£47/person/day) for savings and 'non-essential' spending (mobile phones, clothes, entertainment, nice meals, holidays). Doable - maybe no nice holidays but doable. BoE rate at 0.5% is of course a historic low (average from Jan-04 is 4.84%). Just over a year ago, it was at 5%. The amounts below will be slightly lower because the couple would have repaid some principal but at the original loan amount of £320k, 3% base rate = 4.5% mortgage rate = £1,780 per month (33% of take home pay) 4% base rate = 5.5% mortgage rate = £1,970 per month (36% of take home pay) 5% base rate = 6.5% mortgage rate = £2,160 per month (40% of take home pay) Now that's the best case scenario with both of them earning, and still getting this nice 150bps above base rate deal. Should one lose their job, their take home pay halves to £2,700 per month (£1,300 of which need to be spent on essentials). We also assumed they have no other obligations - not additional debt service, no children, no one else to take care of. Should they decide to have a child and she goes on maternity, their income drops. Childcare adds £1,000+ per month (most nurseries are £1,500+ not full day so if both are working full-time, there is added expense for more childcare) So far I haven't been able to make the maths work to buy. I dread the bad 'what-if' scenarios enough not to be able to take the plunge. How is everyone else doing it?
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I agree state housing by councils or the even less accountable, unelected housing associations has a bigger effect on house prices than the number built by the private sector. Costs to build new increase every year with legislation, rental prices are held low by state housing supply. As the potential to make money by building or letting privately decreases then private investment falls. State investment will continue to increase as they have no interest in a financial return, the thought of a country of council housing estates makes me shudder. Without state supplied housing in such current oversupply (many keyworker schemes are undersubscribed) then house prices would necessarily be affordable to owner occupiers or landlords. At least the price crash in the oversupplied town centre flats (state targets for number of homes, not number of houses) should allow the younger generation to move into the centres and freeup the family homes they have been house sharing in the suburbs.
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"Any GCSE student" will tell you that, on the whole, it's the interaction between supply [i]and [/i]demand that determines price and that statements such as: [i](1) For any given good there's an inverse relationship between the quantity demanded and price, because higher prices mean that the good becomes less affordable, and other goods become more appealing - and as we know house prices are now eye-wateringly high.[/i] do not always apply. For a start, it's at least arguable that housing is a "Giffen good" i.e. one in which a [i]higher price makes it more[/i] attractive. Secondly, housing is still seen by many as an investment, so demand is determined not just by the price on any given day but the future perceived trend in prices. If buyers perceive that prices are rising they may become more likely to buy as this will both reduce the risk of them being priced out of the market and put them in the way of future capital gains. Finally people may take rising prices as a sign that it is now safe to enter the market. So it's entirely possible that someone who showed no interest in a property priced at £180,000 would be queuing outside the estate agent's office when it's put up to £185,000 These, and many other perverse effects, explain why professional economists, let alone GCSE students, regularly fail to predict what is going to happen to house prices.
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04 December 2009