Published: 10 December 2013 | Author: Bob Pannell
- A stronger jobs market and better credit availability are supporting a recovery of the housing market. This is from a low base, and the strong upwards momentum looks set to continue through 2014.
- Gross mortgage lending may grow to more than £200 billion by 2015, for the first time since 2008, helped by a continuing recovery in remortgage activity from 15-year lows as well as stronger housing market conditions.
- We see little evidence of an unbridled housing boom developing. Indeed, given the already stretched nature of household finances, new regulatory environment and likely future course of interest rates, housing market activity may well ease back of its own accord.
- There is a possibility that too much importance has been ascribed to the impact of the Help to Buy mortgage guarantee scheme. While it brings forward a return to higher LTV lending, and so eases the position of those looking to purchase or move home under their own steam, it seems likely to directly help a relatively narrow profile of buyers, given the new regulatory regime.
- Our forecasting horizon embraces a period when the Bank of England may consider increasing interest rates. While we see this as more of an issue for 2016 and beyond, the benign period of falling arrears and possessions may be coming to an end.
CML market view, December 2013
|Residential property transactions, UK
|Arrears, 2.5% or more of balance at end period||Possessions in period|
Note: Figures in brackets show 2013 forecasts as at December 2012
This is an interesting time to be publishing market forecasts. There is a strong consensus about the immediate direction of travel for the housing market, but little agreement as to its eventual destination.
The revival of the housing market owes much to the turn-round in the macro-economy, although the two are closely inter-linked (as the Bank of England’s latest Inflation Report makes clear).
A resilient jobs market and better credit availability has meant an improving tone in the housing market for some considerable while, although until recently this had primarily been a London-based phenomenon. As worries about double or triple dip recessions have dissipated, however, a much more confident national mood has emerged.
We have seen a truly remarkable transformation in household sentiment, despite real household incomes still being under pressure as a result of cost of living increases. This has gone hand in hand with a greater willingness on the part of households to spend and borrow.
The protracted period of subdued housing market activity came to an end in the spring, since when the housing market has powered ahead. Measures of national house prices have picked up sharply, although some of this reflects a recent and still modest pick-up in regions of the UK, away from London and the south east.
We had not anticipated such a strong revival when we published our market forecasts a year ago. This largely reflects the unexpectedly sharp improvement in the economic mood.
The further lowering of mortgage borrowing costs has been an instrumental factor. Yearly mortgage interest payments have dipped by something like £12 billion over the past year, as a result of the general improvement in funding markets and the funding for lending scheme.
Chart 1: Pricing of 2-year fixed rate mortgages by LTV, %
With base rates and mortgage rates already at historic lows, the funding for lending scheme window closing for mortgage lending in early 2014 and economic recovery bringing forward the time when UK policy rates start to climb, this is close to as good as it gets on interest rates.
Help to Buy has also supported the strong pick-up in the housing market, but this is principally through the boost to market sentiment arising from the announcement of the two elements of the Help to Buy initiative. The direct stimulus provided to date is likely to have been rather modest.
Although the Help to Buy equity loan scheme (launched in April) has got off to a much stronger start than NewBuy – with more than 5,000 properties bought under the scheme during its first six months – this is a fraction of the overall market activity of more than half a million transactions completed over the same period.
Meanwhile, the Help to Buy mortgage guarantee scheme only launched a few weeks ago and does not become fully operational until January 2014, and we are only just beginning to see the first loans being completed.
Chart 2: Gross and net mortgage lending, £billion
We expect total gross mortgage lending to exceed £170 billion for 2013 as a whole. This is about a fifth higher than the year earlier. There have been significant increases across most segments, but house purchase activity has benefitted most.
Interestingly, we have seen little evidence of an acceleration in mortgage debt, with 12-month growth rates comfortably below 1%.
Despite this, the rapid pace of housing market recovery has triggered concerns about the risks of over-heating and the appropriateness of government housing initiatives, notably Help to Buy.
The rest of this paper sets out our current views on how the market may evolve over the next couple of years.
Assuming that the economic headwinds stabilise or continue to ease further, there is lots of potential for further housing market recovery, especially as transactions and real house prices are so far below pre-peak levels.
The Bank of England’s latest Inflation Report cautions that the UK recovery may be subdued by historical standards, as a result of the legacy of adjustment and repair left by the financial crisis, and we think that the same may be true for the housing market.
Household incomes have been under pressure over a protracted period, as cost of living rises have outpaced limited growth in nominal incomes. Low rates of pay growth appear to be the flip side of higher employment levels, and this seems unlikely to change quickly.
And, although house prices fell sharply immediately post credit crunch, they have recovered much of that ground across large parts of the UK - supported by loose monetary policy, strong demographics and weak levels of housebuilding activity – and so remain fairly elevated relative to household earnings. The obvious exception to this is Northern Ireland, where a slump in house price values has only recently ended and the market shown signs of stabilising.
While low mortgage rates mean that debt-service payments are manageable for the vast majority of households, there is already evidence of affordability pressures in some of the new lending metrics we report. The average income multiple of first-time buyers, for example, has climbed progressively higher across the southern half of Britain, approaching – and, in the cases of London and the south east, exceeding – previous peaks.
Chart 3: Loan to income multiples , first-time buyers, by region
So, while housing market revival over the short-term seems assured, it is likely to happen alongside stronger house prices and intensifying affordability pressures. This leads us to conclude that the upwards leg of the housing cycle may be relatively short-lived and that property transactions and house price growth may peak over our 2014-15 forecast period.
The new regulatory environment
A key part of our reasoning about an orderly unwinding of emerging housing pressures centres on the different regulatory environment within which lenders, brokers and borrowers now act.
Whereas in the past, households could stretch their borrowing limits in a number of ways, today’s mortgage market offers a much narrower range of coping strategies.
Over recent years, mortgage lenders have adopted more conservative lending policies, many of them in anticipation of the new mortgage market review (MMR) changes, that finally take effect from April 2014.
A central plank of these are new affordability rules. These will, as a minimum, require lenders to verify income, satisfy themselves that the mortgage is affordable on a capital repayment basis (taking into account the borrower’s net income and likely outgoings) both initially and in the light of expected interest rate increases, and also allow an amount for basic quality of living costs.
Notwithstanding the greater relative importance of cash-financed transactions over recent years, we find it difficult to envisage how a runaway housing market could develop without the propellant of ever more readily available mortgage credit.
We do not expect the brakes to slam on from next April, given that mortgage lenders have been following the spirit of these new affordability rules for some time already. There might be some wobbles in the monthly pattern of lending figures around MMR implementation next April, but such effects are likely to be relatively modest.
But, the new affordability rules are designed to lean against the irrational exuberance that has characterised previous housing market booms, and we should expect them to help prevent a full-blown housing boom developing over time.
Critically, this is not the full extent of the regulatory oversight. For the first time, the UK also has a macro-prudential regulator in the form of the financial policy committee (FPC).
The FPC has been closely monitoring developments in the housing market for some while. While the regulator has not expressed undue concern about the short-term, it has been at pains to signal that it has a wide range of policy levers that it can deploy, if necessary, and willing to intervene if it sees risks to wider financial stability emerging.
In its November Inflation Report, the Bank of England sets out a clear preference for the FPC to act on a timely basis, if necessary, in order to avoid being forced into early rate rises. A vigilant and activist macro-prudential regulator thus helps to safeguard a sustainable recovery in th ehousing market.
As well as placing confidence in the ability of the new regulatory structures to stop the housing market overheating, should that become necessary, we also have a less alarmist view concerning the Help to Buy mortgage guarantee scheme than many commentators.
At this early stage, there are considerable uncertainties about many aspects of the Help to Buy mortgage guarantee scheme. This makes it difficult to gauge the likely take-up, and so how much of a housing stimulus the scheme potentially represents. However, for the reasons set out in the boxed article, we believe that the volumes of business written under the scheme may turn out to be relatively modest, such that it has a smaller but more positive market impact than many commentators suggest.
Help to Buy mortgage guarantee scheme
The design of the scheme means that it is not a “must have” product, for lenders or borrowers. As required under EU state aid provisions, lenders pay a commercial fee for the guarantee and, although they may choose which loan buckets to apply under the scheme, they are not able to "cherry pick" which loans go into the scheme. Moreover, lending criteria to any borrower have to comply with the MMR affordability rules and certain borrowers are not eligible to participate.
The bottom line is that the mortgage guarantee scheme is by no means a “golden goose”, as can be judged from the relatively cautious manner in which lenders have engaged with it.
Initial interest has focused on applying the scheme to house purchase lending in the highest LTV bucket (up to 95% LTV). This is understandable, given that greater competition for business up to 90% LTV has begun to emerge over the past year.
From a borrowers’ perspective, we would expect the scheme to appeal particularly to households who, but for a deposit constraint, would be able to get onto the housing ladder under their own steam, so those with somewhat higher incomes and a little bit older than typical first-time buyers. This closely matches the profile of early applicants, as reported recently by prime minister David Cameron.
While this profile may well shift over time (and perhaps become less concentrated on first-time buyers), it does suggest that the two elements of the Help to Buy initiative are fairly complementary in nature.
It remains difficult to get a fix on what volumes of business the Help to Buy mortgage guarantee scheme might eventually support. While the majority of commentaries seem to factor in several hundred thousand transactions over the next three years, this is by no means a given, especially as we are beginning to see competitive offers from firms remaining outside of Help to Buy.
Our instincts are that sustainable volumes may be much lower, given that the overall financial position of households is unclear, and that CML market research earlier this year illustrated that the scheme would not represent a panacea for borrowers.
We recognise that there are potential risks with the mortgage guarantee scheme, especially as, unlike the Help to Buy equity loan scheme, there is no direct link to new build. By making life easier for those who have been deposit-constrained, the scheme clearly has some potential to stimulate demand, and so add to upwards short-term pressure on house prices.
This is not necessarily a bad thing in and of itself - some upward pressure on house prices is a natural bed-fellow to any meaningful recovery in housing market activity. The key issue is one of degree.
This is where the formal role of the FPC to review the scheme each September comes into play. Should it judge that the scheme, or wider developments in the housing market pose risks for financial stability, then it has significant influence to make the scheme less attractive (even if ultimate decisions around scheme features sit with HM Treasury).
This provides a helpful safeguard, and one that the CML strongly supports, given that our industry does not want the mortgage guarantee scheme to become a permanent feature of the market.
Generally speaking, our market forecasts for the next two years are positive.
The strong recovery in property transactions looks set to persist, although volumes are unlikely to approach pre-crisis levels and may begin to edge lower as affordability pressures build.
Chart 4: UK property transactions, 12 month moving totals
While, up until now, the number of movers has languished, a pick-up in the number of owner-occupiers moving house should be an important element of that further recovery, as selling prices improve across large parts of the country and equity constraints loosen. We also anticipate the modest and sustainable recovery in buy to let activity to continue, despite better first-time buyer numbers.
We expect gross mortgage lending to climb above £190 billion next year, its highest level since 2008. While this is largely on the back of the continuing revival in housing market activity, we also expect to see a meaningful turn-round in remortgage activity.
The latter has picked up modestly in 2013, quietly recovering from 15-year lows. Remortgage volumes should reprise 2009 levels, as the UK’s economic recovery becomes more firmly established, lending appetite grows and rising house prices improve households’ equity positions. However, our assumption of little if any movement on policy interest rates over the next two years keeps one of the key drivers of remortgaging on “hold” for the time being.
Despite a strong pick-up in gross mortgage lending, we have pencilled in relatively modest net lending figures - £15 billion in 2014 and £20 billion in 2015. While this would mark a climb out of the sub £10 billion doldrums, where the market has languished since the credit crunch, it does nevertheless represent a rather muted position. This reflects, among other things, our view that some households will use the relatively benign economic conditions to prioritise debt repayments (ahead of medium-term interest rate rises).
As our third quarter figures recently showed, we continue to see improvements in the picture for both arrears and possessions. While this looks likely to continue through 2014, we remain aware that a sizeable minority of households continue to be subject to financial pressures, that any recovery in household incomes may be unevenly distributed and that the prospect of rising interest rates will begin to cast its shadow towards the tail end of our forecast period.
We think that there are good grounds to be optimistic that the vast majority of households will cope with a slow but certain transition to more normal interest rates. This seems to be the game-plan which the Bank of England has in mind, but presumes (as we do) that the UK avoids a destabilising housing boom over the next few years.