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Market commentary: 2017 and 2018 forecasts

Analysis

Published: 15 December 2016 | Author: Mohammad Jamei

  • Our forecasts are more pessimistic about the future than a year ago, partly relating to the economic uncertainty from the EU referendum, but also because of tax and regulatory changes in the housing and mortgage market.
  • However, the housing market is relatively well insulated from Brexit, compared with other parts of the economy, as most activity is driven domestically.
  • Property transactions have been subdued through the second half of the year, even after accounting for the stamp duty distortions on buy-to-let; but, given robust demand, we still do not expect to see national house price falls over the next two years.
  • We expect weakness in the supply of homes to the market, from existing and new build, to continue. The current rate of new-build properties is only expected to increase modestly, while the trend of few home-owners putting properties up for sale is not expected to reverse in the current climate, given high transaction costs and weak house price inflation.
  • Stamp duty and regulatory changes are both likely to weigh on activity in the buy-to-let sector. We expect 2015 to be the high watermark for buy-to-let house purchase activity, with 2016 through to 2018 all to be weaker.
  • We expect arrears and possessions to deteriorate slightly in 2017 and 2018, as the majority of borrowers cope with harsher economic conditions from next year, resulting in forecast figures which compare favourably to the recent past.

CML market view, December 2016

 Year

Residential property transactions

Gross advances

Net 
advances

Arrears
2.5% or more of balance
at end period

Possessions in period

 

000s

£ billion

£ billion

 

 

 

       

 

2007

1,614

357

104

127,800

25,900

2008

900

248

35

182,600

40,000

2009

858

141

9

199,600

48,900

2010

886

134

6

175,800

38,500

2011

885

138

7

161,400

37,300

2012

932

145

10

157,900

33,900

2013

1,074

178

14

144,600

28,900

2014

1,219

203

24

114,000

20,900

2015

1,230

220

33

102,000

10,500

2016

1,238

246

38

93,000

7,900

 

1,250

237

31

105,000

18,000

2017

1,170

248

30

100,000

10,000

 

1,260

261

39

115,000

19,000 

2018

1,155

252

30

110,000

13,000

Note: Figures in italics show CML forecasts as at December 2015 for 2016 and 2017

 

Introduction

Although data since the referendum shows the economy has performed better than was expected back in June, prospects for the UK economy are likely to remain more uncertain than usual for the next few years as a consequence of the vote for Brexit.

Our forecasts therefore carry more uncertainty than usual, as the timing and outcome of any negotiations surrounding the UK’s membership of the European Union vary. In our forecasts, we have assumed a two-year negotiating window from March 2017.

Although no-one can predict how Brexit will pan out with any certainty, it is worth bearing in mind that the housing market is relatively well insulated compared to many other parts of the economy, as most activity is driven domestically. London may be an exception, but even there the impact is likely to be limited to prime areas.

Expectations for 2017 are still weaker than for 2016. This is partly because the UK will go through an adjustment period but also because inflation and unemployment are both expected to rise. This would reverse some of the gains in the jobs market and lead to flat or negative growth in real earnings over the next few years.

Policy responses since June

The Bank of England's monetary policy committee (MPC) unveiled a significant package of monetary measures in early August. The timing was designed to provide stimulus to the economy as growth slows down into next year. Given monetary policy can take up to 18 months to take effect, the MPC sought to act sooner, rather than later.

As well as cutting interest rates to 0.25% from 0.50%, the Bank of England announced a new round of quantitative easing, and a new term funding scheme, which, in effect, is a beefed-up version of the earlier funding for lending scheme.

Up until very recently, another rate cut was on the cards, but the MPC decided to hold fire as economic data has been more positive than expected. But despite this, it is widely accepted that conventional monetary policy is largely exhausted and cannot do much to mitigate any adverse economic developments.

Growth downgrades and weaker tax receipts meant that public finances have taken a hit since March. For this reason, the new chancellor has given himself some flexibility by doing away with his predecessor’s target of a balanced budget by 2019-20. Instead, he now has some freedom to allow fiscal stabilisers to work and loosen policy further down the line if prospects weaken by more than expected.

One of the key autumn statement announcements was the National Productivity Investment Fund (NPIF), a new fund set up to help raise the UK’s poor productivity. Two housing initiatives will be funded by the NPIF. These add to the housing policy announcements made in October by the communities secretary.

The first is a new Housing Infrastructure Fund, which will make £2.3 billion available by 2020-21 to provide infrastructure targeted at unlocking new private house building in areas where housing need is greatest, which aims to will deliver up to 100,000 new homes.

The second announcement will make £1.4 billion available to deliver an additional 40,000 affordable housing starts by 2020-21, which includes affordable rent and low cost ownership.

The chancellor also said he is replacing the autumn statement and will instead have an autumn Budget from next year, meaning that he has two opportunities to make major policy announcements next year, should it be needed.

The government also plans to publish a housing white paper in January 2017.

HM Treasury announced that the Help to Buy: mortgage guarantee scheme would close as planned at the end of 2016. The Financial Policy Committee (FPC) judged it unlikely that the closure would significantly affect the provision of mortgage finance, especially given most lenders in the high loan-to-value space currently operate outside of the scheme anyway.

The FPC also reviewed its macro-prudential rules for the owner-occupied mortgage market and decided to maintain its Recommendations. The FPC announced it will conduct a review of its overall strategy for setting policy to guard against risks from the mortgage market in 2017.

Alongside this, the FPC has been given powers of direction to place limits on buy-to-let mortgages in relation to loan-to-value rations and interest coverage ratios.

Housing and mortgage market

The housing market is currently in a similar position to the economy, slightly subdued but holding up better than expected only a few months ago.

Housing transaction volumes have been distorted in 2016 as a result of the stamp duty change on second properties, but the underlying trend has softened somewhat. While weakness in the first few months after the tax change were driven predominantly by the bringing forward of activity, a more subdued level of activity has continued through the year.

Outlook for the housing market has not been shaped purely by the referendum result. Some of the weakness in the market has been baked in since before the referendum and was expected to show through over the next few years, almost regardless of the result.

As most housing transactions are discretionary, it is often the case that activity levels tend to be bear the brunt of any uncertainty, as buyers and sellers wait to get a clearer picture of where the economy may be headed. For this reason, the slowdown in transactions has been compounded by economic uncertainty, as we expected.

Regulation and tax changes have sharply affected buy-to-let activity and this has contributed to subdued level of overall activity. Meanwhile, in the residential space, activity has been limited by stamp duty in the top end of the market, affordability constraints, and more recently consumer sentiment has weakened.

First-time buyers and home movers face affordability pressures, which are increasingly coming up against the macro-prudential rules announced in 2014, as the loan-to-income soft cap limits income stretch. High transaction costs and relatively few properties on the market are also holding back activity in this part of the market.

But first-time buyers have been supported somewhat by various government schemes, which have helped the number of first-time buyers on an annual basis increase by 116% since its post-crisis low in mid-2009. The real weakness is coming from second steppers and other home movers, whose activity continues to be subdued since the financial crisis, shown by the fact mover numbers have grown by only 44% since the same period.

Chart 1: 12-month rolling sum of number of first-time buyers and home movers

market forecasts chart 1

Source: CML Regulated Mortgage Survey

Download data

As a result, first-time buyers buying with a mortgage have accounted for a higher proportion of house purchases loans in recent years. They now make up about half of house purchases. To put this into context, it was fairly typical for first-time buyers to make up just over a third of house purchases in the early 2000s.

Fewer home movers also have the adverse impact of limiting activity as fewer people put their homes up for sale, a trend seen since the end of 2013. Data from the Royal Institution of Chartered Surveyors survey shows new instructions to sell flat or falling for more three years, while demand for housing holding up well.

We also expect the current rate of new build to increase only modestly, even as government provides more funding for housing. There is some potential upside as we wait for the government to outline its housing policies in the housing white paper.

This pattern of weak transactions puts pressure on house prices, as the relatively few properties up for sale are bid up by a growing number of potential buyers. For this reason, we do not expect to see house price falls but instead expect to see house price inflation to slow over the next two years, and then to grow in line with earnings thereafter.

Overall, we expect to see regulated house purchase activity fall back to 2014-15 levels next year, and remain at the same level in 2018.

Cash transactions are expected to remain a large part of the market, continuing the trend of the last few years of making up just over a third of all transactions.

Buy-to-let

A different set of factors are weighing on buy-to-let house purchase activity. Lenders have been tightening affordability criteria ahead of the Prudential Regulation Authority’s stress tests, which come into effect in January 2017, and the tax relief changes which start to take effect from April 2017. These two changes, along with the change in stamp duty for additional homes, means we expect to have seen peak buy-to-let house purchase activity in 2015, with 2016, 2017 and 2018 all expected to be weaker.

Chart 2: Buy-to-let activity levels, thousands

market forecasts chart 2

Source: CML Economics

Download data

There is a large degree of uncertainty in how landlords react to the income tax changes; research commissioned by the CML shows only half of buy-to-let landlords surveyed felt they had at least a fairly good understanding of these changes. We expect limited or slower growth in landlord’s portfolios but will ultimately need to wait until the changes are in place to get a better idea of the cumulative impact on the sector.

The part of the mortgage market that is expected to grow both for buy-to-let and home-owners is remortgaging, as low mortgage rates encourage borrowers to re-finance. This will push the split of gross mortgage lending towards remortgage activity, away from house purchases.

Subdued house purchase activity also means lower net mortgage lending over the next two years. Over the last few years, buy-to-let has been a big driver of net lending. But given the weaker outlook for buy-to-let house purchases, we expect first-time buyers entering the market to make up a large portion of net lending.

This also implies the stock of mortgage debt will grow at a slower pace than has been the case recently, at around 2% over 2017 and 2018.

Arrears and possessions

Trends in arrears and possessions have continued to be benign. Both arrears and possessions are at their lowest levels since 2004 and continue to show signs of underlying improvement.

Since our December 2015 forecast, household finances have fared well, helped by continuing low inflation, modest earnings growth, and a growing jobs market.

As a result, we expect to see some further improvement in arrears over the short term, but then expect a slight deterioration towards the end of 2017 as unemployment rises and real incomes come under pressure.

The underlying picture for possessions still shows the number of cases falling, but as with our arrears forecast, we expect some deterioration in 2017 and 2018. The reason for this is a legal case that has somewhat distorted the headline figure for 2015 and 2016, meaning some possession actions were put on hold until regulatory uncertainty had been resolved.

We now expect this to unwind in 2017 and 2018, which is reflected in our forecasts.

Overall, we still expect the majority of borrowers to cope with a harsher economic condition from next year, resulting in forecast figures which still look favourable compared to the recent past.

Conclusion

Our forecasts are more pessimistic than a year ago, partly as a result of economic uncertainty, but also because of tax and regulatory changes in the housing and mortgage market. Having said this, the housing market is relatively well insulated from Brexit, compared with other parts of the economy, as most activity is driven domestically.

We expect property transactions to remain subdued going forward but, given strong demand for housing, we still do not expect to see national house price falls over the next two years.

The trajectory for buy-to-let is weaker than we expected a year ago, with stamp duty and regulatory changes both weighing on activity. Our forecasts imply 2015 was the peak for buy-to-let house purchase activity, with 2016 to 2018 all being weaker.

On arrears and possessions, we expect a limited deterioration in the underlying figures, as most borrowers cope with harsher economic conditions from next year, resulting in forecast figures which still look favourable compared to the recent past.