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Analysis

Published: 16 July 2015 | Author: Bob Pannell

  •  A benign economic backdrop should underpin a gentle improvement in housing and mortgage market activity.
  • This follows a softer patch over the past year, which has dragged down our expectations for gross mortgage lending to £209 billion this year, from the £220 billion we had expected previously.
  • Several of the government’s fresh housing initiatives will take time to take effect and so do not fundamentally reshape market prospects this year or next, as far as we can judge at this stage.
  • With house price levels already elevated and continuing to outpace earnings across much of the country, the upside potential for regulated lending is likely to be constrained by affordability pressures, reinforced by MMR and macro-prudential rules.
  • Perceptions of the buy to let sector can be distorted by the fact that remortgage activity accounts for a much larger share of overall buy to let lending (more than half) than is the case for home-owner loans.
  • Although buy to let business volumes continue to expand, the underlying pace of growth in buy to let activity - both for house purchase and refinancing - has been slowing, following its strong recovery over the past few years. Policy interventions in the buy to let space may reinforce this downward trend.
  • We expect a further improvement in arrears and possessions this year and anticipate that the overwhelming majority of borrowers will cope with the modest interest rate increases that start in 2016.

 CML market view, mid-2015

 

Residential property transactions

Gross advances

Net
advances

Arrears
2.5% or more of balance
at end period

Possessions in period

 

000s

£ billion

£ billion

 

 

 

       

 

2006

1,670

341

107

113,000

21,000

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

116,800

21,000

2015

1,210

209

22

102,000

16,000

 

1,180

222

32

115,000

22,000

2016

1,230

230

26

105,000

16,500

 

1,180

240

38

130,000

25,000 

Note: Figures in grey italics show CML forecasts as at December 2014

Introduction

Economic fundamentals for the UK continue to look strong and are helping to underpin the housing market, despite financial markets being unsettled by Greek developments.

Although the latest jobs data signalled a minor reversal, for the first time in two years, household confidence is being boosted by near record numbers of people in work, a low rate of unemployment (5.6%) and recovering real incomes.

The pace of earnings growth has picked up in recent months. Earnings are now about 3% higher than a year ago. The underlying position may be even stronger, allowing for changes in the composition of jobs. This is the strongest performance for several years.

Meanwhile, lower energy and food costs mean that consumer prices remain broadly the same as a year ago.

The Bank of England views the current period of subdued consumer price inflation as a temporary and benign development. The latest Inflation Report anticipates headline CPI returning to its 2% target over the next years. Deflationary risks appear negligible.

Although the anticipated timing for the first base rate increase ebbs and flows, the Bank continues to adhere to the view that, when interest rates do eventually increase, the process is likely to be gradual and limited.

Importantly, financial markets expect a much gentler upwards profile for interest rates than six months ago. The prospect of low rates for longer is helping to bolster market sentiment.

Housing market

The previously strong recovery in housing market activity ran out of steam around the middle of 2014, with overall housing transactions easing back gently until recently.

House prices have been elevated relative to earnings for some considerable while.  With house price inflation outstripping income growth across large parts of the country, it was always likely that household demand would start to fade as affordability pressures intensify.  

Chart 1: Monthly approvals for house purchase

House purchase approvals

Source: Bank of England

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However, the timing of the market slowdown more or less coincides with the implementation of new MMR affordability rules (in April 2014) and the announcement of macro-prudential interventions two months later.

While it is not easy to trace cause and effect, it seems likely that regulatory actions have helped reinforce the recent subdued tone for the mortgage market, a point acknowledged by the Bank of England in its latest Financial Stability Report

Higher income multiple lending has eased back a little over recent months.  But we also continue to see a degree of further income stretch, as borrowers opt for longer repayment terms.  These developments suggest that household finances have been bearing down on activity levels.

Although borrower demand may have softened a little over the past year, it has by no means evaporated.  Most parts of the UK continue to report positive house price growth.

Indeed, the current mix of benign conditions – rising real incomes, improving housing equity positions, and modest expectations of interest rate increases – seems likely to stimulate demand and perhaps also the supply of properties.

The Bank of England’s latest credit conditions survey reports a sharp pick-up in mortgage demand in the second quarter and expectations of a further increase in Q3.

Market data now points to a recovery in activity over the near-term.

According to the Bank of England, approvals for house purchase have been on an improving trend during the first half of 2015, and surpassed year-earlier levels in the past few months.

Our forward estimate, meanwhile, suggests that lenders advanced mortgages worth £20.5 billion in June.  This represents the strongest showing for seven years, but may be flattered by the end of political uncertainties associated with May’s general election.

We do not expect such a strong picture to persist over the coming months, especially for activity levels, if, as seems likely, house prices strengthen and reinforce affordability pressures.

Government measures

The summer Budget and subsequent productivity announcements  feature a range of policies that will directly and indirectly impact the housing and mortgage markets.

There continues to be considerable focus on delivering greater housing supply, with further planning reforms and fewer energy-related obligations placed on house-builders, but still few details about how the flagship starter home initiative – intended to deliver 200,000 below market price homes to first-time buyers by 2020 - will work.

For the purposes of this update, we assume that the government’s housing initiatives overall - including extended right to buy, Help to Buy ISA and starter homes – will provide a gentle but growing stimulus from mid-2016 onwards. These measures should therefore act to offset any dip in activity following the scheduled closure of the Help to Buy mortgage guarantee scheme at the end of 2016.

Spotlight on Buy to let

The Buy to let sector finds itself at an interesting juncture.

Fundamental socio-economic drivers have underpinned a renaissance of the private rented sector over the past 20 years or so. Individual landlords and buy to let lending have been key parts of this transformation.

The private rented sector has recently outstripped social housing to become the second largest tenure, housing about 4.5 million households in England alone. Recent academic work projects that the private rented sector in England will house more than 200,000 additional households annually over the next decade. 

After falling by much more than overall mortgage lending in the wake of the financial crisis, buy to let activity is now in its fifth year of recovery and continues to advance steadily. 

Chart 2: Buy-to-let activity, rolling year totals, % change year-on-year

Buy to let activity
Source: CML Economics
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Although it has grown to represent nearly a fifth of total mortgage lending, the picture is exaggerated by the much greater importance of refinancing activity by landlords. Landlords purchased 100,000 properties with the help of buy to let loans in 2014, but the pace of growth has slowed considerably over the past year. Buy to let is likely to account for about 9% of all property transactions this year – still much lower than in the 2006-8 period. 

While longer-term prospects for the sector should be set very fair, it now faces some prospective headwinds. 

The Financial Policy Committee (FPC), the macro-prudential regulator, has been ratcheting up its stance regarding buy to let activity over many months. The FPC would like to have directive powers to limit buy to let activity, to complement the powers it has enjoyed since April with respect to residential lending. This will be subject to HM Treasury consultation later this year. Meanwhile, at its June meeting, the FPC asked officials to explore what tools it might deploy via its existing powers of recommendation. 

Separately, the Chancellor adopted a pro home ownership position in his summer Budget, announcing two measures designed to limit the financial attractiveness of being a landlord:
- Standard wear and tear allowance (currently set at 10% of rent) to be replaced by tax relief against costs actually incurred from April 2016 
- A 4-year phased restriction of mortgage interest tax relief for individual landlords to basic rate of income tax, starting from April 2017 

Although policy-makers appear to be weighing their actions carefully, interventions by the FPC or Treasury clearly have the potential to trim back future growth of buy to let activity.

The mortgage guarantee scheme has served as a useful catalyst for bolstering lenders’ appetite to lend at higher LTVs and provides a helpful boost in overall market terms.  Depending upon moves to develop commercial alternatives that support higher LTV business and market conditions nearer the time, we might see a little market distortion, if house purchases are brought forwards into the second half of 2016.

Mortgage lending forecasts

We are slightly more optimistic about housing market developments (if not gross lending prospects) than we were at the turn of the year.  This is largely because of the continuing resilience of cash transactions (nearly 37% of all transactions over the past year).

Regulated house purchase activity has continued to edge down relative to the market as a whole over the past year, and this has acted to drag down our overall mortgage lending total for 2015 – we now expect gross lending of £209 billion, compared with our earlier estimate of £222 billion.

Chart 3: Regulated house purchase activity, rolling year totals

Regulated house purchase activity

Source: Regulated Mortgage Survey, HMRC

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We judge that the lull in first-time buyers and movers is now drawing to a close.  A key part of our narrative is that regulated house purchase activity will slowly retrace its 2014 levels through the second half of this year and into 2016, supported by a benign economic backdrop, alongside government housing measures.

Remortgage appetite continues to be subdued, except in the buy-to-let space.  The prospect of higher rates will eventually provide a stronger incentive to remortgage, but not to a great extent during our forecast period, as we will still be in the early stages of rate tightening.

Although activity levels are likely to remain narrowly constrained this year and next, we expect total mortgage lending to increase by £21 billion to £230 billion in 2016.  Some of this reflects increasing loan sizes alongside stronger house prices, but about half of the increase reflects the modest turn-round we envisage in the numbers of first-time buyers and movers.

Arrears and possessions

We have become more optimistic about short-term prospects for arrears and possessions since the turn of the year. 

The key reason is that interest rate expectations are lower than six months ago, which provides a more favourable backdrop for households to plan their coping strategies. 

It is also the case that household finances have fared better than expected recently, helped by low inflation, strong earnings growth and an improving jobs market.  All of this has helped benign trends in mortgage arrears and possessions to continue.

Arrears and possessions are now at their lowest levels since 2006 and continue to show signs of underlying improvement.

Chart 4: Arrears on mortgages, by percentage of total balance in arrears

Mortgages in arrearsSource: CML Economics

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The summer Budget announced that, from April 2016, the waiting period for new claimants of Support for Mortgage Interest (SMI) would revert to 39 weeks and that future SMI payments would eventually be paid as a loan.  The first of these changes will adversely affect new claimants at the margin, but the overall impact on possessions over the 2015-16 forecast period should be negligible. 

Our current judgement continues to be that the vast majority of households will cope with gentle and protracted interest rate rises.  This has led us to materially revise down our arrears and possessions numbers for 2015 and 2016.