Hoodwinked

But still the market contrived to confound most housing experts, selling us the most outrageous dummy. The average UK house price rose by 12.3% over 18 months. And annual transaction levels hit 1.55 million in the year to September 2021, 30% more than the 2017-19 average. That begs the question as to what happens next, especially given the stamp duty holiday is over and many of the factors that encouraged homeowners to reconsider what they wanted from a home are fading.

Looking like a soft landing

Together, this almost certainly means there will be less urgency in the market from 2022. We have already seen three month on three-month house price growth fall from 3.9% at the end of June to 1.7% at the end of September.

We expect price growth next year to be much more muted than we have seen of late, with the prospect of the current burst of inflation persisting into next year and bringing forward the first anticipated interest rate rise.

But in the short term, there are a number of economic factors that support decelerating price growth as opposed to something more dramatic.

Firstly, interest rates are incredibly low. The average rate for a five-year fixed rate mortgage at a 75% loan-to-value (LTV) ratio was 1.29% at the end of September, according to the Bank of England. For buyers with more equity, lenders have fallen over each other to offer fiveyear rates well below 1%.

Secondly, the vast majority of mortgaged homeowners are insulated from rates rising earlier than expected, even if inflation continues to rise over the short term. This insulation has been provided by the 93% of mortgage borrowers who have locked into low, fixed rates and by the proportion of those who fixed for five years or more.

Thirdly, unemployment looks to have been contained, limiting the risk of forced sales. Indeed, mortgages in arrears currently represent just 1.2% of the outstanding loan book. That’s lower than at any point in the past decade.

Lead indicators

Such a moderation is further supported by lead indicators which are specific to the housing market. 

First, the RICS housing market survey suggests that, though demand has softened, supply coming to the market has been more constrained. That means undersupply will continue to characterise the market going into 2022.

Data from TwentyCi supports this. In the three months to September 2021, the level of new stock coming to the market was 12% below that seen in the more normal market conditions of 2017-19. Meanwhile, the number of agreed sales was 26% higher than this benchmark, though much lower than earlier in the year.

Affordability constraints

Hoodwinkings and soft landings aside, you cannot escape the fact that the market has less capacity for price growth in the next five years because of what has happened in the past year and a half.

So while it looks as though the low cost of debt will protect the market from a downturn in the short term, gradually increasing rates are likely to constrain future price growth.

One of the oddities of the housing market recently is that while prices have risen during the pandemic, the average loan to-income ratio among people actually buying has barely moved. That is because the market has been more weighted to more affluent households. As the market normalises, we expect to see that change; something unlikely to escape either the eagle eye of the lenders or the Bank of England.

That is likely to bring underlying affordability more sharply back into focus and, perhaps more pertinently, act as a drag on what households are able to borrow when rates start to rise. The affordability stress testing introduced in 2014 will add to that drag, particularly as rates trend upward.

Interest rates and sensitivities

Accordingly, the capacity for price growth is sensitive to the speed and scale of those rate rises.

Our forecasts assume that the Bank raises rates twice in 2022, bringing them to 1.5% at the end of our forecast period before plateauing at 1.75% at the end of 2027 (beyond the end of our forecasting period). For consumers, this could result in a double whammy: an increase in variable rates and a higher premium to secure a fixed rate, though in part this will depend on the appetite of lenders.

In these circumstances, we expect the average UK house price to rise by 13.1% over the next five years. Growth beyond that would limit the profile of people able to buy with a consequential impact on longer-term transaction volumes.