Research article

Are we heading for a rude awakening?

Rents and capital values of prime property continue to rise despite increasing interest rates and geopolitical uncertainty. But how long might it continue?

Housing market analysts and economists have been uneasy bedfellows for much of the past two years.

Economists have had their sleep patterns disturbed by prolonged bouts of pandemic-related, forecasting insomnia. And just as they were hoping to get a decent night’s sleep, concerns over persistently high inflation have become inflamed by the deeply disturbing events in Ukraine. Unless they benefit from a particularly strong constitution, they remain in need of a strong caffeine hit by mid-morning.

Meanwhile, as far as the day job is concerned, us housing market analysts have largely been able to put these concerns to one side when we hit the hay. We have done so in the knowledge that a buoyant housing market has been underpinned by wholesale reassessment of what people need from a home.

On the one hand there has been a deep reservoir of unmet demand, while on the other there has been a much shallower pool of stock available to buy on the open market. The most basic of economics has done the rest.

Interest rates and market divisions

This is not to say that the macro-economic backdrop has been an irrelevance. From a financial perspective, the ability to lock into low costs of mortgage finance was critical to many households’ ability to move during the pandemic.

More recently, successive interest rate rises (with the prospect of more to come) and growing cost of living pressures have meant the housing market has become increasingly stratified.

In the mainstream market, transactional levels have fallen back towards pre-pandemic levels. Meanwhile, in the prime market – where equity outweighs debt as a source of funding and more affluent buyers are better insulated against increases in living costs – activity has remained well above normal throughout 2021 and so far in 2022.

Indeed, data from TwentyCi tells us that in March and April, newly agreed sales of homes worth over £1 million were 99% higher than in the same months of 2017-19. Though this partly reflects a greater number of properties falling into higher price bands because of price growth, it is just as much about the ongoing appetite of wealthier households to move, despite stronger economic headwinds.

Continued price growth

To this end, three statistical findings stood out from our February client survey. First, a net balance of 30% of respondents said their commitment to move over the next year had increased in the preceding three months. Secondly, 48% of those surveyed had been considering moving for more than a year. Finally, 77% told us that recent interest rate rises, at that time, had no impact on their budget. In the run-up to the spring market, these numbers indicated that there was a strong core of unmet demand largely unfettered by slightly higher costs of debt.

Consequently, it was no great surprise that prices continued to rise across the prime housing markets in the first quarter of the year. They did so by an average of 1.1% in central London, 1.7% across other parts of the capital and 2.0% in the town and country markets beyond the big smoke. That left annual price growth at 2.8%, 4.7% and 9.0% for these three markets respectively.

Chelsea, London

Chelsea, London

A change of emphasis

On the face of it, these annual price growth figures suggest a continuation of previous trends. However, this belies the fact that central London saw its strongest quarterly performance in eight years, as international money began to flow back into the capital. The quarterly figures also indicate greater parity between more domestic London markets and the regions, with the gradual return to the office – more part-time than full – rebalancing demand back towards the capital.

This has been even more noticeable in the rental market. Prime rental values in London, which fell by -5.5% in the first 12 months of the pandemic, rose by 11.1% in the year to March as a surfeit of available rental stock has quickly become a deficit.

Three sources of potential disruption

The evidence from the rental market provides a salient reminder that market conditions can change quite rapidly in any market. So, to stretch the sleep-pattern analogy to its limits, what are the prospects of a rude awakening in the prime housing markets?

As people return to the office – even if for three days a week – they will be reminded of the practicalities of commuting. We anticipate this will progressively curtail the expansion of the commuter zone but we don’t expect it to come to a juddering halt

Lucian Cook, Head of Residential Research 

In this regard there are three obvious potential sources of disruption: one is behavioural, one is economic and the third is geopolitical:

1. At some point the race for space will subside. Yes, we expect some hybrid working trends to become embedded, but the desire for additional square footage will gradually dissipate, especially as any excess savings built up during the pandemic deplete. Additionally, as people return to the office – even if for three days a week – they will be reminded of the practicalities of commuting. We anticipate this will progressively curtail the expansion of the commuter zone that we have witnessed in the past two years. But we don’t expect it to come to a juddering halt.

2. With inflation forecast to hit 8.0% this year, interest rates seem sure to rise further in the near term. We expect the resulting squeeze on household finances to be felt more acutely in the mainstream housing market. But any change in sentiment does have capacity to feed up into higher price bands.

Given the extent to which households have fixed their borrowing costs and had their affordability stress tested, we believe the market impact will be greatest at the point of taking on a new mortgage (as opposed to servicing existing mortgage payments). How much this acts as a drag on the sums people are able to borrow (and puts a brake on the market) depends on how far the Bank of England goes in relaxing mortgage regulation. The speed with which regulators have moved from concept to proposal to consultation suggests that at least some of the impact of higher interest rates will be mitigated over the next 12 months.

3. The least predictable of the three is the effect of the war in Ukraine, particularly on the long-awaited recovery in the prime central London market. Thus far, for a variety of reasons, the direct effect upon supply and demand has been limited.

Indirectly, requirements for greater transparency around beneficial ownership of homes held in offshore corporate vehicles could well have a greater long-term impact on demand. But legislation in this area was inevitable, and much like the recovery in this market, it has always been a case of when, not if.


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