The Housing Market – This leading indicator of economic turnaround showing signs of revival

Owning a home remains one of the critical life objectives of everyone around. We tend to spend large sums of money on buying houses and often, overstretch ourselves when it comes to spending on houses. In addition, we also spend significantly on the internals of the house to make it the best possible place for us. This inclination of not only spending big but also spending disproportionate amounts in comparison to our income, makes the housing market one of the most critical leading indicators of economic activity.

The UK house price index went up by about 25% between 2019 and the first half of 2022. The second half of 2022 saw a decline of 5% to 7% and but now it is showing signs of stabilization. Towards the end of 2022, there were overwhelming forecasts of an impending crash in UK housing prices, which never happened. So, whether those fears were overdone, or is there still a possibility of a crash in housing prices?

As the peak of covid pandemic passed and people started to focus again on their work, the average house price in the UK increased by more than a quarter propelled by work-from-home culture that led to more people seeking out independent living spaces. Lower interest rates and tax incentives further added to the demand. Meanwhile, supply was impacted due to the covid restrictions that were imposed. Annual new build dwelling starts decreased from 169,200 in the year ending Sep 2018 to 123,000 in the year ending Sep 2020.The declining supply and pent-up demand resulted in a significant increase in housing prices.

Prices scaled new highs in 2022 in terms of their comparison to earnings as well. Despite the slowdown towards the end of 2022, the average house price stood at 9x the average UK salary, which was significantly higher than the historical average of 4x. It stood as high as 13x for London housing. The affordability was also severely impacted by the increase in mortgage rates that rose to the highest level since the 2008 financial crisis. While there is a structural desire to own a house, affordability has become a challenge and it was a major reason for the projections of a crash in housing prices in 2023.

The counterweight supporting housing prices despite declining affordability is historically low inventories. The UK has a housing deficit of over 4 million and teething challenges in the pricing system have resulted in only 150,000 – 180,000 new houses being built every year. This undersupply is not expected to correct in any significant way, at least in the near term and therefore it is likely to prevent a sharp drop in housing prices.

Therefore, even a slight increase in affordability can revive housing prices, as buying homes remain a top priority for people. The 2014 British Social Attitudes survey found that given the chance, 86% of people would prefer to own their own homes. This is a social phenomenon that is not likely to change. Two critical determinants of affordability are mortgage costs and labour market conditions. The labour market has remained tight, with unemployment at a historic low of 3.7%, and salary growth has remained robust at 5.9%. On the other hand, mortgage rates have remained high with a five-year fixed mortgage rate of more than 4.5% and a standard variable rate hovering around 7%.The mortgage rate is likely to remain high at least for the next three to six months since the Bank of England is widely expected to consider a decrease in interest rates only in the second half of 2023. This widely accepted projection also incentivizes buyers to postpone their purchase decisions. The good news is that consumer confidence reached its highest level in more than a year in February. Also, the total number of mortgage options available to buyers has crossed 5,000 for the first time since May 2022.

Given the counter currents, it’s unlikely for the UK housing market to face a sharp decline in 2023 while 2024 can be a very good year as interest rates start their downward journey. The resilience of the housing market is likely to be another positive surprise for the UK enforcing our belief that it is an opportune time to invest in UK assets.