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21 June 2023

The housing crash will be different this time

Conditions suggest a long, slow death rather than a sharp shock.

By Will Dunn

The UK is in the grip of a mortgage crisis. Figures released this morning by the Office for National Statistics show that inflation did not slow at all last month, remaining at 8.7 per cent (CPI), while core inflation rose again to 7.1 per cent. Further interest-rate rises from the Bank of England are now inevitable. Some were already priced in by the market: on Monday morning, 19 June, the average rate for a two-year mortgage reached 6 per cent. Households that took out mortgages at ultra-low fixed rates (some as low as 0.83 per cent) two years ago are now facing a severe shock as their interest payments increase by hundreds of pounds per month. Some 1.5 million households will remortgage from a fixed rate this year, but the government can’t give everyone rate relief, and the Bank can’t help but make mortgages more expensive.

The scene appears set for a housing crash; one analyst described the market yesterday as “teetering”. Because prices are so high, borrowers are dangerously over-extended, which makes every fraction of a percentage point crucial. The cost of a typical mortgage at 6 per cent today is similar (as a proportion of income) to the level it reached when interest rates hit 13 per cent in 1989, precipitating a 34 per cent fall in real (inflation-adjusted) house prices.

The housing crash of the early 1990s was severe – more than 75,000 homes were repossessed in 1991, the highest level ever – but it was relatively brief. In 1995 prices began climbing again and by 2002 they had doubled (in nominal terms). The housing slump caused by the 2008 crash was sharper but shorter again, and prices rose still more steeply as near-zero rates and quantitative easing made it much cheaper to borrow. This time, the decline may be slower, but it could last a great deal longer.

A number of factors are holding prices up: it’s June, typically a good month for the market because the evenings are longer and it’s when buyers begin to feel the benefit of pay reviews (which occur most commonly in April). Even at 7.2 per cent, pay growth hasn’t kept up with inflation, but it has exceeded house prices, which grew 4.1 per cent in the year to the end of March (and fell 1.4 per cent that month). The long-term effects of the Covid-19 pandemic (including a shift to more remote working, early retirement and higher savings among more affluent households), combined with new, more accommodating products such as 100 per cent mortgages and extended terms, are still keeping demand aloft.

[See also: What is Labour’s housing policy?]

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At the same time, supply is being pinched. The most recent PMI (purchasing managers’ index, a measure of investment and activity) figures for construction in the UK show that house-building has fallen for five months in a row, and is now declining at the steepest rate since the first lockdown of 2020. While many landlords are being driven to sell by the cost of their buy-to-let mortgages, many more homeowners – especially older people in larger houses – are holding off downsizing until prices rise again.

That may not happen for a long time. Boosted demand and restricted supply will slow the decline in prices, but the downward pressure is not going away. A report released on Monday by the Resolution Foundation found that based on current prices, the average two-year mortgage rate “won’t fall back below 4.5 per cent until the end of 2027”. The near-zero interest rates of the post-crash decade are unlikely to return soon, if ever – and if they did, it would be in an attempt to reheat an economy that was in recession, which would be even worse for house prices.

The long-term picture for demand is not positive, either. In previous decades, prices have been kept aloft by people becoming more affluent and entering the property market in their thirties, but average real wages have stagnated since 2008 and university tuition fees were increased to £9,000 a year. That generation of graduates is now at house-buying age, but they don’t have the money, and neither will their successors, who are currently graduating with an average £45,000 of debt.

Meanwhile, the effect of an unstable and lightly regulated rental market, which charges London renters around 40 per cent of disposable income, has been to move the money that would have been used for deposits into the pockets of landlords. Real wages have fallen back to their 2005 level. Energy prices are expected to remain high and volatile into the 2030s. The new money on which rising prices have been based has disappeared.

It’s also worth noting that in the last splurge on cheap debt, in 2020, half the mortgages that were taken out were fixed for five years. This is a crisis that will play out well into the next parliament.

The most likely future for Britain’s housing market, then, seems to be that made by the ratings agency S&P in January, when it forecast a “sticky, gradual decline”. The drop may not be as sharp, but it is presently hard to see how the boom times could ever come back – and given the damage high house prices cause, why would we want them to?

[See also: The great housing con: why the coming crash will rewrite the UK economy]

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