Property Market Update: May 2023
At the beginning of the year, we published a summary of UK property market forecasts and some of the key reports that helped to gauge the health of the market at the time. Since then, much has changed and the longer-term prospects for investors are changing with them.
In this article, we look at some of the developing trends in the market and some of the most important economic forces that are now underpinning them.
General Economic Outlook
The health of the UK economy affects the property market in a number of indirect ways. For example, faster growth typically translates into more jobs and more people earning better and more regular incomes. That, in turn, tends to encourage more people to move – often to take up new jobs – and it also makes them better able to afford a move to more desirable homes, whether renting or buying. All of that help to support price growth and more rewarding investment returns.
At the start of the year, economic predictions and property market forecasts were grim, still weighed down by the upheaval and pessimism caused by the notorious ‘mini-budget’ of September 2022. The Bank of England was talking of a prolonged recession – likely to be one of the longest on record – and the markets were expecting the base rate of lending to rise to 6% or more.
Since then, the economy – and the housing market in particular – has proved surprisingly resilient. Terms such as “resilience,” “stability” and “robustness” are now used almost routinely in economic reports and house price indices. In its Monetary Policy Report for May 2023, the Bank of England noted that although inflation had remained high, the economy was faring distinctly better than the Bank and many other organisations had previously expected. In particular, it noted that:
· “Economic activity has been less weak than expected in February, and the Monetary Policy Committee (MPC) now judges that the path of demand is likely to be materially stronger than expected.”
· “The improved outlook reflects stronger global growth, lower energy prices, (and) the fiscal support in the Spring Budget.”
· “The unemployment rate is now projected to remain below 4% until the end of 2024.”
· “We expect inflation to fall quickly this year and then meet our 2% target by late 2024.”
Rather than a recession, the Bank of England is now predicting modest economic growth and, crucially for investors, a gradual return to lower rates of inflation.
Importantly, the Bank is not alone in making such a forecast. In its March 2023 Economic & Fiscal Outlook, the Office for Budget Responsibility noted that “the economic and fiscal outlook has brightened somewhat since our previous forecast in November. The near-term economic downturn is set to be shorter and shallower; medium term output to be higher; and the budget deficit and public debt to be lower.” Like the MPC, the OBR also notes that inflation “is expected to fall sharply.”
Inflation and Interest Rates
Inflation is an important consideration for investors. A rising cost of living has numerous significant consequences, such as:
· Increasing affordability pressures for tenants and house-buyers, which have the effect of slowing price growth;
· Reducing real-terms returns from capital and rental growth;
· Raising costs for investors: e.g. repairs, insurance, agency fees and so on.
Another very important consequence is that it puts pressure on the Bank of England to raise the Bank Rate – i.e. the base rate of lending – in an effort to wrestle down the rate of inflation. However, by increasing average borrowing costs, a higher Bank Rate generally compounds affordability problems for anyone with a mortgage, it reduces landlords’ margins and it has a further braking effect on capital growth.
That’s why recent predictions from OBR, the Bank of England and others should come as welcome news. The Bank’s Monetary Policy Committee expects the Consumer Prices Index “to fall quickly this year,” to around 5% by year-end and back to its 2% target before the end of 2024. In its Monetary Policy Report, it adds that the CPI inflation rate will fall even further thereafter. It predicts:
“CPI inflation declines to a little above 1% at the two and three-year horizons, materially below the 2% target.”
The OBR is forecasting an even sharper fall. It writes that “CPI inflation peaked at 11.1% in October and is expected to fall sharply to 2.9% by the end of 2023; a more rapid decline than we expected in November.” It adds that is expects the rate to oscillate “around zero in the middle of the decade.”
Whatever the actual figure proves to be, it’s clear that inflation should be trending steadily downward. Consequently, some of the negative effects listed earlier should go into reverse. In other words, affordability pressures should ease, landlords’ costs should moderate, and ordinary people should find themselves with more to spend in real terms. As a result, they should be better able to compete to secure new homes, so property values should gradually start to pick up again.
Similarly, if inflation begins to drop, the Bank of England may well opt to reduce the Bank Rate sooner than expected. It will be acutely aware that a high rate is currently doing nothing to nurture economic growth so it can be expected to reduce the base lending rate at soon as it believes it is safe and prudent to do so.
Even before then, it’s clear that a number of lenders, pressed by keen market competition, have been lowering interest rates on their longer-term, fixed rate products. In short, borrowing costs have been falling – and may continue to do so – regardless of recent changes in the official Bank Rate.
Few commentators have been willing to predict what average mortgage rates will look like in 2024 but it seems safe to assume that borrowing costs will peak in 2023 and then gradually decline next year and beyond. That’s certainly the belief of the International Monetary Fund, which regards the current rates of global inflation as a temporary spike, caused largely by the aftermath of the Covid pandemic and by Russia’s invasion of Ukraine.
In its World Economic Outlook report (April 2023) it refers to the concept of a ‘natural rate’ of interest, which it describes as “the real interest rate that neither stimulates nor contracts the economy.” It expects this underlying rate to fall steadily within developed economies for several decades to come. It writes:
“Common trends such as demographic changes and productivity slowdown have been key factors in the synchronized decline of the natural rate… Overall, the analysis suggests that once the current inflationary episode has passed, interest rates are likely to revert toward pre-pandemic levels in advanced economies.”
In summary, then, national and global expectations are changing. Markets were shaken by the September mini-budget and by the associated hike in the Bank Rate, but confidence is returning and the longer-term outlook for property investment is looking steadily brighter.
The cost-of-living crisis and high borrowing costs have been two of the chief causes of the housing market’s slowdown but these headwinds should ease relatively quickly. In the meantime, there is no doubt that the forces of supply and demand continue to work in the investor’s favour.
Supply and Demand in the Housing Market
Tightly constrained supply and intense demand are commonly quoted in UK house price indices and rental market indices. These have been key features of the economic landscape for many years and, together, they have been perhaps the most powerful drivers of rising values.
In its April House Price Index, Zoopla notes that its “leading indicators of housing market activity and pricing show a steady and sustained recovery in demand… Demand for homes reached its highest level this year after the Easter break and is 14% higher than 2019 levels.”
In recent reports, several sources have noted that stocks have begun to recover after the record lows recorded during the pandemic years. However, these modest annual increases still leave supplies of homes below where they were in 2019.
Nevertheless, stock levels do seem to be improving, and activity in the house-buying market is gradually returning to more usual annual and seasonal averages. Such trends will mean slower but more sustainable rates of capital growth than we saw in 2021 and 2022, but it’s important to recall that these are the same, steady conditions that have produced solid returns for investors over many decades. In its April House Price Index, Rightmove notes that:
“Available stock has now ‘normalised,’ providing an increased choice of properties for buyers… The great news is that both buyers and sellers appear to have adapted and accepted the current economic and property market conditions. There are now more attractive fixed rate mortgages available, providing buyers with more confidence, and there has been a noticeable increase in sales activity.
“The number of new instructions and sales agreed is the highest it has been for several months, and while this is not the very high levels they were during the pandemic years, they are high compared to before the pandemic. This upturn also suggests the economy is far stronger than expected and this is reflected in the buyer’s confidence in the market.”
Sales stock may be on the increase but, in its Q1 Rental Trends Tracker, Rightmove notes that supplies of rental homes remain “very constrained” and although they show signs of slow improvement, “the number of available properties to rent is still 46% below 2019’s level.”
Some of Rightmove’s key findings include:
· “The gap between supply and demand has narrowed slightly compared to last year; however, it is still near record levels, with the number of tenants enquiring greatly outweighing the homes available to rent.”
· “Competition between tenants (is) more than double (+173%) the level it was back in 2019.”
· “Tenant demand is 4% higher than this time last year, and 48% higher than 2019.”
Numerous other sources make similar points. For example, the latest UK Housing Insight Report from Propertymark notes that, on average, its member branches registered 106 new prospective tenants every month but had an average of only 10 properties available to let.
Most indicators suggest that rental stocks are slowly increasing but a huge imbalance remains and it will not be rectified this year or any time soon. As a result of the great surplus of demand over supply, upward pressures on rental values must surely continue.
House Price Indices
Capital growth rates have been weighed down by rising mortgage costs and the cost-of-living crisis, so they are far lower now than they were at the same time in 2022. However, most sources still put the annual rate in positive territory and, perhaps more significantly, some of the more recent ones are reporting a return to monthly growth.
Below is a summary of recent house price indices.
Index / Source
Annual Price Growth
Monthly Price Growth
+0.1% (April)
-0.3%
-0.8% (May)
+0.8%
-2.7% (April)
+0.5%
+5.5% (February)
-1.0%
+1.7% (April)
+0.2%
+3.0% (April)
Zero
Rental Indices
If capital growth has only been modest lately, rental growth certainly hasn’t. Many of the industry’s most reliable sources indicate that rental values have been rising very quickly, at close to (or above) the rate of inflation.
Index / Source
Annual Price Growth
+8.98% (April)
+12.4% (May)
+9.9% (April)
+9.4% (April)
+11.1% (Q1 2023)
Capital and Rental Forecasts
Given the turbulence and complexity of recent months, it’s perhaps understandable that few commentators have been eager to publish new forecasts for either capital or rental values.
However, the economy is proving more resilient than many had expected, some market confidence has returned, interest rates haven’t gone as high as many feared, and it seems all but certain that inflation will start to fall at quite an appreciable rate. Moreover, Britain has narrowly avoided a recession, employment rates are high and wages have been rising relatively strongly. To cap all that, demand for housing is stronger than ever and, in the lettings market at least, stocks are still well below their usual levels. Conventional economic logic dictates that average values should rise.
This all amounts to a strong foundation for growth and for improving returns in 2024 and subsequent years.
Capital values may not end the year in positive figures – most sources still seem to agree that a small annual price contraction is inevitable – but it will be surprising if many of the key industry figures stick with the downbeat predictions that they made towards the end of last year. Indeed, some have already moved. In its April House Price Index, for example, Zoopla noted that it had revised its capital growth forecast in a more encouraging direction, from a drop of -5.0% by year-end to a more restrained -1.0%. Given the changes now being seen in the UK economy, it may not be the last to amend its forecast.
The further ahead one looks, the harder it becomes to predict price movements with any confidence. Nevertheless, given the enduring strength of demand and the likelihood of falling mortgage costs, a recovery in capital values does seem to be on the horizon. It could happen in 2024 or the following year, but few are putting hard numbers to that. Savills is an exception, and it expects to see average UK-wide annual growth of +6.2% by 2027. Over the same period, it expects rental values to rise by +18.3%.
Experienced property investors are used to playing the ‘long game,’ so the present challenges shouldn’t be overstated. While it’s true that 2023 is unlikely to produce spectacular capital growth, values will gradually improve and, in the meantime, strong rental returns should ensure that property still outperforms most other asset classes this year. What’s more, as inflation falls over the coming months and years, so real-terms returns will steadily improve, as should profitability.
In our Property market Forecast at the start of the year, we said that we expected 2023 to mark a turning point and, thus far, the year seems to be living up to that.
In summary:
· We have seen the end of a prolonged period of rapid but unsustainable growth.
· The UK economy has avoided recession and can look now forward to modest growth.
· Inflation seems to be peaking, and most credible sources expect it to fall quickly hereafter.
· Interest rates may also be approaching their peak and should begin to drop back again over coming months.
· The property market did not see any sudden collapse; instead, it showed its underlying strength and continued to deliver impressive rental returns.
· The market appears to be returning to more predictable and sustainable annual norms.
Any return to normality must be regarded as a good thing. Quick wins are ‘nice to have’ but the real value of buy-to-let property is its capacity to deliver solid, dependable returns over the long term; its ability to reward investors over a period of many years while riding out any shorter-term peaks and troughs in the British or global economies.
We are still witnessing the effects of some powerful global shocks but those effects are already diminishing and, in time, the fundamental forces of supply and demand should reassert their influence. When that happens, returns from property investment should return to their usual upward trends.
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