UK House Prices: Is this the turning point? Probably, but not in the way that most commentators suggest!

Implications: First time buyer activity is the traditional prop for the market:  despite continued high levels of household formation (225k per annum, compared with build rates of 160-180k per annum), increasing numbers of newly forming households are choosing to rent rather than buy. In parallel, buy to let activity, the boom industry over the last five years, has evaporated as a result of the credit crunch. Where are the buyers to allow people to trade up from entry level properties?

Analysis: UK home-builders have just had a very quiet Easter weekend, with disappointing visitor levels and reservations, particularly by first time buyers.

First time buyers represented 49% of mortgage advances in 1996, 36% in 2006 and 19% in 2007: without new buyers coming in to the market, the whole housing market could stagnate. On the other hand, there remains a shortfall of housing supply in the UK (unlike the USA), which suggests that this will lead to improved yields for landlords, rather than a major crash in house prices.

House prices have tripled in the UK over the last ten years (compared with a doubling in the USA), as a result of which there is an affordability crisis amongst first time buyers. Across the country as a whole, the multiple of lower quartile earnings (gross household income) represented by lower quartile house prices is now x7.1. In some areas, that multiple is x10. The conventional wisdom is that housing is “affordable” at a multiple of x3.5.

As mortgage lenders have become more risk-averse, virtually all of them have now withdrawn 100% mortgage offers, with the maximum loan to value ratios now being in the order of 85-90%. Linked to that, valuers are now remembering that they are valuing the security rather than the purchase price of the property, i.e. net realizable value in the event of repossession: typically, they are setting security valuations at £10-15k below current selling prices i.e. a further 5-10% below asking price.

Press coverage is increasing nervousness, with much coverage of an impending house price crash.

Demand is the need or want backed by the ability to buy.

Plenty of people need a house, as the result of continuing high levels of household formation. However, the negative press coverage means that increasing numbers do not necessarily want to buy at present.

Almost certainly, many cannot exercise their ability to buy as a result of affordability levels, declining loan to value relationships and conservative security valuations.

Therefore, demand from first time buyers is likely to be very subdued for the foreseeable future. Without that first time buyer “trickle down”, trade-up from entry level properties will be very limited. Therefore, low demand is likely to spread throughout the housing market.

However, apart from city centre apartments where speculation has inflated both prices and production to ridiculous levels, there is still an overall shortage of supply. Therefore, unlike the USA, the main result is likely to be one of very low volumes of trade up transactions, rather than a 20-30% crash in prices.

This is likely to be good news for private landlords, who have seen yields decline progressively over the last 10 years as house price increases have outstripped rent levels. That scenario is likely to go sharply in reverse over the next couple of years with static or slightly falling prices and increasing rents: yields could start becoming quite attractive again.