Blain’s Morning Porridge 15th June 2023: The UK Housing Market is a metaphor for confidence in the UK economy – and its looking wobbly
“We’re not time-share salesmen, but this an opportunity you can’t afford to miss!”
The UK housing market is at its’ highest income multiple since the 1850s, at a time when real incomes have flatlined for 2 decades, and mortgage borrowers are levered higher than ever – its set for a wobble, sustained only by supply shortages. If it crashes.. all bets on the UK will need re-examined.
Things ain’t all bad in dear old Blighty! Ding Dong and Boris is gone. The economy is growing slightly faster than an arthritic snail after a couple of pints of old Peculiar. Sterling is strong – but only because of the highest rates in G7. And the Bank of England has had the decency to admit it got inflation a bit wrong. But.. we are not out the woods yet.. consequences, consequences…
One of the key drivers of confidence in UK is the housing market. Confidence drives markets. “There’s nowt as safe as houses”, has been a core investment belief for decades.
As long as UK house prices are rising – and historically, most of the time they are – then every home owner is happy, confident they have a steadily rising asset behind them. Climbing on to the “housing ladder” became the single most important “growing-up” ritual a young person could undertake. Becoming a home owner, and the sense of future security it brings, is one of the reasons the English middle classes are so insufferably nice. (And still talk incessantly about how much their homes are worth.)
To not get on the housing ladder means a life-time of paying someone else rent, watching the value of their housing asset go higher, and retiring without a tangible asset to fall back on. Those trapped in the rental markets – when demand vastly outstrips supply – find quality tumbling and rents soaring. 35% of UK households now rent – and they are not happy as rents are rise at double the rate of inflation. The rental cohort – and young people who will become renters – now includes the majority of younger millennials and GenZ – which has massive political implications.
Perhaps the smartest move ever in UK politics was Margaret Thatcher making home ownership a political imperative from 1979 – creating a new middle class of former council house renters who became staunchly conservative as a result. 70 years ago less than 30% of the UK housing stock was privately owned. It peaked in 2001 around 70%.
According to National Statistics, in the boom times of the 1980s and 90s, average homes generally cost 4 times average earnings (peaking briefly at 6). Since 2000 that’s risen to over 10 times earnings, higher than any point since the 1850s when private homes were the preserve of the rich and wealthy.
Conventional wisdom says UK housing markets only go up. The data backs it up. I recall working on a large residential property securitisation where we showed London prices might decline up to 15% during times of extreme financial stress, but always recovered back to 100% plus within 2 years. Even when interest rates hit 18% in the 80s, the market quickly bounced back. (Market pockets can remain in negative equity for longer – for instance cladded flats.)
The reason home prices are so reliably strong is their acute shortage. There has never been a time when Britain has built enough homes. The demand/supply imbalance pushes up prices, and pushes up rents. As homes are scarce long-term assets, no one worries much when minor economic inconveniences; like raging inflation, crashing real incomes, sterling up and downs, or galloping hikes in interest rates hit the market. Don’t panic.. the sun will come out tomorrow.
What if it doesn’t…..?
There is lots of noise in the media about a looming housing crash. Prices have registered their first annual fall since 2012 according to the Chartered Surveyors. Higher mortgage rates, affordability tests, and buyers struggling with falling discretionary incomes mean demand is slackening.
If UK housing was to fundamentally correct and crash back the average of 4-5 times real earnings – which implies collapse of around 50% from current levels – as it was over the decades prior to 2000 – then there are four critical and closely linked reasons we need to worry about UK housing markets:
- Mortgage Rates and leverage
- Real Incomes and affordability
- Groupthink Fiscal and Monetary policy
The only factor holding prices high is the massive demand/supply imbalance – the housing shortage. If it was ever to be addressed – which the 65% of homeowners who are home owners will hate – then prices are bound to fall. The 35% of younger voters already in rentals, and young people still at home destined to join them with little prospect of getting on the housing ladder – will be aligned to demand govt policy changes to fix the housing shortage.
Today, the average small London (if you accept London is now defined as somewhere half-way to Birmingham) home costs £680,000. The average London salary is £36k according to the Office for National Statistics, but I’ve seen £57k quoted by estate agents trying to push up markets. Let’s call it £45k. A young couple could possibly buy a small house on 7.5 times their combined wage. I looked up some numbers: in 1985 the average salary was £7.5k but that same small house cost £35k. Therefore, the same young couple could by a house on 2.3 times their combined earnings. Nice…
Today, that same young couple will be 5 times more highly levered by the cost of their home than they were in 1985 – meaning they are much more sensitive to any change in interest rates. When mortgage rates effectively triple from 2% to 6% – they are financially ruined.
The leverage hit is one thing. Real incomes are another. Recent data shows UK real incomes have fallen since 2005 – folk have less disposable income today than they did 20 years ago. That means at a time when housing costs more, incomes have fallen – fundamentally unsustainable.
And then there is greed – apparently the most popular word in the market today is greedflation: greedy producers, retailers and the sellers of anything pushing up prices to make windfall gains from inflation. It’s happening in housing. I’m seeing shared accommodation is being pushed heavily by housing sales firms: buyers can buy 25% of a property “to get on the housing ladder”, but it’s really a way for property developers to sell more small rabbit-hutch flats.. If property prices collapse, these buyers will be the first to be crushed.
And then there are landlords. Most landlored are fair and just, but I’ve already told the tale of my daughter getting a 32% rent hike this year, then served a section 21 notice to quit – as was the whole block of a purpose built “affordable housing/key workers” block on the Olympics site. The landlord is renting it to price insensitive returning Chinese students.
To avoid a fundamental collapse in UK housing based on the unaffordability of homes, falling real incomes, and leverage (high mortgage repayments) we need to engineer a soft landing. The obvious way would be to encourage more house building, raise real wages so they become affordable – but that would mean an element of inflation, which would actually smooth the process.The alternative is rising unaffordability, the perception only the rich can afford homes, angry renters and an element of political populism leading to chaotic polices like nationalisation of rental property, rent controls and such. That way lies madness.
Perhaps the greatest thing that could help avoid a property-linked economic crash landing is a fundamental reappraisal of policy – and understanding that high levels of “sustainable” debt is ok to fund the nation if accompanied by sound spending policies. That is not meant to sound a bit Liz Truss: cut taxes, increase borrowings, nonsense. It could be done with a bit of thinking and imagination – a massive programme of social housing building where jobs are, lower home prices for those on the ladder and looking to step on, sorting out planning, and letting wages edge higher to sustain current private housing prices – avoiding the catastrophic consequences a collapse would have on national confidence.
Interesting to see what happens – the solution involves an element of inflation, but if housing does collapse the consequences on the economic confidence of the UK will be immense.
No time for Five Things This Morning
Out of time and back the day job
Bill Blain – Strategist and Author of the Morning Porridge