What's going on in the housing market?

You may have noticed that over the past year or so, during a widespread pandemic, certain asset classes have performed strangely well. While each of these unsuspected booms are worthy of their own discussions, here I’m focusing on the one most important to us in the UK. The average price of a house in the UK increased 13.2% (ONS) in the year ending June 2021, a growth rate unseen since 2004. The price hike is so extreme that many commentators are already referring to it as a housing crisis. In this article I’m going to try and demystify the logic behind this bull market and lay out the factors leading to this surreal price action.

Urban flight has been synonymous with disease breakouts for as long as we have known. In the plague of 1655 those who could afford it, including the doctors, fled the city to the much safer countryside. A similar effect has been observed over the Covid pandemic. One of the ways we can see this mass migration is through house prices. Using Halifax’s mortgage-based house price index, thisismoney.co.uk ascertained that Plymouth’s inner-city house prices increased by 5.8% between March 2020 and June 2021, meanwhile in the surrounding areas the increase was 16.1%. To put this in perspective, it is likely that many people living in the areas outside of Plymouth’s city centre earned more in capital gains on their house than from their actual salary over this period.

There is, however, a question about whether all of this could cause a housing boom: if people are leaving their homes in the city and flocking to the suburbs, won’t the homes they leave increase the housing supply and balance out the market again? The short answer is no, not necessarily, for several key reasons...

First-time buyers are likely the ones driving this market. This seems unnatural given the fact that the number of first-time buyers decreased in 2020 compared to 2019, from 351,000 to 300,000. This depleted number of first-time buyers was able to push the market because the total number of house sales also decreased from 2019 to 2020, in England and Wales there was a 22.1% fall in houses sold (compared with only a 14.5% decrease in first-time buyers)(Yorkshire Building Society). The reason first-time buyers are so important to house price increases is that when they buy a house, they don’t have a previous house to sell. This means that, in an economy with population growth, either houses are built to accommodate the increased demand (which they haven’t been in the UK) or prices increase as first-time buyers try harder and harder to get homes.

But what made these first-time buyers so eager to move in the middle of a pandemic?

The help-to-buy scheme was launched in 2013 as a measure taken by the conservative government to get young people on the property ladder. It allows a first-time buyer to borrow 20% of the property’s value (40% in London) from the government with no interest payments for the first five years and fairly lenient ones after that, it also permits 5% deposits on mortgages. Between October and December of 2020, 21,000 houses were bought using loans from the help-to-buy scheme, up 50% from the same period in 2019. The total value of these loans has increased around three-fold since 2014, signalling what I refer to as “the help-to-buy cycle”: as the government funds house purchases the house prices will inevitably increase, if the government wants to keep funding purchases it has to increase the funds available thus increasing house prices further and so on and so forth. The government also offers “lifetime ISAs”, allowing people to put up to £4,000 per year into an account where the government pays an extra 25% on whatever was paid in. You are only allowed to take your money out of a lifetime ISA account when you’re 60 years old or when you buy your first house. The ISA is a huge incentive to buy a house instead of renting (for comparison, with the same £4,000/year cash flows the FTSE100 would, on average, have taken about six years to overtake this almost riskless government loan). These ISAs were introduced in 2017, so around about now is when you would expect to see people start cashing them out for a house. Other than schemes to fund purchases, the government also announced a Stamp Duty Land Tax holiday, ultimately lasting from July of 2020 to June 2021. This meant houses worth up to £300,000 were exempt from the tax versus the regular level of £125,000, (more on that later).

As you can see, the government was on your side if you wanted to buy your first house over the pandemic. However, these incentives may not have been enough on their own to produce the manic buying we’ve seen since the summer of 2020. An important question remains: how could people afford to move during a widespread economic downturn?

Over lockdown, people have been saving historically sizable portions of their incomes. In times of economic uncertainty, it is understandable for people to want to save more, but the recent savings rates are some of, if not, the largest on record. The average savings rate for the 20 years ending 2019 was 7.85%. In 2020 it was 16.3%, in quarter 2 of 2020 (the beginning of the pandemic in the UK) it was 25.9%, so far in 2021 it has been around 20% (ONS). This means people have had cash to buy houses, and since homes and retirements are the two things people save for more than anything else, it is natural that some of this saving will have helped cause the runaway housing market.

Have there been any supply-side forces at play here?

A further leading cause of the boom was the violent fluctuations in the commodities markets. The Office for National Statistics released data showing a 20% average increase in costs of construction materials from July 2020 to July 2021 with the biggest increases coming from imported plywood (81.7%) and fabricated structural steel (64.7%). This has massively increased the cost of renovation and new-build projects. It is possible that increased demand for housing caused these increases in material prices, but the fact that it was imported goods showing the largest increases while domestically produced materials like aggregates showed little or negative growth tells us that this was caused by a supply-side, (specifically import) situation. The construction issues don’t stop there, the UK’s case-by-case approach to planning permission has been called slow, inefficient, and incapable of meeting demand for some time now, this no doubt exacerbated any supply-side factors contributing to the housing boom.

Will this last? There are arguments that this price movement will not last, here are some of those arguments...

The government, with its lenient lending through low interest rates and help-to-buy loans, is over-leveraging first-time buyers to buy houses they can’t afford at a time when house prices are historically overpriced. It is obvious that homebuyers are being pushed to their limits of affordability when you look at the house price-to-income ratio. (The house price-to-income ratio compares the average house price of an economy with its average income, it is also known as the affordability ratio, the UK’s affordability ratio was 8.67 in August 2007 preceding the 2008 financial meltdown. This is the highest the ratio ever was. It reached 8.66 in March 2021 and it has reached the 8.5 level three times since 2017.) The key point here is over-leveraging, this means people are taking on financial liabilities that they cannot afford to pay back, it also means that other people (the government in this case) are lending too willingly to risky debtors.

The transportation and import issues experienced over the pandemic period will most likely be solved soon, house price increases resulting from these issues could reverse when these issues are resolved. Planning permission reform is a hot topic in parliament, and it has already started. This government looks keen to get houses built fast. These moves should begin to cool down the market, but the real changes are taking a typically long time.

Forecasting the future is not within the scope of this article and anyone claiming to be able to should be listened to with caution, but the case for the current market being weak is compelling. The comparisons with 2008 are to be expected in every economic event and should be taken with a grain of salt but here they are notable, for instance the similar level of house price-to-income ratio as 2007/8 is alarming (I am using the mean average figures from longtermtrends.net, some other calculations are more alarming, some less). It should, however, also be noted that (as we have seen in the savings rate) households are more solvent now than they were in 2008. There is also a key difference between the type of debt being created now and the type of debt that households owed back in 2007/8. Due to the help-to-buy loans, much of the debt that has occurred from the Covid housing boom is owned by the government. They are very lenient loans and it isn’t in the government’s interest to take your house as collateral. Contrast this with the predatory lending of the 2008 crisis.

(Whilst drafting this article, data was released showing that the end of the stamp tax holiday caused a sharp £10,000 drop in the average house price in July 2021. Some see this as an expected dip, a slight overreaction, and something the market will move on from. Others see it as a sign of underlying weakness and skittishness, a foreshadowing of a future crash. Time will tell.)

This is one of the most important stories to follow at the moment if you’re interested in the UK’s economic situation. Hopefully, I’ve given you some clarity in this article so you can follow the story better for yourself. We will try and keep you updated as the story develops.

If you would like to know more, here are a few useful resources:

• Move IQ’s “People in Property” is a series of interviews of housing industry professionals.

• Halifax House Price Index is a useful tool for looing at trends and geographic differences in the housing market.

• Rightmove’s house sales database is a list of sold properties in the UK going back many years.