This week economists warned that growing borrowing costs would trigger a steep fall in house prices. The Bank of England is expected to raise interest rates again, possibly within days despite the last hike being announced just earlier in September because the committee’s next scheduled meeting isn’t until November. Many feel the central bank will decide it can’t wait that long with the pound slumping this week after the government announced a mini budget of tax cuts and spending.
A lack of clarity on the Bank of England’s base rate over coming months, and the fear it may have to rise to levels not seen since before the financial crisis of 2008/09, has seen Britain’s leading mortgage lenders pull products this week. They neither feel confident in how to price mortgages nor, it can be presumed, just how badly the market might react to a leap in interest rates and mortgage repayment costs.
HSBC and Santander suspended new mortgage deals this week and Nationwide became the first big lender to increase fixed-rate deals with its two-year rate rising to 5.59%. As recently as three months ago it offered a comparable mortgage at 2.54%.
The increase is equivalent to a family with a £500,000 mortgage spending an extra £881 a month on repayments.
A lack of mortgage availability and affordability will also itself stick a spanner in the housing and commercial property markets, reducing demand. Or at least the ability of demand to be expressed in the market in the form of buyer activity.
The combination of a cost-of-living crisis and recession, much higher interest rates than we’ve seen for years and a lack of mortgage availability will inevitably hit UK property prices. The question for buy-to-let landlords and homeowners has become “how far could property prices fall”?
We’ll look at that question and how property investors might be impacted.
How far could residential property prices fall?
Analysts at Credit Suisse warned that the combination of higher interest rates, inflation and the risk of recession could lead to house prices falling by between 10 and 15 per cent. Quoted by The Times newspaper, Credit Suisse director Andrew Garthwaite commented the combined forces of recession, higher interest rates and high levels of inflation would pull the housing market down, concluding:
“On current swap rates, the [average] mortgage will be 6.3%. House prices could easily fall 10% to 15%.”
Andrew Wishart, a senior property analyst at Capital Economics, is also quoted as saying that if the Bank of England raised rates to 6.1%, quoted mortgage rates might rise from 3.6% last month to about 6.6%. That’s a level not seen since 2008 when household mortgage debts were lower and one that could put household budgets under significant pressure.
How well they are able to cope with the heavier burden of increased payments will influence how far residential property prices might drop. Enough mortgages moving into default would spook the market and could be expected to lead prices lower again in a vicious spiral that could push more and more homeowners who bought near the peak into negative equity.
The case for the defence rests on a combination of a lack of supply and the hope a large majority of homeowners find a way to absorb increased will underpin prices.
But some experts are becoming increasingly sceptical supply constraints will provide a strong enough floor. Quoted by The Guardian newspaper, Graham Cox, a director of the mortgage brokerage firm Self Employed Mortgage Hub believes house prices could fall by even more than 15%:
“Unless we are very lucky and inflation falls much more quickly than predicted, I don’t see any other outcome than a sizeable fall in house prices – possibly 20%-plus over the next two to three years. I’ll be accused of being a doom-monger, but if you use simple maths and common sense, how can house prices not fall? A lack of housing supply won’t help one iota when mortgage rates are somewhere between 5% and 7%.”
“the decade-long property bubble is about to burst … It’s a buyer’s market now.”
The Bank of England’s upcoming annual Stress Test of banks announced this week will assess for financial solidity in a scenario where house prices fall by a third, interest rates rise to 6%, inflation hits 17%, and the economy falls into deep recession with GDP slumping by 5%. That is a perceived worst-case scenario, not the expected outcome. However, it is worth keeping in mind that a succession of worst case scenarios forecast by the Bank on interest rates over the past year have been proven overly optimistic.
On the plus side, unlike in 2008, mortgage lenders are not suffering from a liquidity or funding crisis and are in good financial shape. The carnage in the mortgage market is more about lenders not being able to confidently price products due to the level of market volatility. When that calms down, products can be expected to be repriced and rereleased onto the market.
The big question is how current homeowners on variable rates, of whom there are around 2 million, cope with mortgage payment jumps and if would-be buyers can afford mortgages. According to Pantheon Macroeconomics, the proportion of the average new buyer’s disposable income absorbed by monthly mortgage payments could reach 32% early next year, from 22% at the start of 2022.
“Few potential buyers will commit to such a burdensome stream of future payments; many others will fail lenders’ affordability tests,”
Nationwide have said that even at the start of this summer mortgage payments typically swallowed up more than 50% of take-home pay of first-time buyers in London.
What can property investors do? Sell up or weather the storm?
Homeowners, buy-to-let investors and investors in listed homebuilders across the UK will currently be considering how best to act. The reality is there probably isn’t an option available that will avoid any negative impact from exposure to an embattled UK residential property market.
Let’s start with investors exposed to homebuilders. The good news is the liquidity of the stock market means investors have an easily accessible exit door should they choose to cut their losses. The bad news is those losses are already significant with the UK housing index down over 50% to an 11-year low from its peak at the beginning of the year.
Barrat’s Development and Persimmon, the UK’s two largest homebuilders, are down 57% and almost 59% since the beginning of the year respectively. Investors who haven’t already sold and don’t need to for at least another couple of years may well at this point be better to hold tight and wait for the market to bounce back.
The alternative is locking in big losses and the major homebuilders do look relatively financially secure despite the prospect of debt burdens becoming much more expensive to service. Given time they should recover from this year’s losses but investors will have to brace themselves for potentially more pain in the months ahead before things start to get better.
For those wondering if now is a good time to buy into housebuilders, while there is considerable long term upside from current prices it is probably still too soon to make a move.
Homeowners who are concerned they may not be able to meet increased mortgage payments should speak to their lender before the point instalment cannot be met. Lenders don’t want to have to force the sale of a home or, in the worst case scenario, repossess it, and should try to help you find a solution that will avoid that outcome. You may be able to increase the term of your mortgage, reducing monthly payments among other options.
Buy-to-let investors will have to re-assess their business case. How will increased mortgage payments affect the profitability of the investment? Will it still offer a reasonable return? If it will, even if it takes a hit for a period, and you feel confident in the security of your rental income flow, the immediate future will is unlikely to be a good time to sell. In the near term, it might be difficult to find a buyer at all with mortgage availability questionable.
If you are concerned you might get into difficulties meeting mortgage obligations on a buy-to-let property, speak to your lender sooner rather than later to assess options. The silver lining is that overall inflation and lack of stock in most rental markets should mean rent levels are unlikely to drop sharply.