Market Commentary – 2023 Review

2023 started with the last dregs of the Truss turmoil still working their way through the housing market. Activity levels were well below normal levels and house prices were falling, reflecting the rapid rise in mortgage rates the previous autumn. It was clear that a market downtown was in progress, but there was still uncertainty about the likely scale of its impact. Were we about to see the double-digit price falls suggested by the rise in rates or would the market stagnate with house prices mostly falling in real (inflation-adjusted) terms thanks to a lack of forced sellers. Despite the uncertainty and ongoing cost of living crisis, there were already some signs of improvement as interest rate expectations had already fallen (Fig 1) and quoted mortgage rates began to ease (Fig 2).

For example, Zoopla (PDF) reported “demand” and sales agreed were both higher in January than the 2017-2019 average while in February Rightmove (PDF) reported “the number of people contacting agents is up by 11% in the last two weeks compared with the same period in 2019”. With rates falling and demand holding up, house prices bottomed out in March and began rising again – the Nationwide index shows prices had fallen 6.1% from their peak in August 2022 to trough in March 2023. With house prices now rising on a monthly basis, some commentators suggested the worst was behind us (PDF). However, there are some unanswered questions about just how strong this buyer demand was given the bounce in sales agreed has not fed through to transactions.

As Fig 3 shows, the number of initial DIPs and DIP accepts have been relatively robust compared to 2019, especially in March and April. This is likely the point in the house buying process when offers have been made and sales agreed. Unfortunately, tracking the IMLA activity levels through the mortgage process shows an increasing fall-through in activity. It appears prospective buyers have been passing the first hurdle with a DIP and making offers, but then struggling to pass the more difficult parts of the borrowing process and actually buy the home they offered on. The continued rise of the SVR and stress test rate over the course of 2023 will be a factor despite the removal of the +3% stress test in August 2022 (see Fig 2). The failure to complete was highlighted in October when Zoopla launched a “Back to Market” tag for listings and reported “approximately 40% of sales falling through at the moment”.

It appears a significant proportion of the sales agreed during the first half of 2023 may not reach completion but at the time it looked like the housing market was improving. House prices increased slightly during the spring and early summer as low turnover and the constrained supply of homes available for sale ensured a competitive market for those people who could still afford to buy. There was clearly an expectation that high rates were a temporary challenge and, if households and corporates could just hold on till the autumn, then everything would be ok as rates eased.

Evidence of this behaviour can be seen in the rise in proportion of new loans on variable rate mortgages in Q1 and Q2 (Fig 4). Borrowers were clearly hoping that by suffering some short-term pain, they could benefit from lower rates later in the year. However, it wasn’t just house prices that were proving sticky. Inflation was showing no sign of easing (Fig 5) and the cost-of-living crisis was still firmly underway.

The April inflation data published by the ONS in May marked a turning point. The data showed a smaller than expected fall in inflation while core inflation increased. Financial markets reacted and expectations for the Bank of England base rate rose again (Fig 1) and mortgage rates followed (Fig 2).

There are several reasons why it is turnover and not house prices that absorbed the increase in mortgage rates last year. The large number of outright owners and  high proportion of borrowers on fixed rates has help insulate many from the immediate impact. Meanwhile, the support for those struggling with higher rates is significant (FCA/Mortgage Charter) and, in theory, most borrowers have been stress tested at higher rates (Fig 2). This has helped limit forced sales but does not explain how buyers have continued to be active despite higher rates.

Our analysis of UK Finance data shows that, while there has been an increase in cash only purchases, mortgage dependent buyers have also adjusted to higher rates. As Fig 6 shows, the average price paid by a mortgaged buyer (black line) has fallen since the market peak in August 2022. However, it should have fallen much further given the rise in mortgage rates (blue bars) but has been mostly compensated for by a rise in the average repayments (purple). Basically, house prices haven’t fallen further because new borrowers are paying more each month.

The state of the private rental market has been shocking for many years, with affordability and security of tenure among the serious issues. 2023 saw rent affordability worsen as  high tenant demand continued amidst a lack of homes available to rent. There was also actual evidence of a net sell-off by landlords as the number of outstanding buy-to-let mortgages fell and sales by landlords increased. The Scottish Government reacted by capping rental increases to 3% and the government finally introduced the Renters (Reform) Bill in May.

There are some signs that rental growth is easing and re-linking Local Housing Allowance to the 30^th percentile of local rents will temporarily help some households while the supply of new build flats looks set to increase in some cities in 2024. But there’s still a lack of properties available to rent relative to tenant demand and, with first time buyer numbers around 20% lower than last year, the upwards pressure on rents will probably continue through 2024.

Despite the lower sales volumes, housebuilders have been unwilling to adjust their headline pricing, instead preferring to use incentives where possible and increase marketing. During the Help-to-Buy boom years, housebuilders abandoned listing portals as  they built their own lists of ready and willing new build buyers. But with reduced demand, housebuilders are now increasing their advertising on portals with large numbers of new listings in some local markets. For example, Rightmove recently reported the majority of the growth in their key metric “average revenue per advertiser” was thanks to new homes developers. Assessing the use of incentives is difficult but it’s regularly said that housebuilders will offer anything other than lowering the price. Last year I spotted a local housebuilder offering a BMW i4 and cash rebate though I’m not sure what a lender would make of it.

The corporate side of the residential market was also not immune from the worsening outlook. Many businesses had clearly hoped to wait it out until the market improved but as the recovery in rates got pushed further out, there were growing signs that the they were starting to suffer. The listed housebuilders had already seen a collapse in sales rates, and many were looking for efficiencies and consolidation in their businesses while cutting back on future development activity. The build-to-rent market also saw a slowdown in investment activity despite the positive spin put on it by agents (a larger share of lower activity) and a shift to single-family rental (houses on new build estates). With a collapse in overall transactions, those businesses dependent on turnover will also have struggled. There will be lots of people and businesses hoping the recent fall in rates increases activity.

As Fig 10 shows, while the nominal price correction has been minimal, the correction when adjusted for average earnings has been larger, taking the price to earnings ratio back to pre-pandemic levels. However, the fall has not been as sharp as suggested by long-term trends in what might be considered “affordable” as borrowers have squeezed lending criteria and paid more each month to cope with higher rates. This outcome raises an interesting question of what might happen if rates rapidly improve but the recent relaxation in lending criteria does not tighten in response. Our simple modelling suggests house prices could end up around 20% higher than the 2022 peak if average mortgage rates fall to 3% and the stress test rate falls by a similar amount.

Perhaps the biggest difference in the housing market compared to this time last year is the increase in available supply for sale. Although new listings have been in line with normal levels, the number of homes available for sale has been rising due to lower transaction volumes. This is especially the case for larger properties at the upper end of their respective local markets and could be a drag on prices if buyer demand does not bounce back as mortgage rates fall but could also trigger more activity if the market recovers.

In summary, the prospects for the housing market this year are more positive than last year, but we still have serious concerns about the short-term economic risks created by this period of higher rates and inflation. While it is possible for a rapid rebound in house prices if mortgage lending criteria remain relaxed, the long-term potential for price rises and higher activity will be constrained if rates stay closer to historic levels than their pre-pandemic lows.

Economy – UK

The ONS estimated monthly GDP increased 0.3% in the year to October 2023. Thanks to recent revisions, monthly GDP was 1.6% above the pre-pandemic peak recorded in January 2020. However, this monthly data will continue to be revised in the future.

House Prices - UK

Rightmove reported a 1.1% annual fall in asking house prices in December 2023 while Nationwide reported a 1.8% annual fall in their mortgage approval based index over the same period. Meanwhile, the ONS reported a 1.2% annual fall in its sales agreed index for the year to October 2023.

Transactions – UK

HMRC provisionally reported 80,780 residential transactions in November. This was 17% lower than the same month in 2019. Meanwhile, the Bank of England reported mortgage approvals for house purchase were 24% lower in November 2023 than the same month in 2019.