Watch our webinar where our CEO Gavriel Merkado will talk through the below points
Read time: 11 minutes
Time and again I find myself being asked: What about the future? What can you tell me about what will happen tomorrow? Next week? Next month? Next year? In this article we’ll play the dangerous game of plotting the future course for the UK market – breaking down the key factors that will have a significant impact on housing prices in 2019.
Before we get started however, it’s worth exploring exactly why trying to see into the future is so problematic, and why using a rational approach can lead to better (and far more likely) predictions grounded in data. Foresight of coming events used to be so valuable that in ancient Greece the Oracle of Delphi could lay claim to being the most powerful woman in the world.
When a vast Persian army invaded Greece and the Oracle was consulted for guidance, she told the Athenians to “trust in a wooden wall.” Personally, I would have gone out and built a big fence, but instead this was interpreted as an instruction to construct a fleet of wooden ships. As a result, history took a different course, and the Persians were halted.
This highlights the problem with attempting any forecast; the sheer complexity of the present moment. The endless number of different variables that can have a bearing on every possible outcome, even in systems that are governed by determinism and clearly quantifiable principles, make them near impossible to predict. The mystery element is what fascinates (and frustrates) us when considering the future.
Let’s start with a simple example. You could forecast that if you were holding a ball, and then decided to let go of it, the outcome would be the ball falling to the ground (thanks gravity!) and anyone could pinpoint with great precision where the ball will land.
Now, try throwing the ball at a specific point on a wall. The distance, time and angles of movement all start to confound the accuracy of where it will actually hit. Harder to say for sure if it’ll land perfectly every time. Finally, try throwing that ball, into the wind, with a thousand other people all throwing balls at the same time. Some argue that the majority of forecasts are unreliable because the past cannot be used to predict the future in a meaningful way, because the elements are a Markov process. However I don’t consider that to be the case when human psychology is an active part of the process.
The value of any forecast is a function of the deviation from the actual, the time span and the perceived value it has for the recipient of the forecast (usually monetary). So if we return to our earlier example, telling you with absolute certainty that the ball I dropped is going to land on the floor in one third of a second, has almost no value at all.
Telling you that the ball I dropped now, in the year 2317, is going to roll under the left wheel of the future robot king and cause it to catastrophically malfunction, is actually also pretty much worthless, for a different reason. Because of the finite nature of the human lifespan, we often devalue long term forecasts, much to the chagrin of many environmentalists.
But, we digress. I have been asked to forecast the relatively near-term future, of house prices, here in the UK and for 2019. So, firstly, some definitions and ground rules:
House prices – The median price change of residential property, in aggregate, not weighted by value. So if a £1m house goes down 10% and £100k house goes up 10%, the median change is 0%, not -9%.
The UK – All of what is currently considered the UK at the time of writing, regardless of what happens with any EU issues around Northern Ireland and Scotland.
2019 – January 1st, to December 31st.
What do we know about the largest inputs which will be affecting our forecast?
From a Macro perspective: Interest rates and credit availability, global economic growth (or decline), auto-correlation of activity, inflation, UK economic growth, supply & demand.
From a Micro perspective: Individual expectations of housing markets, pricing, and macro factors, as well as changes in fashion, personal wealth etc…
For the past ten years there’s been talk of the Bank of England raising base rates, and then finally it happened towards the end of 2017. The forward curve has been upward sloping for almost as long as I’ve been looking at it, so just because there is an ‘expectation’ of rising rates, doesn’t mean anything, as the expectation has been there for the past decade and hasn’t happened. What it will come down to, like so many other things in the near future, is what happens once the UK leaves the EU.
If there is a poor economic situation following Brexit, it may result in immediately lower rates in the UK, even negative rates (as have existed now in Europe for several years) as the Bank of England aims to improve the economic environment. Conversely, if there is a run on the currency, then the BoE may choose to raise interest rates to stop the depreciation, as was done in 1992 during the ERM crisis.
In a muddled-deal situation, with some kind of halfway house of the UK/EU not being entirely resolved, it is likely that rates would stay around the same level or slightly increase, dependent on the global economic environment.
In a good economic situation, following the UK leaving the EU, whereby either the UK gets a good deal from the EU or quickly creates favourable new deals with other significant trading partners, rates may actually increase.
Similarly, credit availability will likely be impacted by the outcome of Brexit votes, with a poor economic situation leading to looser credit availability and perhaps even returning to QE.
Overview – Rates remain the same.
What is interesting beyond the political mire of the ongoing spat between the UK and EU is actually the changing financial and economic characteristics of the rest of the world around them. While the majority of the EU has been lagging far behind, the UK has over the past few years been returning to some sense of economic well-being. Meanwhile, the US has been steaming ahead. Markets are up, interest rates are up, growth is up, incomes are up. The US is now in the second longest ‘bull run’ in history.
However for a variety of reasons, US yield curves briefly inverted last week, a tell-tale sign that moods are shifting and the party may well be over in a year or two. As the world’s largest economy, when the US sneezes, the world catches a cold. While it is slightly outside the scope of this one year forecast it is worth keeping any eye on what happens across the Atlantic in 2019.
In the world’s second largest economy, China, we know growth is slowing, power has become even more centralised in Xi Jinping (creating decision risk) and the enormous debt taken on by the corporate sector (total debt in China is now equivalent to 300% of GDP) increases their economic risk weighting. The UK’s recent relative currency weakness does potentially create a nice buying opportunity for overseas buyers, if they believe there is more economic upside in the UK.
Why is this relevant to us? Keep in mind that a large proportion (if not the majority) of buyers of newbuild properties in major cities UK are overseas buyers, and that demand from those foreign buyers has been largely supporting the current price levels of new property developments. If those buyers go, because of changes their local economies, the support for the high prices in the UK goes along with them.
Overview – Slower growth globally
Have you ever noticed how people talk about ‘property prices going up’ in an area, and there’s some kind of palpable excitement to it, like a panhandler telling you about a fresh seam of gold they’ve just heard about up yonder? Word of mouth spreads, and other people start buying in the same area, hoping to get in on the wave of price increases while they still can, this pushes prices up further, encouraging the next batch of people to buy in before it’s too late.
The same buying behaviour can be seen whether it’s in houses, cryptocurrency or the latest fashion sales. Property prices are auto-correlated, and because of this we can often predict that the future will closely resemble the present. What we’ve seen over the last year is a significant decrease in the volume of transactions. The uncertainty around Brexit, and the already extremely high prices in many parts of the country, as well as secondary impacts from changes in stamp duty and the changing dynamics and spending power of overseas buyers have all led to reduced volumes overall.
These reduced volumes are likely to continue until such time as something significant changes in the political and economic environment, which gives people more clarity on what the immediate future may be like. The housing market in Australia is currently going through this period of auto-correlated decline now, having gone through an extended period of price increases. People there are now waiting for the market to bottom out, but it’s expected to continue to decline by a further 10%, so they keep on waiting. Lower volumes doesn’t necessarily create a directional impact on the market, although some would claim that it does.
As every transaction must have a buyer and a seller, all that a lower volume of willing buyers and sellers does is to push pricing in favour of either the buyers or the sellers overall, depending on which group is more desperate. The likelihood is that someone who needs to sell, needs to sell, they have to do it. For example, the seller has to pay their inheritance, alimony, move to somewhere else etc. Yet there is no such thing as someone who needs to buy, since you can always rent, or find somewhere else.
In a market with fewer deals going on, the impact of the desperation of sellers, can over time, cause them to drop prices well below what they would previously have accepted.
Overview – Expect low volumes to remain, and for that to push down on prices.
Ever hear of stagflation? Its when you get a low or negative growth economy, coupled with high inflation, effectively the inverse of the normal economic relationship. Usually inflation follows real growth, growth goes up, and then so does inflation a little later, and then in theory central banks use interest rates to control growth and thereby limit inflation, or at least the expectation of inflation.
However, you can have a situation where there is low growth but rising inflation, where you’re paying more for the same thing (inflation) but the environment around you isn’t changing. It doesn’t happen very often, but when it does it’s caused by a shock external factor causing prices to rise. Well, how about a country leaving the world’s largest political/economic bloc as a shock? Exchange rates took the brunt of the impact of the referendum vote, resulting in higher import costs for the UK (and interestingly, putting a real quantifiable value on a voting behaviour, but perhaps that’s another story).
If the economy continues to work ‘as normal’ in the coming year then inflation will simply be a factor of economic growth and commodity costs, which are not expected to be particularly high in 2019. However if the exit from the EU creates further currency devaluation, then it could lead to higher inflation as the cost of imports rises. As inflation rises, people beginning to mentally price in that inflation will continue, causing them to change their buying behaviour and pricing, resulting in a spiral of unwanted inflation. Inflation makes it harder to price assets and commodities in real time, as if inflation is higher, the price of the asset may be changing faster than you can keep up, creating all kinds of inefficiencies, and often lowering the number of transactions. The Bank of England is also forecasting higher than ‘normal’ inflation for 2019 at 3.2%.
Overview – Possible negative risk, keep an eye on FX markets
There are a great many pundits and think tanks out there making economic forecasts, usually picked up on by news outlets depending on their own particular political bias. Some come from very important sounding organisations, and most forecasts are usually wrong. As we’ve shown, it is incredibly hard to make an accurate forecast of a complex system where the majority of parts are unknown and the relationships between them can often only be guessed at.
However one organisation I believe has come closest to proving itself accurate more often than not is Oxford Economics. Their forecast for 2019 in 1.5% GDP growth in the UK, which is somewhere between 2017 and 2018 results. So the expectation is that next year will be somewhat like this year and the year before. It could be that a no-deal situation in Brexit results in import and export tariffs, increasing both the cost of purchases of EU stat products in the UK and the cost of EU states purchasing UK products, that may be offset by opening up the UK to greater trade with the rest of the world. Conversely a trade deal with the EU could maintain the status quo.
Overview – No change
The official population of the UK is c.66M, however it may well be higher, and according to government statistics there are 25 million homes (although our own figures show a higher number). So there are 2.6 people per house in the UK. Germany for comparison comes in at 2.2 people per house, the USA at 2.4 and Japan, (often characterised by very tight living conditions in its major cities) at 2.5 people per house. Of course there may be different styles of living in those countries, for example people living with their parents longer, or demographics resulting in smaller family units (which i’m not taking into account) this is simply a guide.
So it would appear that the UK is undersupplied in housing by at least 4% (if we want to catch up with Japan), if not more likely 10%-15% (if we want to catch up to somewhere near the USA or Germany). Which is roughly equivalent to either 1 million more homes, or 3.75m depending on which comparison you prefer.
The UK is currently building ~200,000 new homes per year, although the average over the past few years is closer to ~150,000. So it would take at a minimum, assuming a constant population level, five years for supply to meet demand. In reality, the population of the UK is increasing by about 400,000 people per year, so all of those new houses are actually going straight to new additions to the population.
Realistically for supply to meet demand, the UK, over a five year period based on the persons per house found in other countries, would probably have to produce close to 800,000 new homes per year over five years, or 400,000 over ten years. This is unfortunately very unlikely – in fact almost guaranteed – not to happen.
So supply is constrained, however so are incomes, thus the only logical choice for prospective home buyers is to either move further afield from their place of work (maybe buy transportation stocks?), or to rent instead. Additionally, the uncertainty around the housing sales market may encourage some people to either continue renting or start renting rather than risk a poorly timed or unaffordable purchase.
Overview – Strong positive for ‘commuter towns’ and central renting locations, negative for central sellers.
This is a tricky one to understand, however sentiment can often drive markets just as much as, if not more so, than fundamentals. Individual sentiments and expectations, in aggregate create economic action. So what are those individuals expecting? Looking at the PMI (purchasing managers index) and the CCI (consumer confidence index) shows that while both are down somewhat over the year, neither is in a particularly different position to where it has been over the past couple of years. So the expectation in that sense is that next year will be much like the past couple of years.
Overview – No change
Why have property prices gone up in the past half decade? Did everyone suddenly get a lot richer? Did the population increase exponentially? Did half the supply of houses in the country disappear? Nope, two things happened, interest rates fell, and lending increased. However, at the same time, banks changed their lending requirements, generally forcing a requirement for higher deposits. Meaning that housing became very much dependent upon the ability to raise a deposit, and this was often found from the equity held in a property that is already owned.
While on average people have gotten somewhat wealthier, it hasn’t been by much, and arguably a large portion of the population isn’t better off than they were a decade ago. Recent economic figures don’t indicate that this trend will change, with some recent metrics marginally positive and others marginally negative, effectively cancelling each other out.
Meanwhile, the income-to-price ratio of most residential properties has already reached, or is in excess of, the maximum sustainable level. With that in mind I don’t see a huge change resulting from personal wealth and income over the year that lies ahead.
Overview – No change.
To sum up, we have the following results:
With all of the above in mind, I believe that the UK will see a mixture of different results depending on the location and property type. However in aggregate we’ll see modest price and rent increases primarily driven from the supply/demand imbalance, but constrained by limited changes in personal wealth and downward pressure from macroeconomic factors.
Let’s see what happens in 2019, who knows, I might actually be right!
© Treex 2020