Coronavirus could fast forward structural changes to house prices by 10 years. Housebuilders need to react fast
It is now plainly evident that the housing market cannot function at all during the coronavirus lockdown. At the very least, viewings, listings, surveys, mortgage appraisals and removals just can’t happen for as long as it lasts. It is therefore easy to say that property market transactions will be lower, probably much lower, this year than last.
More difficult to predict though is what will happen to the housing market in the medium to long term, after the current restrictions on human interactions end. My view is that the coronavirus crisis will have long-lasting effects of many different types. Many of these impacts will act as catalysts to speed up housing market reactions that were already in train long before 2020 but which would otherwise have played out more slowly over the course of this decade.
To deal with short-term inevitabilities first, if the current lockdown only lasts until May, that’s a quarter of the housing market year lost and, importantly, a significant chunk of the critical Spring selling season. It only takes one buyer or seller to pull out for whole chains to collapse, so this will definitely affect transaction numbers. Even if the economy and market were to rebound in the late summer, which seems to me highly unlikely, housing market turnover will be at least 30% down on last year, and probably much closer to 50% lower. I estimate that annual transaction figures are likely to be around 650,000 at most, in 2020. This compares to around 105,000 in the whole of 2019.
The medium-term and long-term effects of the current crisis are much harder to predict as they depend on a variety of variables such as the duration and frequency of any subsequent lockdowns. The big question is what happens to the economy after this scale of disruption, job losses and public spending. Economic forecasters seem to be moving away from the ‘short, sharp shock’ prognosis of one or two quarters of negative GDP growth – barely a recession – towards a more prolonged downturn. A “U shaped” recession rather than a “V shaped” recession is increasingly talked about, even an “L shaped” one. Some even talk of depression.
The fact is, we just don’t know what will happen to the early 21st century global economy. A global pandemic like this one, and the response to it by national governments, has never been seen before.
What we do know is that global property markets were already changing. In a world of stable and low interest rates, there never was going to be inevitable, ongoing significant capital growth. That was a feature of the last 60 years, not the next 60. The realisation was already dawning in many cities that real estate values are on a high plateau: expensive but not growing. The most far-sighted real estate owners and investors were already starting to put a higher value on future net income streams rather than expectations of continued capital growth.
Price falls seem inevitable. Using previous recessions, transaction levels and repossession rates in previous downturns, my guess is anything between -10% and -30%
UK house prices were therefore going to see a significant slowdown anyway. Why? Simply because low and stable interest rates mean property yields have bottomed out – or are about to bottom out in most markets. This sounds like a technical issue but it means that the asset price inflation which characterised the late 20th century and which was part of ‘the great acceleration’ is over.
So the prognosis was already for low, slow growth. Overlay a recession on this and price falls seem inevitable. Using previous recessions, transaction levels and repossession rates in previous downturns, my guess is anything between -10% and -30%, depending on the length and severity of any recession. The extent to which fear, uncertainty, layoffs, closures and furloughing have already impacted on sentiment and household incomes is enough to virtually guarantee falls of 10% in my view.
What of the longer term? How will we value our homes in future? I think we will pay much more attention to three things.
The first is rental value, that is, the amount of monthly household income people are willing to forego to pay for the shelter they want and need. This can take the form of either rental paid, mortgage paid and/or return on capital foregone. The ‘speculative’ and ‘investment’ value of owner occupied housing which relies on expectations of future capital growth will recede but the rental market will become more sophisticated.
Rent levels are much more immediately responsive to supply and demand than capital values are as unwilling vendors can put a drag on the for sale market. This is particularly relevant during the crisis as landlords can’t let short term and for hospitality use so rental supply is rising. At the same time, household incomes are falling, ‘rent holidays’ and voids are rising so downward pressure on rents is mounting. Landlords of higher-quality homes (particularly those with roof-terraces, gardens and balconies from which you can sing with the neighbours) will be in higher demand and they will find their voids are lower and rents hold up better.
The second thing governing future house price values is the “cap rate”. That is the interest rate at which people, either explicitly or implicitly, capitalise rents or imputed rents on their home. The opportunity cost of capital (the return that an investor might be able to obtain elsewhere) will play an increasing role in how ordinary people value the use of their capital in property. Mortgage borrowers will continue to capitalise their ‘rent’ (mortgage payments) at the interest rate at which they can borrow the money as they always have, but it will become less likely in uncertain times that people will be willing to accept a return lower than they might get on cash in a bank, for example.
Although Bank of England base rates have dropped to an all-time low of 0.1% during the crisis, there is a disconnect between these short-term rates and people’s longer-term expectations or returns from, say, stocks and bonds. My feeling is that the average UK property will continue to be valued at a cap rate of around 3.5% to 5%. If this rate remains stable, there will be no capital growth without rental growth. So we will become much more focussed on the fundamentals that drive rental growth which include demand & supply, affordability, popularity, service, amenity and neighbourhood.
The third thing which will increasingly come into play when putting a value on property in a low growth, low interest rate, low inflation economy is holding costs. Owners have not paid a lot of attention to upkeep, maintenance, obsolescence and depreciation over the last 60 years.
With double-digit house price growth creating ‘gains’ of thousands of pounds each year for even the average owner, there has not been much reason to pay attention to service charges, sinking funds, repairs, energy costs, maintenance and the long-term viability of a property. In future, these costs will likely outweigh capital gains in most years.
In a cash-strapped, post coronavirus world, these costs will weigh against the imputed or actual rental income on a property. They will make the difference between high gross, initial yields and low, net effective yields. For homeowners, they will make it sensible to buy a truly sustainable home with high amenity or even additional income generating value rather than an energy-hungry, high fashion, high maintenance, high service charge property with little additional intangible value. Housing developers can expect to see a big divide opening up between each type of property. Values will hold up better on the former but suffer disproportionately on the latter.
Coronavirus is a catalyst. A catalyst speeds up reactions. The housing industry will now have to speed up its reactions to this crisis. It will have to do things quickly which it may find painful and unfamiliar but which it was going to have to do over the next 10 years anyway. Don’t think we are returning to ‘business as usual’, don’t think you can fix everything back to what it was before. Use the current disruption to ‘fast forward’ 10 years. Don’t waste this crisis.
Source: Housingtoday
