UK Housing Market: is the bubble about to burst?
by George Hatjoullis
In an earlier blog I considered how the London house price bubble might burst and concluded that political and regulatory action was most the most serious risk. The March budget included further measures to make holding UK residential property through tax-efficient offshore vehicles more expensive. This may ease the upward pressure on prices arising from overseas investment. More important, from 26 April, 2014, the process of getting a mortgage will also become more exacting.The purpose of the new mortgage regulations is to try to ensure that the mortgage is not only initially ‘affordable’ but is robustly affordable, allowing for potential interest rate variations. Further information can be found at the FCA website (http://bit.ly/1peHjT3) but I will highlight the most interesting aspects.
The key change is that lenders will become fully responsible for assessing whether the borrower can afford the loan. Income must be verified in all cases, with at the very least committed and basic essential expenditures accounted for in the affordability assessment. The mortgage must be stress tested for interest rate variations and other potential changes in circumstances. Interest only mortgages are only possible if there is a credible repayment strategy in place. All this is logical and one wonders why it is not already in place. The upshot is that mortgage lenders will want a lot more information, and verification, before granting mortgages and, potentially, will not grant them quite as easily as has been the case. The lenders will be wary of retrospective mis-selling accusations and financial penalties if things do not work out. They must act in the customers best interests and be able to prove that they have done so. There has already been a tightening up of lending through much lower loan to value ratios (bigger deposit requirements) and this new regulatory regime will add to this. Mortgages will not become easier to come by and this can only impact the effective demand for housing.
Coincidentally the Halifax House Price Index fell by 1.1% in March. This is a large fall and takes the standardised average house price from £180,163 to £178,249. Of course, one month does not a trend make, but it is a wake up call for all those thinking house prices are a one-way bet. The tax changes, regulatory changes and prospect of higher interest rates should all work to slow the pace of house price increases. This will not, however, alter the fact that there is a shortage of affordable homes, especially in London. Only supply can properly pop this bubble but a greater volume of property for sale that no one can afford will certainly pop the bubble. If further political changes induce overseas investors to sell and/or buy-to-let investors to exit, then illiquidity could see prices collapse. The mere fact of lots of people needing an affordable home will not necessarily keep prices firm.
There seems to be a popular view that the budget pension reforms will result in a surge of pension cash exiting into buy-to-let. This is repeated in todays (5/04/2014) Daily Telegraph along with some snippets on the economics of buy-to-let in a rising interest rate environment (http://bit.ly/1oAcFs4). However, the amount of additional money that the pension reforms may see directed towards buy-to-let (I am sure there will be some impact) is in danger of being overestimated. The tax-free lump sum of 25% of the value of the pot was always available to be invested in buy-to-let and no doubt often has been. Additional sums taken out will still incur the pension holders marginal tax rate. Assuming the pension holder needs income on which to live, the additional sums are likely to incur at least 40% tax. This is a large penalty to incur in order to re-invest in buy-to-let. Despite the new freedom it makes more sense to move to a drawdown plan and use eligible investments within these plans. The new flexibility does make it easier to plan withdrawals in order to keep the marginal tax rate down.