Prospects for UK regional housing market

Prospects for UK regional housing market

This article assesses the prospects for regional housing markets in the UK and the outlook for the next five years. Will a significant fall in prices be averted in the face of these headwinds?

Yael Selfin - Chief Economist at KPMG in the UK.

Chief Economist

KPMG in the UK


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Recent months have witnessed increasing signs of weakness in the UK residential housing market. While performance varies significantly across the different regions, the prospects of continued medium term uncertainty associated with the Brexit process, coupled with rising interest rates on the horizon, could trigger further adjustments in house prices.

This article assesses the prospects for regional housing markets in the UK and the outlook for the next five years. Will a significant fall in prices be averted in the face of these headwinds?

Valuations remain solid but other factors are also at play

The extent that residential housing markets are overvalued at present differs across regions, supporting a possible correction in only a few places. Valuations, as measured by the ratio of average house price for first time buyers to the average income in that region, have remained broadly in line with long term average across most of the North but less so elsewhere (see Figure 1 below).

Figure 1: UK regional housing affordability
figure-1-UK regional housing affordability

Source: Nationwide

A number of factors have supported valuations, making each region’s dynamics diverge at times, with valuations in the South historically higher. However, even when accounting for region specific factors, valuations in London seem particularly high compared to their historic average at present.

The availability of housing has been one factor influencing prices, with dwellings per resident lowest in London and highest in Scotland (see Figure 2 below), but other factors are also at play.

Figure 2: Housing stock per resident

Source: ONS, DCLG, Scottish Government, Department for Social Development (NI). 2016 data for English regions, 2015 data for Scotland and Wales and 2014 for Northern Ireland.

Our analysis found that changes to stamp duty in spring 2016 made a significant impact to prices in the majority of regions, including the impact on the buy-to-let market from the additional increase in duty and the removal of interests deductibility. Other government interventions, such as the help-to-buy scheme, which is aimed at helping first-time buyers save for a deposit though a government equity loan, has had a more muted impact, affecting around 2% of all properties bought.

Our outlook for the next five years

Our outlook for the UK regional housing market is shown in table 1 below . In the short run, our projections show a continuing overhang from the changes to stamp duty, as well as from Brexit-related uncertainty, which are expected to moderate house price growth in most regional markets. While in the medium term, muted increases in households’ real income are expected to dampen growth rates relative to what we witnessed over the past five years.

Table 1: KPMG residential housing market outlook (table shows year-on-year changes, please see Table 2 for growth rates of average annual house prices)

  2016 2017 2018 2019 2020 2021 2022
London 3.7% -1.6%
1.2% 3.4% 3.9% 4.7% 5.1%
South East 6.9% 1.3% 1.3% 2.8% 3.3% 4.3% 4.8%
Yorkshire and The Humber 4.0% 1.1% 1.1% 2.5% 3.2% 3.9% 4.4%
North West 3.7% 3.0% 3.0% 3.3% 3.2% 3.8% 4.2%
North East 0.0% 0.2% 0.2% 1.3% 2.2% 3.5% 4.0%
South West 4.5% 4.3% 4.3% 4.6% 3.8% 3.7% 3.7%
East of England 10.1% 4.4% 4.4% 4.6% 3.5% 3.2% 3.5%
Wales 2.4% 3.2% 3.2% 3.1% 2.1% 2.8% 3.5%
East Midlands 4.9% 4.0% 4.0% 3.7% 2.8% 2.9% 2.8%
West Midlands 4.2% 3.1% 3.1% 3.0% 2.3% 2.5% 2.5%
Scotland 2.2% 1.9% 1.9% 2.0% 1.5% 2.0% 2.3%
Northern Ireland 0.6% 0.4% 0.4% 0.5% 0.4% 1.1% 1.9%

Source:Nationwide for historic data, KPMG forecasts for 2017-22.                

London is expected to see the most significant moderation in house price growth in the short term, given current valuations and its disproportionate exposure to the changes in stamp duty. However, we expect that by 2021 it will recover ground and return to being the fastest growing market in the UK.

Price rises in the South East are also expected to moderate further next year before starting to recover in 2019, with both Crossrail and Thameslink developments likely to continue boosting sales in areas such as Reading and Brentwood.

Improvements to regions’ infrastructure should have positive impacts in other areas, with HS2 supporting sales value in Birmingham in the Midlands, while cities in the north of England, such as Leeds, Sheffield and Manchester benefiting from Northern Powerhouse-related initiatives.

Our projections assume that the Bank of England will commence a gradual tightening of interest rates in 2018, which will feed through into interest rates paid on mortgages, impacting the affordability of mortgage borrowing and slowing down the rate of house price growth.

Our regional house price model also takes into account how buyers’ expectations of house price rises can impact buying intentions. This means that areas where house prices have risen more strongly recently are expected to be more resilient to adverse new developments such as a rise in interest rates.

Other factors affecting our projections include the trends in regional employment and population, which will affect the degree of housing shortages experienced across regions, although these are not expected to drastically depart from recent trends in our forecast.

There are a number of uncertainties around our projections, both around the economic performance of the UK in the next five years, including the impact of Brexit, as well as the potential for any further government intervention in the residential housing market. But with the average price of a house around £282,000 – and housing assets comprising up to 50%2 of UK households’ net assets, fluctuations in this market will have far-reaching consequences on every part of the UK economy.

Table 2: Growth rates in average annual house prices 

  2016 2017  2018  2019  2020  2021  2022
London 7.9% 1.0% -1.0% 2.5% 3.9% 4.4% 4.9%
South East 9.1% 2.9% 0.5% 2.1% 3.3% 4.0% 4.6%
Yorkshire and The Humber    2.6% 1.3% 0.2% 1.9% 3.0% 3.7% 4.2%
North West 2.6% 3.7% 2.6% 3.0% 3.3% 3.5%
North East -0.6% 0.8% 0.4% 0.8% 2.0% 3.0% 3.8%
South West 5.1% 4.4% 3.3% 4.4% 4.3% 3.7% 3.7%
East of England 7.2% 4.0% 3.4% 4.5% 4.1% 3.3% 3.3%
Wales 1.1% 1.6% 2.8% 3.0% 2.5% 2.5% 3.2%
East Midlands 4.1% 4.3% 3.6% 3.8%
3.3% 2.9% 2.8%
West Midlands 4.5% 4.1% 2.8% 2.9% 2.7% 2.4% 2.5%
Scotland 1.1% 1.9% 1.5% 1.9% 1.8% 1.7% 2.2%
Northern Ireland 1.6% 3.0% 0.3% 0.2% 0.5% 0.8% 1.6%

Source: Nationwide for historic data, KPMG forecasts for 2017-22. 


How we produce our forecasts

Our forecasts are produced with a set of error correction models of regional house markets. An error correction model describes the dynamics in terms of long-run and short run changes. For this exercise, we made use of house price indices from Nationwide, and quarterly regional economic data from the ONS. Data on historic mortgage interest rates was sourced from the Bank of England.

In the long run, the level of the house price was determined by factors such as earnings, employment and the level of real mortgage interest rates. We have chosen to follow the national model used by the OBR (2014) and included a term taking account of past changes in the level of house prices to proxy for the effects of price expectations.

In the short run, changes in house prices are determined by changes in income and employment, earlier changes in house prices, and the level of disequilibrium in the long run relation.

The parameters of the equations are estimated using OLS and all coefficients have the expected sign and are statistically significant. Our forecasts of the explanatory variables make use of publicly available forecasts as well as forecasts produced by KPMG macroeconomics.

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