Assessing Covid-19’s impact on the UK housing market

Summary 

The UK government’s response to the Covid-19 pandemic has utterly transformed the current economic and housing market landscape. The big question is what will its longer-term impact be?

The outlook we set out below confirms a sharp fall in activity. Looking beyond the short-term, however, and we predict an equally sharp uptick in the housing market into 2021, mirroring the outlook for the economy. 

For now, everything is dictated by the length and severity of movement restrictions. As soon as conditions are able to be relaxed, activity will return. However, if the government is to encourage a full return to normality, the existing economic stimulus announced in recent weeks will need to be supplemented by incentives such as reform to Stamp Duty.

Global context

The global response to Covid-19 confirms a near universal support from governments for strict movement restrictions, which in some cases amount to a virtual lockdown. As the crisis continues, however, there is a growing recognition of the need to balance public health and economic objectives. 

The Economist magazine estimated last week that even by the most conservative measure, the global stimulus provided by governments in 2020 to help mitigate the effect of the restrictions will exceed 2% of global GDP, well above the 1.5% spent in the wake of the global financial crisis. 

A survey of economists by Oxford Economics, published 27th March, found that 58% of respondents expect Covid-19 to lead to a global recession lasting for two quarters (Q2 and Q3 2020). In the same survey over half, 52%, expected a longer ‘U’ shaped recovery, with 44% anticipating a sharper ‘V’ shaped upswing. 

UK context

While the number of confirmed Covid-19 cases continues to rise in the UK, Oxford Economics last week predicted that we may see the peak of new cases within weeks rather than months, particularly if the spread in the West mimics the pattern seen in Asia.

While data released last week was negative, the services PMI declined from 53.2 in February to 35.7 in March, a record low, and the manufacturing PMI fell from 51.7 in February to 48.0 in March. There is some cause for optimism if the UK is able to follow the economic trajectory witnessed by Asia’s major economies.

The key factor that will determine the performance of the UK economy is the speed with which the government feels able to relax the current movement restrictions that prevent many businesses from operating. 

Our outlook is based on the assumption that current restrictions will remain in place during April and May with a gradual lifting through June. Any loosening before this time implies an improvement in the activity levels and price movements we are forecasting. 

The underlying economic forecast we have adopted points to a 4% contraction of GDP in 2020 and growth of 4.5% in 2021. 

Unemployment, which stood at 3.9% in December 2019, will be a key indicator to watch. While Oxford Economics currently forecast the jobless rate to end 2020 at 4.9%, the latest new claims for Universal Credit, released 1st April, suggest that the unemployment rate could jump to around 5.5% in April.

Residential sales market

The political certainty provided by last December’s general election boosted housing market confidence during January and February. A sharp uptick in sales was seen across the UK, with even the prime central London market seeing prices climb for the first time in five years. 

These positive trends were expected to have continued through 2020. The arrival of Covid-19 put this recovery on hold. 

Transactions 

Our view at the beginning of 2020 was that the volume of UK residential transactions would end the year around 5% higher than the five-year average - around 1.26 million compared with the 1.18 million seen in 2019. 

If we assume that the current movement restrictions are maintained through to the end of May this will obviously have a dramatic impact on sales volumes. Sales will slow sharply over the next quarter before recovering somewhat in the second half of the year. 

Our view is that sales across the UK will total around 734,000 for the full year, a 38% decline from the level seen in 2019, with slightly smaller falls seen in Greater London and in the prime central London market.

While we expect a revival in activity to continue, with volumes next year expected to be 18% above the level seen in 2019, this expansion will not fully offset the drop in 2020. Of the nearly 526,000 sales we expect to be “lost” this year, fewer than half will be carried into 2021.

For the government to see a full recovery of the market, with all of these “lost” sales carried forward, there will be a need for substantial incentives to ease market liquidity - including a reform to stamp duty. 

Prices 

Annual price growth in the UK to the end of March was 3% according to Nationwide, the highest figure in more than two years. Meanwhile, prices grew 0.2% in prime central London over the first quarter of the year, the highest figure for Q1 in five years.

With the market largely on hold evidence of the pricing impact of Covid-19 will remain sparse in the near-term.

Once the current crisis passes and activity begins to resume, we have to expect that weaker economic activity in the first half of 2020, the dislocation in the jobs market and weakened consumer sentiment will impact on prices, however the relatively finite timespan of the crisis means declines will be limited. 

Our view is that mainstream UK house prices will fall by 3% in 2020 with prices in prime central London remaining unchanged following a 25% fall in some markets since 2014. Our expectation is that prices will recover sharply in 2021 – and have pencilled in 8% growth for prime central London prices for next year. 

London rental market

Rental values have been strengthening in prime London markets in recent months and, unlike the sales market, this process started long before the general election.

The upwards trajectory was partly due to lower levels of supply as landlords trimmed their portfolios or left the sector altogether after a succession of tax hikes and a growing regulatory burden. 

At the same time, well-documented affordability pressures meant renting had become the obvious route for a growing number of residents.

The rental market is subject to the same government Covid-19 restrictions as the sales market. We believe the net impact of a phased return to more normal levels of activity is that the number of tenancies agreed in prime markets in London and the Home Counties in 2020 will be around 25% below the five-year average. 

Rental values in prime central London grew by 1.2% in the year to March 2020. In prime outer London, the annual increase was 1.1%, the highest rise in more than four years.

Our view is that rental values in prime central and outer London will remain flat over the course of 2020, with some upwards pressure returning during the second half the year.

We are maintaining our view that rental values will rise by 10% in prime central London and 11% in prime outer London in the five-year period to the end of 2024. 

Residential development

A pause in construction activity, as housebuilders down tools due to the Covid-19 restrictions, will undoubtedly lead to a drop in new home completions this year and probably next. New homes sales are also expected to fall this year as a result, in line with our forecast outlined above.

The full impact of the hiatus depends on the duration of current movement restrictions and on economic conditions once these are lifted, much like the resales market. Our current view remains that the disruption will be relatively short-term and, indeed, developers are still pursuing land opportunities.

Finance and mortgage markets  

Lenders have been scrambling to adjust to two Bank of England emergency rate cuts, the introduction of three-month mortgage holidays and the closure of many of their processing centres.

Bank of England approvals data for house purchases in February, before the onset of the crisis, reached the highest level since 2014, highlighting the momentum that had been gathering amid the competitive lending environment.

However, the influx of enquiries while banks were operating with skeleton staff led some to temporarily turn away new business, place caps on loan sizes and loan-to-value ratios and in some cases notch up the price of fixed-rate products. Obtaining valuations became particularly difficult and will remain so while restrictions on movement remain in place.

Others, however, have been eager to step in and support borrowers while gaining market share – particularly many private banks - and those that have been taking time to adjust remain eager to do business within the new parameters they’ve set themselves.

We continue to see lenders overhaul their product lines at an unprecedented rate in a sign of their desire to lend while managing risk and they are likely to be increasingly competitive as they adapt to the new conditions.