This time last year, we foresaw a turbulent time for mainstream house prices and anticipated that austerity measures in the economy would start to impact on household finances and homebuyer confidence. These effects have indeed turned out to be negative, but not as damaging to values as we thought.

The main casualty of the current housing market downturn has been transaction levels. Owners are simply not selling in the current climate and, with interest rates at manageable levels, are not forced to sell.

While these circumstances prevail and repossessed and distressed stock levels remain low, it is difficult to see the mechanisms by which widespread price falls will take place.

This means the shape of the mainstream housing market has changed rather more than house prices over the past 12 months. In this article we argue that it is inflation, rather than nominal price falls that will erode housing value over the next few years (see Graph 'Components of Housing Affordability').

More equity, less debt

Transaction levels have been far lower than the pre-crunch norm for some four years now. Proportionately more equity and less debt has been used to buy property. This has led to relatively stable prices, with little upward or downward movement across the country as
a whole.

In recent decades, average house prices have outgrown inflation by around 2.5% per annum. Due to the recent downturn, though, there has been no real (inflation-adjusted) growth so that in real terms, average mainstream house prices now stand at 2003 levels.

This raises the question of whether austerity measures have created a new era for mainstream house prices, with the trend of inflation-busting house price growth firmly consigned to history.

Affordability levels

With the economic outlook weakening over the past 12 months and forecasts for the recovery being pushed out further, the Bank of England is likely to maintain base rates at their historically low level for longer than expected.

Following the announcement of a further expansion of quantitative easing by £75 billion, our economic forecasters do not foresee any base rate increase before Q2 2013 at the earliest. This should have the effect of preserving affordability levels for longer, but it can no longer be relied upon to enable a return to real house price growth.

Our model of house price affordability is based on whether, after taking care of basic expenditure, households can afford the mortgage payments on the purchase of a new house. Through 2008 house price affordability soared as prices, levels of borrowing, and interest rates all fell, but we have already seen some of the affordability cushion built up during that period eroded by the rebound in house prices during 2009, high levels of inflation and flat real incomes.

Growth constraint

A continuation of these factors combined with base rate rises further down the line, are likely to erode affordability further. This is likely to limit the capacity for price growth at a national level, with the lack of economic growth meaning the trigger for house price growth is also pushed back.

Taking all of the above into account our mainstream forecasts have been cut back since this time last year. At a national level, prices are forecast to remain flat. We are predicting total nominal growth of 6.0% in the average UK house price over the five-year period covered by our forecasts.

We expect the picture to vary geographically. Relatively strong five-year price growth in London (19.1%) and the surrounding markets (South East 15.7% and East 14.1%) is expected on
the back of stronger economic performance and a lesser reliance
on mortgage finance. By contrast, northern regions are set to lag, seeing little to no growth.

While real house price growth is likely to be put on hold for some time, it does not necessarily follow that it is consigned to the history books forever. At the end of 1995, inflation-adjusted house prices were at the same level they were 12 years previously. In the following decade they rose by 140% in real inflation-adjusted terms. We now expect a period of necessary house price affordability correction that will push out yields and be a draw for investors (see Table 'Housing Market Forces').

Taken from
Residential Property Focus, Q4 2011

Expectations for global economic growth now incorporate a ‘second slip’ over 2012 that wasn’t there this time last year.

The implications for the UK are that 2012 GDP, which was expected at around 2.5%, is now likely to be closer to 1%, provided Eurozone collapse and its wider economic implications are avoided. The resulting levels of unemployment will suppress household income growth and, in turn, suppress both household consumption generally and spending on housing in particular.

Positively for the housing market, poor economic growth prospects serve to depress base rates and help prevent mass repossessions flooding the market.