In London, the total value 
of housing rose by 20% 
or £247 billion in 2014 alone and by 61% or £563 billion over the past five years. This has huge consequences for Londoners, whose finances are being stretched further and further as house prices continue to rise 
at a disproportionate rate to the rest of the country.


This value gap simply cannot widen at this rate indefinitely, which is why we expect mainstream London to see just 10.4% growth over the next five years, compared to 19.3% across the UK as a whole.

Why just 10.4%?

Mortgage regulation is one of 
the main constraining factors to further house price growth. This new lending environment is one of loan to income caps, stress testing of borrowers’ affordability and capital repayment requirements. Coupled with fast-moving house prices against a context of limited income growth, this means higher deposits are required.

Jump forward five years and we expect that prices will grow just 10.4%, as fewer first time buyers will have been able to access home ownership for these reasons.

Affordability examples

The infographic below shows how the average person in London is struggling to keep up with house price growth in this changing lending environment and how we see the market in 2019 being slightly more balanced (see Figure 3).

click on image below to enlarge

Third Quarter 2013

At the end of the third quarter of 2013, a first time buyer household earning £53k (the median in London according to CML), could have afforded to buy a property worth £264k at 3.74 loan to income multiple with a 75% loan to value mortgage. This assumes they could raise the required £65k deposit. At prevailing interest rates servicing this mortgage would account for 21% of gross household income.

Third Quarter 2014

Over the course of 2014 incomes grew by 4%, and if we assume the same mortgage conditions as before our hypothetical buyer can now borrow £206k and afford a property worth £274k. The amount they can afford has risen by 4%, but, as we have seen, house prices will have risen much more.

In this example, the £264k house is now worth £320k, resulting in a funding shortfall of some £46,000. The options for buyers are pretty stark – find a much bigger deposit, borrow more money at an even higher multiple of income (4.57x earnings), or buy a smaller property or one in a less expensive area. The first two options may not be possible, the last may not be desirable.

Third Quarter 2019

If we fast forward to 2019, our subject property would be worth £353k while incomes will have risen by 22% according to Oxford Economics. Assuming loan to 
value ratios remain the same, 
our buyer could now obtain a property worth £324k with a £252k mortgage. This means that while the funding shortfall is reduced, it still sits at £29k.

Even if that shortfall can be found, the costs of servicing the mortgage will have increased to 26% of gross income because of interest rate rises. This 26% is much higher than the 21% average of the past 20 years. Essentially, this would mean affordability would be as stretched as 
it was prior to the credit crunch.

If, however, the 2019 shortfall is added to borrowing it would be necessary to get an 80% LTV, 4.18 LTI mortgage. This would mean that the cost of capital and interest repayments would shoot up to 29% of gross income. This is a level not seen since the affordability driven downturn of the early 1990s, so it is highly unlikely that this level of lending would be sustainable.

Consequences

These affordability considerations 
limit future price growth potential. While, annual price growth across 
all of London averaged 17.8% during 2014, the last six months saw just 1.6% according to the Nationwide.

This indicates that we are already seeing some of these affordability implications play out.

Together with the cost of the deposit which buyers need to accumulate, these also have implications for transactions levels. This will place more demand on the private rented sector or the hotel of Mum and Dad.

But, assuming local governments respond to the changing housing needs, it will also present developers with an opportunity to build for the private rented sector and develop the intermediate housing offering.

Supply shortage

Identifying the hidden value

Despite these affordability issues there is still a shortage of new supply in London – we are currently building less than half of the 50,000 new homes required in the capital every year. This is one of the fundamental reasons why we do not expect average price falls across London in 2015, despite the recent change in sentiment.

For developers there will undoubtedly be pockets of hidden value which will see growth levels above the average, though it will require them to place significant emphasis on unlocking it through the nature and scale of the development they undertake.

Taken from
Residential Property Focus Issue 1 2015