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Bubble bursting

Bubble Trouble

27 October 2014

Will measures to stem the rise in house prices lead to a more sustainable market?

To combat the threat of another property bubble, measures have been introduced to stem the rise in prices. Here, we assess their impact and ask what else could be done to create a more sustainable housing market for the long term.

According to conventional wisdom, there is little that makes the average British homeowner feel better than rising property prices. So it was no surprise that the Government was desperate to kick-start the housing market in the latter days of the last recession. Back then, the paramount concern was that the housing market had been plunged into a prolonged state of depression.

Three years on and the mood is very different. In June, Bank of England governor Mark Carney warned that the threat of a property bubble was the ‘biggest risk’ to economic recovery over the medium term.

To combat this looming possibility, the Bank imposed extra affordability tests on borrowers and said only 15% of new mortgages could be offered at multiples of more than 4.5 times income.

The Bank’s measures followed the introduction in April of the Mortgage Market Review from the Financial Conduct Authority, which changed affordability criteria, forcing lenders to look not just at would-be borrowers’ income but also their expenditure.

Early signs suggest the moves are having a tentative impact. Data from the Land Registry showed that seven out of ten UK regions recorded falling house prices in June; property website Rightmove said the average asking price fell 0.8% in July, the first nationwide monthly drop of 2014; and the Royal Institution of Chartered Surveyors’ July survey said the housing market had ‘paused for breath’.

Bernard Clarke from the Council of Mortgage Lenders thinks this will be the new pattern. ‘The combination of tighter lending criteria and new affordability tests mean that the upward cycle will be relatively short-lived and it will plateau as we move into 2015,’ he says.

Nationwide figures mask the fact that there are huge regional variations. As Nick Parsons, head of markets strategy at National Australia Bank in London, explains: ‘Increasingly, there is no such thing as the UK economy and there is no such thing as the UK property market. There is London and the South-East and there is the rest.’

Figures from the Land Registry bear this out, showing that, while London prices were rising at an annual rate of more than 16% last summer, the average national increase was just 6.4%, while prices barely moved in the North-East.

As the Council of Mortgage Lenders explains: ‘There is a wide gulf in house price since 2007. Prices at the end of the first quarter of 2014 were 20% above their previous peak in London but still 11% below their peak in the North-West.’

Such an extraordinary discrepancy does not just make it hard to talk about ‘national averages’; it also poses a challenge for policymakers. ‘Much of the London housing boom has been driven by overseas and cash buyers. The Bank of England’s new lending criteria will not affect them in the slightest,’ says George Buckley, chief UK economist at Deutsche Bank.

He believes tax could be used to reduce foreign demand for London property. ‘When foreign buyers use London property purely as an investment, it creates real problems for first-time buyers. But the government is bringing in Capital Gains Tax for overseas buyers from next April and there is talk of increasing Council Tax on unoccupied properties. This could assuage overseas demand,’ he says.

Parsons believes policymakers have two possible tools at their disposal to take the froth out of the London market without sending prices into a dangerous downward spiral.

‘The Government could reduce the upper limit on Help to Buy to £250,000. Most Help to Buy mortgages are less than £250,000, but an official reduction in the upper limit would send a strong psychological message. They could also announce their intention to scale back mortgage interest relief for buy-to-let* investors. That sector of the market is centred on London and now accounts for at least 14% of all mortgages, up from 9% in 2008¹,’ he says.

The Building Societies Association (BSA) also believes the market can be influenced by robust messages from policymakers. ‘The introduction of loan-to-income limits and a greater focus on affordability sent a clear message from the Bank. To mortgage lenders it said “We are not afraid to take action if we need to”, and to consumers it said “Let’s pause for breath a little”,’ says Paul Broadhead, head of mortgage policy at the BSA.

The BSA suggests that a more coordinated approach to the housing market would help to smooth out prices over the long term.

‘More needs to be done to balance supply and demand,’ says Broadhead. ‘We need more homes that people want to live in, built in places that people want to live. Owner occupancy has fallen from

73% to 65% over the past decade and the private rental sector has overtaken social housing. These are very big shifts. The government needs a coordinated approach and a coherent policy to address them. But at the moment, housing is handled by four different government departments.

The situation is delicate. Regional shifts are wide, the market is still well below its peak in many parts of the country and there are ongoing concerns about the link between rising prices and consumer confidence. ‘The housing market has a massive effect on consumer confidence. When prices go up, people feel better,’ says Parsons. Not everyone agrees however. ‘There is a widespread belief that rising prices are good for the economy. But rising prices mean that people’s cash is locked up in the housing market, which is detrimental to the wider economy,’ says Capital Economics’ chief property economist Ed Stansfield. ‘What we need is a decade of stagnation to improve affordability. The Bank needs to tighten mortgage regulation even more and impose stricter caps on loan-to-income multiples.’

Most economists suggest that, even if increasing prices feed into the consumer feel-good factor, employment, rising income and job security have a larger role to play. If wages are rising and people feel more secure, they may well be prepared to pay more for their home. But they would also be able to afford it. And that would mean a more sustainable housing market for the long term.

Balance sheet. Rising house prices might be good news for homeowners, but not necessarily good news for the economy. Measures may still be needed to smooth out prices over the long term.

1. Council of Mortgage Lenders

Your home may be repossessed if you do not keep up repayments on your mortgage.

*Buy-to-let mortgages are not regulated by the Financial Conduct Authority.

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