Britain’s property market faces a reckoning – the house price plunge is only beginning (2024)

James Setright, 36, has seized an opportunity to move house while prices are falling.

“I wanted to take advantage of the market. I don’t think I will be able to buy a five-bedroom Victorian house in London for under a million quid ever again,” says Setright.

Across Britain, homes are getting listed at prices far below what they would have sold for during the pandemic as homeowners, buy-to-let investors and first-time buyers alike creak under the strain of high mortgage rates and the cost of living crisis.

But the pain has only just begun – and it will be driven by the mortgage market.

Inflation has not come down as fast as expected, meaning the Bank of England will not yet cut its official rate, and lenders will keep mortgage rates high. The result could be a slow-motion crash, more akin to the early 1990s downturn than the sudden, but short, 2008 crash, some economists think.

Setright is snapping up his five-bedroom house for just over £875,000, a discount on its £895,000 asking price, which he thinks was already cheap.

“That property should be [selling for] £1.2m but the guy obviously needed to get rid of it. There is an awful lot of this happening. It’s obvious that they need to sell because they can’t afford to live there and they are moving somewhere else,” says Setright, who works in property himself.

House prices in March were down by 4.6pc compared to their August peak, according to lender Nationwide’s seasonally adjusted index.

The sale figures, which are not adjusted for seasonal variations, are more stark. In August, the average UK home sold for £273,751. In March this year, this figure was £257,122. That’s a drop of £16,629, or 6pc.

The British property market has become the domain of pragmatists. Those who don't need to sell have taken their homes off the market, leaving sellers who need to move or offload rental properties prepared to sacrifice some of their gains generated in the frenzy of the pandemic.

But the bigger question is not where house prices are now – but where they are going. Analysts say the top third of the market is where the blow will land first, as expensive houses being purchased with large mortgages become unaffordable.

Buy-to-let landlords – who can no longer offset mortgage interest against profits – have even more incentive to sell, which should also depress prices when the market is flooded with ex-rentals.

Back in the autumn of 2022 the market faced Armageddon. The mini-Budget fallout evoked the spectre of financial meltdown and sent mortgage rates soaring at the fastest rate on record. But the crisis passed. Mortgage rates have fallen, the market has stabilised and signs of green shoots have been emerging. Is the market out of the woods, or is this a false dawn?

There is a major threat that should not be ignored just because it is so far invisible.

Credit conditions – namely, how willingly banks will lend – are a major factor for the housing market that is not being talked about enough, says John Muellbauer, senior research fellow at the University of Oxford and a former government adviser.

The collapse of Silicon Valley Bank in America was symptomatic of the slow, insidious toll of successive central bank interest rate rises. There will be more casualties, and economists do not yet know where they will be.

“These things take longer to work through than you might think. Not seeing an immediate effect can be misleading. The medium term effect could be bigger,” says Muellbauer.

Invisible threat

This presents a looming potential threat for the mortgage market. UK banks have substantial portfolios of government bonds, also known as gilts. As the financial system creaks under the pressure of rate rises, bond prices are fluctuating. “Banks’ portfolios have shrunk, which means their balance sheets become more constrained,” says Muellbauer.

House price falls, which will also hit the value of their portfolios, will add even more strain. “Putting all of that together, I think banks are going to be extra cautious, and their lending criteria will be tougher in the coming 12 months,” says Muellbauer.

This is likely to mean more stringent “affordability tests” for borrowers, smaller loans in proportion to income, and higher mortgage rates on loans for buyers with smaller deposits.

These changes will magnify the blow of higher mortgage rates, extra pressure that buyers can little afford. Debt service ratios – a measure of borrowers’ ability to service their mortgages – are around double what they were in 2019, says Muellbauer. “The cashflow effect on potential new buyers is very severe,” says Muellbauer.

If credit conditions tighten significantly, house prices could fall much further than expected.

The British housing market is much more exposed to higher mortgage rates than other European markets.

Across the Continent, debt service repayments increased on average by a third between 2021 and 2022, according to the International Monetary Fund. In the UK, the jump was 70pc. This is because debt-to-income ratios are particularly high in the UK, and because mortgage rates have climbed much higher than in other European countries.

Homeowners in Britain are also more exposed to changes in interest rates.

“In the Netherlands and Denmark, homeowners have higher debt-to-income ratios than we do, but they have much longer fixed-rate deals. While there is an impact on new buyers, there is much less of an impact on the cash flows for people with mortgages, which is what translates into arrears and repossessions, and in turn feeds back into the caution that banks exercise on their balance sheets,” adds Muellbauer.

While British borrowers are more protected from higher rates than those in countries such as Sweden, where the vast majority of mortgages are variable rate deals that fluctuate in line with interest rates, that security is short-lived.

Fixed-rate deals in the UK are often only short term deals lasting two or five years, unlike in the US where buyers fix for 30 years. This means a large number of existing homeowners will still get hit when their fixes expire, as will be the case for 1.4 million borrowers across 2023.

“The distress will come from people coming off a low fixed rate and going onto a much higher repayment, which will be a massive stretch on top of the large hike in fuel prices and the general cost of living,” says Allan Fuller, a south London estate agent.

But mortgage rates have cooled steadily since their autumn peak. The average quoted rate on a two-year fixed-rate mortgage on April 6 was 5.32pc, according to Moneyfacts, an analyst. This was down from a peak of 6.65pc on October 20 last year. A buyer taking out a £200,000 loan will now pay £2,660 less per year in interest.

Deals are unlikely to get much cheaper. Mortgage rates have stopped falling and have seen marginal increases since March. Lenders have removed the premium they added in the wake of the 2022 mini-Budget and there is nothing left to take off.

Rates might no longer be approaching 7pc, but they are stuck at a level that is twice as high as a year ago, and five times the sub-1pc rates buyers were able to secure during the depths of the pandemic. They will not fall materially until the Bank of England starts reducing the Bank Rate, and the surprisingly high inflation data in February was a clear signal that that moment is a long way off.

“For the Bank of England, that was pretty horrendous,” says Muellbauer. The tight labour market is a further burden. “The Bank will be terribly wary about taking the pressure off and allowing inflation to remain high.”

Inflation will make it much harder for policymakers to step in and alleviate the strain on the housing market if values do fall dramatically.

After the global financial crisis, the Bank of England slashed interest rates. Back then, there was no inflationary pressure. “That meant that the fall in house prices that occurred then was relatively small and temporary,” says Muellbauer.

With inflation so high today, this is not an option on the table for the Bank. This downturn has more similarities with that of the early Nineties, when the Bank had a similar inability to lower rates, says Muellbauer.

Back then, the downturn was less sharp than in 2008, but it was far more protracted. House prices fell for years.

Even if these specific risks are averted, the British housing market must adjust to a painful new reality.

When mortgage rates hit 6pc, buyers saw their buying power reduced by 35pc compared to the start of 2022, according to calculations by Zoopla. Today, it is possible to get a mortgage at a little over 4pc. That means buyers have 20pc less to spend than at the start of last year, says Richard Donnell, executive director of research at Zoopla. And that is with the best deal on the market. The average two-year fixed rate is more than 5pc.

Cheaper to rent than buy

Robert Lewis, 36, is also buying a home in London with his partner and two children. Since they began their house hunt a year ago, the mortgage rate they can get has doubled. As a result, they have shifted their house hunt to a cheaper area.

But even this will not offset the blow. “When we first started looking, one of the main drivers was to save money compared to our rent. Now, whatever we do, we will be spending more on our mortgage than we do on rent,” says Lewis.

The family’s monthly rent is £3,500. Their mortgage bill will be £3,800, roughly £1,000 more than when they started house hunting. “That means a different lifestyle to the one that we are going to have, a lifestyle where you’ve got to worry about the bills,” says Lewis.

The property market is recovering from the mini-Budget, but it is adjusting to a new reality of permanently higher interest rates.

In October 2022, as mortgage rates soared following Kwasi Kwarteng's fiscal statement, agreed sales slumped by a third compared to pre-pandemic levels, according to TwentyCi. Rates have since cooled and sales have recovered. In March, they were up by 1.4pc on the 2017-2019 period.

But these deals are entirely price dependent. Back in October, the share of sales that were agreed after price changes was up only 2.5pc compared to the pre-Covid norm. In March, the share was up 44pc.

“Clearly, it is price sensitive. Maybe what you’re seeing is a realisation amongst sellers that circ*mstances have changed, that buyers’ budgets are more constrained and there isn’t much point in waiting for the market to catch up with their price expectations,” says Lucian Cook, head of UK residential research at Savills estate agents.

The Halifax house price index surprised analysts when it reported a 0.8pc monthly increase in house prices in March, meaning house prices were down 2pc from their August peak. The monthly change was the exact opposite of the Nationwide index, which reported a 0.8pc monthly drop.

But this divergence likely reflects the fact that buyers are shifting to different types of properties, says Andrew Wishart, senior property economist at Capital Economics. Both indexes are based on mortgage approvals, which means they can only reflect the types of properties each lender’s customers are buying.

“The average size of mortgage approval has fallen by 9pc as households can’t afford to borrow as much at higher mortgage rates. For the Halifax approvals-based index to only report a 2pc fall in prices despite that suggests that the homes being transacted are less valuable, they will be smaller properties and in cheaper areas,” says Wishart.

“A lot of these movers, they’re not aspirational moves, they’re not people pushing for the most expensive property they can buy. They’re far more value-for-money, common sense, good decision moves,” says Donnell.

Higher costs mean a clear differentiation is emerging across the market with buyers flocking to cheaper properties. Sales in the cheapest third of the market were up year-on-year in March in every single region of Britain, according to Zoopla. In the West Midlands and Wales sales growth in this segment was up by 21pc.

The top third of the market is an exact mirror image. Sales in this part of the market fell dramatically in every region, with drops in Scotland and the South East down by 20pc and 12pc respectively. Sales also fell in the middle third of the market in every region except for Scotland and the North East, which recorded only marginal upticks.

“The housing market at the top end has been a bit slower to catch up post-mini-Budget. They have the most money, but equally if they have got the biggest mortgages, they are paying the most interest on it. They need to be more cautious about where the market is going,” says Kesha Foss-Smith, area director at John D Wood estate agents in London.

A two percentage point change in mortgage rates would cost a homeowner with a £1m loan an extra £1,670 per month.

City watchdog the Financial Conduct Authority has handed lenders generous amounts of leeway to help homeowners who are struggling with their mortgage payments. This includes options such as making a temporary switch to interest-only payments without the usual affordability checks.

Few analysts are expecting a large number of repossessions. But the strain of higher rates can push people to sell up and move long before they get into financial distress.

And the data shows that more and more people are listing their homes for sale. The number of properties for sale per estate agent branch in March was up 65pc compared to last spring, according to Zoopla.

A major rebalancing between the supply and demand metric is underway. Buyer inquiries in March climbed on a monthly basis as the spring selling season kicked off, but they were down by more than a tenth on the five-year average and are just a little over half the level recorded in March 2022.

Bank of England data shows mortgage approvals rose by 10pc month-on-month in February. However, approvals are still subdued and, excluding the 2020 housing market shutdown, they are at their lowest level since the start of 2011.

In February 45pc of homes listed on Zoopla had their asking price cut at least once. “I think sellers are getting the message. If you’re serious about moving, you have got to get realistic on price. Homeowners have made so much money over the pandemic, they have got room to play with, it’s not like losing real money,” says Donnell.

“If you’re a vendor and you try to overprice, you’re gonna very quickly see that there is no interest and you’ll have to reduce that price,” says Foss-Smith.

But years of short supply mean buyers are keen to move when they can afford it. “The way agents used to value houses was never listing the same as the price that your neighbour sold for – you would always try higher. Now, we’re looking at what sold last year and saying let’s price it just under and see how much interest we get,” says Foss-Smith.

Sellers also have much more scope for price cuts than during previous downturns. From the start of the pandemic in March 2020 to the peak of the market in August 2022, the average house price jumped from £219,583 to £273,751, a rise of £54,168, or 25pc.

“Everyone is sitting on bigger gains and they are going to have to give some up,” says Donnell.

Landlord exodus

The most motivated sellers are likely to be in the buy-to-let sector.

Tax changes announced by George Osborne, which came into full effect in April 2020, mean that landlords who own properties in their own name can no longer deduct all of their mortgage interest from their profit calculations for their tax bills. This means that even if their mortgage bills soar, they will have to pay the same amount of tax.

These changes have been a blow for “the dinner party landlord”, says Richard Rowntree, managing director of mortgages at Paragon, a buy-to-let lender.

While larger portfolio landlords have the tax benefits that come with using company structures, many small-scale landlords who own one or two properties do not have the income to absorb higher costs, says Rowntree. Crucially, these smaller landlords make up the majority of the rental housing supply, he adds.

Property investors are slowly starting to sell up as they adjust to the toll of higher mortgage rates.

“If your mortgage has gone from £400 a month to £1,500 a month and your rental income is £1,800, you are still paying the same tax on that,” says Foss-Smith. “Particularly at the lower end, those one- or two-bedroom, accidental landlords, they’ve most certainly started to come to the market,” says Foss-Smith.

“We haven’t seen as many as I think we had anticipated, but I think a lot of landlords haven’t yet come to the end of their fixed rates,” she adds.

Now that house prices are falling, slightly fewer landlords are shedding their assets. Buy-to-lets made up 11pc of the homes for sale on Zoopla, down from 13.5pc in 2022, but these figures are still high compared to historic averages.

But many may be pushed into selling when their fixed rate deals expire, says Donnell. Incoming energy efficiency regulations for the private rental sector will be another key driver. The Government will announce deadlines for new minimum Energy Performance Certificate requirements in the private rental sector at the end of the year.

Those who quit are unlikely to find many buy-to-let investors willing to replace them, particularly in London, where high house prices mean lower yields.

In the first three months of this year, to purchase a typical buy-to-let in the capital, an investor needed a 50pc deposit, or £257,000, according to Zoopla. A year ago, the figure was only £129,000. The property will have a gross rental yield of only 4pc, pretty low compared to what is on offer to investors in the north and Midlands.

Concentrated pockets of landlord sales could trigger larger house price falls in areas such as city centre flat markets.

There is another cohort of sellers who could emerge en masse over the next few years, says Donnell.

“We’ve got the biggest number of over 75-year-old homeowners we have ever had. Their insurance bills are going up and council tax is going up and their energy bills are going up. That’s a group of people who haven’t moved very much in the last few years and they are going to become a really important group for the housing market,” says Donnell.