We are currently at a stage where the average daily Covid-19 death rate is falling in the UK. The government has eased the lockdown rules and reopened its borders to stimulate the economy.
Chancellor Rishi Sunak has announced a £30bn plan to protect jobs, including a VAT cut on food, accommodation and attractions. The government is also providing active support to people who struggle to buy a house during the coronavirus crisis by removing the stamp duty for properties under £500,000 for the next 6 months.
The housing market has been impacted by all this. Property transactions in April decreased by 53% compared to the year before and the Halifax UK House Price Index has decreased for four months in a row.
With no vaccine currently available, it is inevitably difficult to make long term predictions about the housing market in the UK. Health officials have raised concerns of a second wave and that could result in new local lockdowns that will impact the economy.
There are several macro-economic factors, such as GDP and the bank rate, that are historically important to the residential housing market and the mortgage market.
These factors are all affected by the current pandemic. The GDP index of the UK was down by 20.4% in April compared to March and the interbank interest rates have reached a record-low level of 0.1%.
It is therefore more insightful to investigate how these variables are impacted by the pandemic and the implications that it could have on the housing market.
Through this article, we highlight macro-economic factors that have historically influenced the real estate market and discuss how they are impacted by COVID-19. Given the many variables at hand, we limit the scope to interest and mortgage rates, GDP, risk aversion and changes in deposits and credits.
The money that a household can afford to buy a residence is a function of their income and their savings (the deposit). The mortgage a household can afford is mainly driven by these two factors and it therefore relates directly to the GDP.
Figure 1 shows the log price index and the log GDP index. In the last decade with stable interest rates, the GDP index and the residential price index increased with roughly the same rate.
Figure 1 – GDP index versus residential price index
In contrast to the long-term trend, UK GDP fell 20.4% in April 2020, a decline much higher than the one seen in the previous mortgage crisis. If the economy takes a long time to recover and GDP stays lower than its pre-COVID-19 levels, then this can have a direct impact on the housing market. New GDP data will show how the economy responded to the opening of bars and restaurants.
The steeper growth between 1995 and 2008 can be explained by the increase of debt per household relative to their income. Households obtained higher mortgages with the same income and could therefore afford to pay more for a property.
Several factors led to the subprime mortgage crisis, such as the introduction of ninja loans, subprime mortgages and interest-only mortgages. Due to a lax regulatory environment, banks allowed consumers to take on mortgages with higher loan-to-value (LTV) ratios. In some cases, the value of the mortgage could even exceed the value of the property.
Figure 2 highlights relative debt to income – showing an increase of 60% between 2000 and 2008. This trend also pushed the housing prices up as households were able to get a higher mortgage with the same income.
Figure 2 – Annual debt to income ratios
The continuous growth in debt was unsustainable and the debt-to-income ratio had to stabilise or correct at some point – there is only a certain amount of money that households can spend on their mortgage.
Higher relative debt levels also increase the risk of households failing to meet their mortgage payments – either when mortgage rates go up or household income decreases. This situation was widespread in the 2008 mortgage crisis when unemployment levels spiked.
Since 2008, regulations have been put in place to restrict capital requirements for mortgages and also the amount of debt that people can take to buy a property. Banks also perform stress testing to see if a household can still make the payments in adverse scenarios, increased interest rate environments or changes in lifestyle.
Bank rates and mortgage rates
The Monetary Policy Committee (MPC) sets the base rate which commercial banks must pay the Bank of England to borrow money. It is one of the factors that influences mortgage rates. The mortgage rates and the base rate do not follow a 1:1 relationship, since banks are still free to set their own mortgage rates.
Figure 3 shows how the base rate has been extremely low in the last decade and has remained low. This is in large part down to increased quantitative easing after the financial crisis in 2008.
Figure 3 – Bank and mortgage rates in the UK
As a response to the coronavirus crisis, the Monetary Policy Committee lowered the base rate from 0.75% to 0.1% on 19 March. Andrew Bailey, Governor of the Bank of England, commented that negative interest rates are under ‘active review’.
With a negative base rate, mortgage rates are expected to drop again and reduce the burden of mortgage payments on households. Rishi Sunak recently added a stamp duty cut for houses up to the value of £500,000 which will last until 31 March 2021.
Quantitative Easing (QE)
During the mortgage crisis in 2008, the Bank of England lowered the bank rate and initiated quantitative easing to reduce the cost of borrowing for households and businesses. This encouraged spending, but QE ultimately must be reverted as some point. When this happens, bank rates will increase, resulting in higher mortgage rates.
Quantitative easing is the large-scale purchase of government bonds to lower yields. As the yields on sovereigns approached zero, the Corporate Bond Purchase Scheme (CBPS) launched in August 2016. This triggered portfolio rebalancing into riskier assets and stimulates the issuance of new corporate bonds.
The full unwinding of quantitative easing has not yet taken place. The question is what will happen if the central bank reduces the purchase of new bonds or sells their current bonds.
This is not likely to happen in the short term. On 17th June, the committee voted to increase the stock of government debt by an additional £100 billion to raise the total stock to £745 billion . They will also continue with a £200 billion purchase of government bonds and corporate bonds.
People are still worried about the consequences of an active unwinding of quantitative easing. Former Fed Chair Ben Bernanke worries that “in practice, attempts to actively manage the unwinding process could lead to unexpectedly large responses in financial markets”. The taper tantrum in 2013 is a famous example of how US Treasury yields spiked when the Federal Reserved announced the future tampering of quantitative easing. Even though that plan was never put in motion, it demonstrates how yields and bank rates could make drastic changes in the future when the central bank reduces QE.
If the Bank of England attempts to reduce quantitative easing, rising bank rates will result in higher mortgage rates and impact the ability of households to meet their payments. If the cost of a mortgage increases, people might also decide to take on a lower mortgage amount. This, in return, impacts the capital that consumers can put up for a property, and thus the ultimate price of the property.
The size of the residential mortgage market changes continuously based on the amount of newly issued mortgages and the repayments made on existing ones. The mortgage market increases if the value of new mortgages exceed the repayments paid on existing mortgages.
Mortgage market activity was extremely high before the mortgage crisis and the amount of newly issued loans have never approached pre-crisis levels again. Even though the absolute mortgage market growth in 2019 reached similar levels as seen in 2007, the growth relative to the GDP is lower. This means that the mortgage market is in a healthier situation now compared to 2007, and more deleveraged.
The lockdown has had significant impact on the residential housing market. Property transactions in April decreased by 53% compared to the year before. This can mainly be caused by restricted viewing and employment uncertainty. The mortgage market has further exhibited recent shrinking as more repayments are made than new lending secured. This was last experienced when the market shrunk in 2009.
Figure 4 – Repayments and new lending by households
Savings and credit
Mortgage rates are dependent on the loan-to-value (LTV) ratio and that is linked to the down payment that households can afford for a property, and therefore the amount they have been able to save.
The lockdown has severely impacted consumer spending, as people were restricted in transport, entertainment and holidays. A recent Barclays report indicates that consumer spending was down by 26.7% compared to a year ago. As a result, people have been increasingly paying off outstanding credit and increased their saving rates.
Figure 5 shows monthly money flows with banks and building societies by households, private non-financial corporations (PNFCs) and intermediate other financial corporations (OFCs).
Households have saved record amounts in April, May and June. In addition to that, household credit has been reduced on average. The question is if this money will all be spent in the following months now that restrictions are being relaxed.
Figure 5 – Monthly savings by households, PNFCs and OFCs
The UK is currently at a stage where it can start to rebuild the economy. The easing of the lockdown restrictions has allowed restaurants and pubs to open up again, which should reduce the number of people on furlough and incentivise consumer spending.
The uncertainty in employment and the ability to work from home has undoubtedly impacted the housing market, resulting in a decline in housing prices over the past four months.
The development of certain macro-economic variables should provide valuable insight into how the housing market will recover. Changes in income have historically been correlated to changes in the housing market and people should therefore focus on how the GDP and employment statistics will develop in the months to come.
Even though there were many downfalls to the lockdown, there are many opportunities for PropTech companies to generate new traction in the housing market.
Covid-19 has presented an opportunity for innovation in the PropTech industry, with companies like Matterport enabling an immersive 3D experience for digital property viewings. Moreover, there are smart brokerage platforms, such as Purple Bricks, that can provide virtual valuations as well.
Aside from uncertainty that people have about their jobs, the conditions for taking a mortgage and buying a house have improved considerably during the lockdown. Bank rates have decreased, private savings have increased, and there is no stamp duty to be paid in the coming 6 months. If the economy recovers well, this could present a favorable juncture for people to enter the housing market.