HOUSE PRICES WARM AS TEMPERATURES SOAR
(1 August 2006)

• House price growth picks up to 0.8% in July
• Annual rate of growth more than double this time last year
• Rental demand supports house prices as affordability deteriorates

Commenting on the figures Fionnuala Earley, Nationwide's Group Economist, said: “While temperatures soared on the streets, house price growth remained fairly comfortable in July. After three months of broadly flat growth, house prices increased by 0.8% in July. Annual house price growth is now 5.9%, more than double the rate of growth seen this time last year when prices were increasing at an annual rate of only 2.6%. However, the strong rate of annual house price growth reflects the weak patch in prices this time last year. The three monthly rate of growth has picked up slightly compared with last month, but remains on a fairly benign trend. The price of a typical house in the UK is now £167,733, which is £9,385 more than at the same time last year.

“Indicators of market activity suggest that housing market demand remains fairly buoyant. This will help to support prices, at least in the short term. House purchase approvals picked up surprisingly strongly to 120,000 in June to equal the peak at the turn of the year. Indicators of demand early in the house purchase process have also been fairly positive. Estate agents’ stock to sales ratio is a good indicator of changes in the balance of supply and demand in the market and of the direction of house price movements a few months later. The stock to sales ratio has been climbing since the summer of last year. However, the ratio has been broadly stable for the last three months which may suggest some softening in price increases in the latter part of the year.

AFFORDABILITY CONSTRAINTS

“House prices have been increasing more quickly than earnings for some time and fixed rate mortgage rates have been increasing since mid-April. Both of these have caused affordability to continue to deteriorate. However this does not seem to have dampened demand as much as we may have expected. So what has softened the impact of affordability on the housing market?

Worsening affordability curtails demand among potential owners but boosts tenant demand “Strong demand and insufficient supply of housing puts upward pressure on house prices for potential buyers. While some can afford to buy, others will delay and save until they can, and others will choose to rent. As affordability deteriorates there is a flow through these categories as fewer have the resources to buy straight away or the will to save for years to raise the necessary deposit. As a result more people will end up in the third category, having given up on buying for a while and choosing to rent. This reduces the demand from potential owner-occupiers and should relieve the pressure on house prices.

“However, owner-occupation is not the only source of demand for housing. Houses and flats transfer easily between the rental and owner-occupied sectors, so the reduction in demand from owner-occupiers may have been replaced by landlords increasing their demand for house purchase to respond to increased tenant demand. Higher house prices boost tenant demand as potential owners are priced out.

Stronger tenant demand also comes from increased numbers of immigrant workers and from people who choose a spell in rented accommodation to secure a property sale or as a lifestyle choice. The improved quality of rental property has made these choices more attractive than in the past. For the landlord however, this larger pool of tenants means fewer void periods which partly compensates for the higher prices paid.

“While rental yields have been falling as house prices increase, landlords are still attracted by the performance of housing as a long term investment. Evidence suggest that about half see their rental properties as a nest egg 1, perhaps supplementing or replacing more traditional pension investments. Furthermore, access to finance for landlords has also become easier as lenders become more familiar with the risks.

Between 2000 and 2005 the average maximum loan to value for buy-to-let increased from 75% to 85%. More recently the average minimum rental cover required by lenders has fallen back to 125% of debt payments, from 130%. Landlords with growing portfolios also have access to the rising equity in their properties to leverage the purchase of subsequent properties.

LANDLORDS OVERCOME AFFORDABILITY CONSTRAINTS

“Landlords are not the only ones to benefit from rising housing equity as a source of housing finance. There are increasing reports of parents using their own housing equity to help their children raise the necessary deposit or taking joint mortgages out with their children to help them achieve ownership. And, in the same way as credit conditions have loosened for landlords, the Bank of England pointed out “…some lenders have increased their maximum loan to value (LTV) ratios, although average ratios on new lending remain considerably lower than during the early 1990s”. Indeed competition among lenders has not only led to more competitive pricing of loans but also more sophisticated risk assessments which can ease credit constraints such as the income multiples offered.

“Overall the housing market remains fairly buoyant. In spite of rising fixed rate mortgage costs, affordability has not bitten as sharply as we had expected which suggests that buyers are still able to overcome traditional lending constraints. This could be as a result of loosening credit criteria, but also the ability for parents to release their own housing equity to help their children or act as guarantors.

Furthermore additional demand for homes has increased tenant demand and landlords’ incentives to invest. Increased housing equity, more competition and more sophisticated risk assessment techniques have helped both landlords and owner-occupiers overcome some of the traditional affordability barriers. However, while affordability may not be biting so hard now, like a guard dog’s bark, it cannot be ignored indefinitely.”

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