Property prices in the UK are now growing at their fastest rate for four years, but will the property boom continue?
A new report has shown that property prices increased by 0.8% in March, however this headline figure hides the fact that it is mainly rises in London house prices that are contributing to this figure – price increases were more modest throughout the rest of the UK.
There are various factors at work to determine how property prices will fare in the future, however one of the strongest drivers is a continuing shortage of housing.
Low house occupancy drives prices up
The biggest concentration of second homes is in central London, presumably because people work and live in London during the week and then go back home somewhere else at the weekend. This creates low occupancy rates which when coupled with a scarcity of property in London, drives up prices.
We also see a rise in the number of second homes purchased in sought after rural areas, so many houses are left vacant for most of the year. This strengthens the demand for these houses, and increases their prices for those who can afford to buy them.
With more people being able to afford second homes in desirable areas, this sector will continue to force house prices upwards unless there is a change in legislation which penalises second home ownership, which is unlikely.
Buy to let and Buy to sit investors can influence prices either way
Buy to let investors are buying up properties in the hope of finding tenants, and drive house prices upwards with a strong demand for this type of speculative investment. In many areas of the UK, particularly London, it has been the buy to let investors who have powered the rise in house prices.
However if rental demand outstrips supply then rents will fall, squeezing the margins available to buy to let investors. Further rises in interest rates may then drive these investors into a loss, forcing them to sell. If this happens, prices will inevitably fall, but would probably not induce a price crash, because of the inherent demand for houses from people looking to buy them to live in.
Rising property prices attracts investors who are prepared to buy new properties “off plan” and then leave them empty for a couple of years so that they can sell them “as new” for a large capital gain. These “buy to sit” investors are mainly large scale investors who have the funds to buy a large numbers of properties, leaving them unoccupied and increasing the overall demand for housing, which drives the house prices up further.
The buy to sit investor relies on increases in property prices to be bigger than their costs, however a general price reduction threatens this business model, forcing this type of investor to start selling their properties.
Rises in interest rates can increase their costs in the same way, so there is huge sensitivity to interest rate rises and market sentiment.
Interest rate rises could drive house prices down
Interest rates have been rising over the last eighteen months and the trend looks set to continue as inflation is now above the threshold set by the Bank of England. A further 0.25% rise is expected in May.
As people have to borrow heavily to buy their homes at current high prices, they are very susceptible to rises in interest rates. Further rate hikes could stop people buying houses, driving prices downwards and for some, unfortunately, into negative equity.
Further interest rate rises would certainly cause house prices to stop increasing and maybe start a slow decline.
When America sneezes…
Widespread problems with escalating debt in the USA is causing house prices to fall throughout the country. Fewer new houses are being built and fewer investors are investing in residential property. House prices over there, could fall further.
All too often, events in the USA are mirrored on this side of the Atlantic. The UK is experiencing record levels of debt and the number of people with debt problems is increasing rapidly. There is a definite risk that the UK debt burden could trigger a downturn in the housing market, as is occurring in the USA now, particularly if interest rates continue to rise.
So will house prices continue to rise?
Taking these factors into account, it is likely that they will, at least during 2007.
What happens in 2008 and beyond will depend on interest rates and the overall burden of debt. We consider that a reduced desire to borrow, coupled with higher interest rates and a saturating rental market will stop house prices rising at the very least, and probably trigger a slight decrease in house prices towards the end of 2008. Time will tell!