Perspective - Markets

This is why UK house prices might be sturdier than you think

Brexit uncertainty appears to have hit sentiment for UK property, but while certain sentiment indices have led to gloomy headlines, actual home price results have been much better.

27/02/2019

Michelle Russell-Dowe

Michelle Russell-Dowe

Head of Securitized, US Fixed Income

Chris Ames

Fund Manager, Fixed Income - Global and US Securitised Credit

The disconnect between sentiment surrounding house prices and actual price results is important for investors in UK mortgages to appreciate, and potentially creates value for those that can go the distance in looking at the data.

Once a month, the Royal Institution of Chartered Surveyors (RICS) index asks its members (property appraisers) if they expect UK house prices to go up, stay the same, or go down over the next three months. The RICS index subtracts the percentage that predicted “down” from the percentage that predicted “up” to deliver the reading. The index does not give any idea of the magnitude of expected price movement, just how broadly the group believes in the direction.

We can see from the chart below that property appraisers have been predicting near-term price declines since August 2017.

RICS House Price Expectations Index continues to see price declines

price_expectations_RICS_UK

Source: RICS, January 2019

But the Nationwide Building Society’s house price index tells us quite a different story. The Nationwide indices track actual house prices for the UK and London (over time, adjusting for housing quality, mix, and seasonality). These indices provide a good picture of actual home price changes nationally and regionally.

 According to the Nationwide House Price Index, values are up about 45% since the lows of 2009, while prices for homes in London are nearly double that of their 2009 level. Even since the Brexit vote, house prices have, nationally, risen by about 5%, whereas house prices in London have fallen by about 1%. These actual price changes clearly contrast with the powerfully negative sentiment of the RICS Index shown in the first chart.

Nationwide House Price Index for the UK (all regions) and London

House_prices_NationWide

Source: Nationwide Building Society, December 2018

Why is there such a difference?

The different pictures represented by the RICS and Nationwide indices is, ostensibly, puzzling. After all, the RICS index is a survey of surveyors, who should know prices better than anyone else. Surveyors expected near-term price declines for nearly 18 months, where actual prices have either grown or showed a very minimal decline. We believe the answer to this question lies in transaction volume.

Houses are different from most other assets. They have day-to-day utility value and they represent a “good” that owners both consume (use) and regard as an investment. Typically, transaction costs are high and there is no perfect substitute. So when asset prices decline, or when selling conditions deteriorate, the first thing that happens is that homeowners become (unless they have a pressing reason to sell) less likely to put their home on the market.

It’s worth noting that UK mortgages are “full recourse” to the borrower. That is, there’s no “walk away” option in the event the value of the home is lower than the amount that has been borrowed. The borrower remains liable for the difference between the sale value and the amount borrowed, which is not always the case in the US. The recourse aspect is a distinct difference between UK and US housing finance.

The charts below show that sales of residential property are markedly lower in the UK and in London since the Brexit referendum.

Residential property sales have sharply declined since the Brexit vote

UK_resi_house_sales

London_resi_house_sales

Source: UK Office for National Statistics, December 2018

Since the Brexit vote, residential property sales volumes have declined 12% nationally, and they have declined 30% in London. This is good evidence that while the negative expectations for house prices don’t necessarily lead to house price declines, they can lead to transaction volume declines. This in turn reduces available supply, which then provides a cushion to house price changes.

We’ve seen this mechanism at work before. The chart below shows house prices and transaction volume over a longer term. During the financial crisis, home prices declined by 20%. However, the volume of transactions declined by 63% over the same period. With the reduction in home sales, property available to buy declined. Prices began improving again less than 18 months after the initial falls.

The decline in UK housing in the wake of the financial crisis provided a floor to house prices

house_prices_versus_volume

Source:  UK Office for National Statistics, December 2018

House prices are sturdier than you think

We think this voluntary supply limiting mechanism, which is driven by the asset characteristics of homes in the UK, will serve as a support, or floor, for house prices in the UK.

The reciprocal agreement already agreed between the UK and the EU will allow EU citizens who currently reside in the UK to remain even after Brexit, so there won’t be any forced selling from that front, at least over the foreseeable future. And a “hard Brexit”, which carries the risk of rising unemployment, is a low probability event.

In summary, while headlines have focused on the RICS decline, there are some tricks to considering the transmission of gloomy sentiment to lower asset prices. For professional investors, owning “seasoned” UK mortgages – mortgage loans that have had exposure to the 2007-2009 asset price decline – may even be an attractive way to gain some “Brexit” premium, in a market with borrowers that have been tested previously through a period of asset price stress.