In a recent webinar for Investec, Philip Shaw, Chief Economist at Investec, and Tom Bill, Knight Frank’s Head of UK Residential Research, reflected on how this climate could affect transaction levels and price trends. Read on for a summary of the key points they discussed or watch the video in full here.

Read highlights from the discussion:
  • How are rising interest rates impacting the property market?

    P: Interest rates have not finished rising. The base rate began at around 0.1%, but after five successive interest rate increases at the Bank of England's Monetary Policy Committee meeting, we're now at 1.25%. Historically, that's still pretty low and not likely to ward off various inflation pressures hitting the economy right now.

    There's not much the Bank of England can do about price increases and prospective energy increases in the pipeline, but its goal is to reduce inflation down to 2% in about two to three years’ time.

    T: The property market will be impacted in a couple of ways. First, mortgage rates are going to increase, and we’re seeing lenders pulling their best deals on a weekly basis.

    There are a lot of people on fixed-rate mortgages who won't be immediately hit, but as they come off these fixed-rate deals, there will be some financial pain felt which will dampen demand.

    Secondly, since the Bank of England put the base rate up to 1%, there has been a noticeable impact on market sentiment. People are anticipating more bad news, so there’s been more prospective sellers coming to the market. This has seen supply and demand become more balanced.

    We'll see how that progresses through the year, but it’s given people a wake-up call in the short term. In the longer term, we will see more downward pressure on demand from rising mortgage rates as things return to normal.

  • There are talks of a possible recession in the UK. Is this where we're heading, in your opinion?

    P: Put bluntly, yes. The economy has not expanded in three of the four months this year so far.

    Right now we’re facing a cocktail of higher interest rates, tax increases and higher inflation. Given this hasn’t been matched by high wage increases, the economy has slowed down. Essentials are costing people more, and they have less money to spend on discretionary items, which is slowing demand [for goods and services].

    The same thing is happening in the corporate space, where higher inflation and higher interest rates can slow down corporate investment.

    There has been some mitigation for lower income households from the Chancellor, but these will only come into effect later this year. Overall, you're looking at a consumer facing a 2% hit to real incomes in aggregate over this year.

    T: When the word ‘recession’ is thrown around, it can have a psychological impact on buyers and sellers – there doesn’t necessarily need to be a recession for the impact to be felt.

    What's happening in the economy isn’t necessarily reflecting what’s happened in the property market however, which seems to have ‘defied gravity’ over the course of the last 18 months. House prices are rising despite inflation being so strong because of supply chain disruption in the housing market.

    We're not currently factoring in a recession into our forecast. We're not seeing any warning signs that tell us a housing market correction is coming. We don’t expect house prices to fall, but they'll certainly slow down.

  • Speaking of supply and limited stock in the housing market, why are we simply not building more housing?

    T: New-build homes are a drop in the ocean compared to the wider second-hand market.

    It's best to think of the UK as a series of local markets with local demand and supply drivers. We do need to build more houses across the UK, but there are only a certain number of house developers who can fulfil that demand in an area. Developers will build houses according to where there is supply.

  • Are we settling in for a period of long term instability in the world economy?

    P: We hope not, but there are a number of factors in play that have impacted supply. One being the war in Ukraine.

    Ukraine is one of the top ten wheat producers in the world, and its fifth biggest exporter. The Black Sea blockade is restricting wheat exports and wheat supply, causing shortages and inflation globally. Another commodity from Russia, potash, is a major ingredient in fertiliser which helps increase food supply. So you put those two things in the equation and you have severe disruption to various parts of the world economy.

    We hope these will pass in due course, but the reality is that we can expect a difficult economic period in the UK.

  • Are you seeing international buyers return to the market?

    T: Yes, but numbers are not back to the levels that they were before the pandemic. We think that's going to support prices in markets like prime central London, North Surrey, and other areas where international buyers are most prevalent.

    One of the factors driving them back is currency related; the Sterling has taken a hit over the last few weeks which is helping. There’s also the perception that real estate has very attractive investment qualities.

  • Historically house prices correlate to interest rates, and at the end of the increase cycle we see property prices soften. Do you expect this to be the case this time around?

    P: There are relatively few periods where you see sustained falls in house prices in individual markets.

    What you would tend to see is that house prices are pretty flat, rather than an outright decline in difficult economic times. It partly depends on how far interest rates have to rise.

    We anticipate a bank rate peak of 2%, but If you look at what's being priced into markets, they're looking at 3%. We think that's excessive, and we won't need interest rates to rise that quickly or that far.

    T:  I think we’ll gradually see house prices return to normal. Property has been behaving in a way that's taken most people by surprise, mostly because of supply chain disruption.

    We anticipate double-digit growth will go back to single-digits. After that it will come down further; staying in the low- to mid- single-digits for the next three or four years.

    There will be regional differences however. We expect parts of the country, such as the Midlands and Eastern parts of the north, to outperform markets like London over the next four to five years. London as a whole we think is going to underperform.

  • How does that translate into the rental market? How will London property perform as an investment going forward?

    T: The rental market has been crazier than the sales market. Rents in prime parts of London are sitting at 20-25% plus annual bases. This is because they plunged at the start of 2021.

    Supply is very tight, and will get tighter over the summer. International students will be coming over, international corporate relocations will begin to pick up, so there’ll be competition for stock.

    There's some easing going on, but given it's a seasonal market, it's going to be very tight over the next three to four months. I don’t think it will be back to normal for the lettings market this year, but we expect rents will start to come down to about 10%.

  • How does the central bank raising interest rates slow down inflation?

    P: Looking at the 54% increase in the energy price cap in April, and the anticipated 50-55% in October, there’s nothing interest rates can do about that.

    Central banks are generally concerned that with a series of high rates of inflation, you get inflation-busting pay awards. Banks are against this happening because once you get an inflationary wage spiral, they are very difficult to close.

    Also, inflation is rising because of lack of supply. Central banks can't do much about supply but they still have to contain inflation. So with periods of limited supply, there is a tighter policy to reign in demand.

  • When is a good time to buy a house when house prices are this high?

    T: The answer I give is to not think of it as an investment. It's a good time to buy when you need a property, and it suits your needs.

    Trying to read, and play the market is much trickier. That said, it's always good if you spot an opportunity. For example, it would have been a very good moment to have locked in a five-year mortgage back in September last year.

    The other thing is that you can't beat the power of local knowledge. If you know the ‘right’ or ‘wrong’ sides of a street in a particular area, investing in knowledge can be quite beneficial. Things can really vary from postcode to postcode, so local knowledge is a real advantage.

  • What is your five-year view on interest rates?

    P: Central banks are more concerned about inflation than they were a month ago. If you look at various central banks around the world, you’ll see they’ve stepped up the pace of increases.

    The Bank of England has actually been a lot more cautious and started raised gradually in December last year.

    In the UK we might see three reductions in the bank rate by 0.25%, bringing us back to 1.25%. Hopefully then the economy recovers, and interest rates can start to rise gradually. It depends on global supply chains, and how the world economy performs as an integrated unit. I anticipate interest rates rising then next year beginning to fall, and a couple of gentle increases thereafter.

  • Why do you think there is such low continued supply, particularly in the London market?

    T: Hopefully it's turning a corner, but there was a vicious cycle where people couldn't find anything to buy and couldn't list their property. There was a frenetic market for many months, as things were flying off the shelf very quickly. Quite often it is just the nature of the residential property market, which is a fairly slow moving asset class.

    I think we’ll see more supply coming through now, and hopefully will start a more balanced market because demand has been so high.

  • We’re seeing a lot of offers above the asking price. Will transactions below asking price be something we see again?

    T: Absolutely, they will inevitably come back as the market starts to decline and prices calm down.

  • Are there possibilities of further support for house buyers from the government?

    T: By the time the next election comes around, I can see housing moving a little bit more into the centre stage, but I don't think there'll be another stamp duty cut. What you might see is the government looking at things like downsizing and stamp duty easing in the context of social care issues.

    Right now, I'm not sure the Government has any bandwidth before the next election to make any meaningful adjustments to property taxation.

  • Would you expect interest rates to be higher or lower than current levels in two years’ time?

    P: “Looking historically at interest rates, in the ten years running up to the financial crisis rates averaged about 4.5%. Between the end of the financial crisis and beginning of the Covid period, rates didn't go beyond 0.75%.

    Where we end up over the medium-term depends on a couple of factors. It partly depends on how rampant inflation pressures are; if wages overtake inflation, the bank will have to step hard on the brakes. Then, we might see a period where interest rates are high by recent historical standards. We don't anticipate this happening, but it's a risk we must consider.

    We expect to see rates somewhere between two and 3%. Not next year perhaps, but if we're talking about 2024-2025, that might be the average we’ll see.

  • Given the likely social pressures ahead, do you feel that increasing levels of tenant protection laws will be put in place? If so, what could this do to property prices?

    T: I think it’s inevitable given the way the housing market is used by the Government to make political points. It will be a good thing to protect tenants, but there can be unintended consequences with these things.

    Hopefully there will be a set of pragmatic conditions that benefit tenants as well as landlords, but the government needs to be careful that it doesn’t put people off from becoming landlords.

  • With potentially more people pulling out of property purchases, do you think the English system should be moving closer to the Scottish system where there's more onus on the buyer?

    T: Yes, as I think there’s plenty wrong with the UK’s system. It currently takes an inordinately long time to process transactions. It’s gotten better than it was during the pandemic, but overall the system is pretty antiquated.

    Use of blockchain is being spoken about, but undoubtedly, it might speed up parts of the process rather than revolutionising it.

    In terms of people pulling out of transactions? Yes, I believe there could be better protections in place. Will we see them in the short term? Unlikely, but perhaps over time it'll drag itself into the 21st century.

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