House prices in the UK's biggest cities might be set to follow rents lower

I've written a fair bit about the housing market over the past year. The big headline-grabbing story has been that, despite Covid-19, house prices have surged (which is a global phenomenon, not just a UK-based one).

However, there's another, arguably more interesting phenomenon going on. And it's one that suggests that in certain areas at least, the surge in prices may run out of steam.

Rents have collapsed in some of the UK's biggest cities

House prices in the UK and elsewhere shot up last year. That's not much fun for first-time buyers, and it's probably not what most of us expected when the global economy was shutdown by a nasty virus. But something much more interesting has happened in the rental market.

According to property website Rightmove, in the fourth quarter of last year, the average rent across the UK went up by 3.7% on an annual basis. That's relatively unremarkable. What's a lot more interesting is that prices in major cities absolutely collapsed. Average asking rents (and bear in mind that achieved rents are likely to be lower) fell by 12.4% in inner London, while Edinburgh city centre has seen rents dive by 10% and Manchester saw a fall of 5.3%.

Why's this happening? Because supply has exploded. Again, according to Rightmove, the number of rental listings has more than doubled in inner London and Nottingham, and nearly tripled in Leeds.

This backs up a lot of the anecdotal evidence I've been hearing. Quite a few acquaintances have managed to get far better rental deals in London during lockdown, trading up to bigger, nicer places in better areas for the same money. The question is: what's driving this and how permanent is the shift? 

Firstly, there's the demand side – people are moving out of the cities. They don't need to be there for commuting purposes, so why not live somewhere that's a bit more bearable during lockdown? It also gives you the chance to try out life in the countryside before you decide whether or not to make the move permanent.

There's also the fact that a lot of workers from overseas left Britain during the lockdown. According to the official data, something like 1.3 million foreign-born workers have left the UK during the pandemic, and of those, about half of them left London.

A lot of news reports seem to be keen to blame this on government policy. But the reality is that huge numbers of overseas workers were in the restaurant, hotel and retail industry. Those jobs are gone for now, and they may not come back. If you haven't got a secure job, do you really want to sit out lockdown in a rental flat in a foreign country, shut away from your family, whose health you might be concerned about? It's no surprise that so many people have left.

On that note, a lot of younger people have also moved back in temporarily with parents who have bigger properties, in nicer parts of the world. Why stay in a small flat in London if you're not getting any of the benefits of being in London, and all of the downside?

Throw in all the university students who aren't going anywhere right now at the student accommodation end, plus all the jet-setting executives who are stuck at home and aren't putting any money into the corporate lettings market, and you can see why there's a demand issue in the cities, particularly those with significant university and financial sectors.

So that's the demand side. On the supply front meanwhile, the collapse in tourism means that short-term lets (properties bought to permanently AirBnB basically) no longer pay for themselves. So they've been converted into long lets and are competing with the traditional rental market.

So it's no wonder that a major tourist city such as Edinburgh (with all those reliable festival profits) has seen rental prices slide so heavily. The question now is: what happens next?

Why big city house prices could be heading for a fall

As with everything else about the housing market, most of this is about how permanent the changes we've seen might be. On the demand side, the students and the high-flying execs will probably come back before too long. But the shift to working from home suggests to me that demand to live in cities will be lower.

It's also an open question as to how many overseas workers come back. Ultimately, that will depend on the economics, as it always does. Are there jobs to be had? How many of those retail and leisure industry roles are going to still exist? And do they pay sufficiently more than the jobs that can be had elsewhere? Finger in the air stuff here – but I would suspect that in the long run, this adds up to at least a slight drop in demand relative to the past.

What about supply? Tourism will eventually come back. But can those AirBnB hosts hold out for that long? Which is before you start to consider that long-term lets are very different to holiday lets (both in practical terms and for taxation purposes). Overall, this points to ongoing downwards pressure on rents. If you're a landlord, that's a problem.

The most obvious way to decrease the quantity of rental property on the market is for some of it to be sold. But you're going to struggle to sell it to another landlord in this sort of environment. So your most likely market is first-time buyers.

This could end up being the mechanism by which our cities start to become more affordable. If homes in London (or Edinburgh) no longer command the same rental yields they once did, then prices have to fall to make it worth people's while to buy.

As Marcus Ashworth and Stuart Trow pointed out on Bloomberg the other day, "skinny rental yields... have long been a feature in London... Rental properties have often been held as more of a trophy asset, with owners comforted by the perception of liquidity and endless international demand... Now this illusion is faltering".

So, surprising as it may seem right now, it's just possible that London and our other big cities may become significantly more affordable in the coming few years. Of course, by that point, everyone might not be quite as keen to live in them.

Meanwhile, if you're currently renting in the city (particularly London or Edinburgh) and you haven't moved in a while, get on a listings website and have a look around. You might be pleasantly surprised at what you can trade up to.