Are UK house prices set to fall? It’s not so simple

Figures suggest UK house prices are starting to slide, but we shouldn’t take these numbers at face value, explains Rupert Hargreaves.

According to UK land registry data, flat prices in London declined 11% between August 2020 and April of this year.
(Image credit: © Getty)

One of the biggest challenges in finance is trying to break down headline numbers to understand what is going on in the real world.

Headline figures often give one picture while deeper analysis of the underlying components of any market can throw up different conclusions.

The UK housing market is no exception. Most house price indexes show that property values have increased across England by a double-digit percentage over the past 12 months. However, in London the increase is closer to around 4% (a negative return in real terms), but even this figure masks a more mixed picture.

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Price growth in London has been strongest in the outer boroughs. Some inner boroughs have seen property prices decline by as much as 9% (Tower Hamlets). And then we need to consider the type of properties being sold.

According to UK land registry data, flat prices in London declined 11% between August 2020 and April of this year. In comparison, house prices increased nearly 20%.

Meanwhile, sales of homes worth £5m or more during the first half of 2022 hit a record, although the average price of prime London property is 14% below 2016 levels.

All of these numbers illustrate how difficult it is to predict property prices, especially in the current economic environment.

Interest rates will have an impact on property prices

Here at MoneyWeek we have long argued that interest rates have been more important to property prices than any other factors. For most, the cost of the monthly mortgage repayment is far more important than the overall cost of a property (unless you’re lucky enough to be an all-cash buyer).

Ultra-low interest rates have reduced the cost of borrowing helping homeowners take out much bigger loans, but with smaller monthly repayments. Of course, other factors have also influenced the market, such as a lack of supply and the change in working patterns during the pandemic. Still, the financial implications of taking out a mortgage are often the most important factor buyers review before making a purchase. No matter how much you like a house, if you can’t afford the monthly cost, you can’t buy it. It’s as simple as that.

As interest rates rise, there are already strong signs that higher borrowing costs are having an impact on the market. According to Halifax, property prices declined by 0.1% between June and July, and that was before the Bank of England‘s latest 0.5% hike.

We can look to other markets to see what might be in store for the UK. In New Zealand, the most unaffordable housing market in the world, the central bank has increased interest rates to 2.5%. According to the country’s Real Estate Institute, property prices fell 2.9% year-on-year in July. The most pessimistic forecasts are projecting declines of 20% if the central bank continues to hike.

Still, these are just headline figures and the underlying fundamentals of different parts of the market are far more nuanced.

Buying a house is not just about the price paid

With the UK energy price cap now expected to exceed £4,000, the cost of maintaining larger properties is going to increase dramatically.

The cost of buying these large properties is also going to increase with interest rates on the up. This trend may push buyers away from larger, older properties towards newer properties that are more energy-efficient.

A survey conducted by global estate agent group Savills showed earlier in the year that buyers would be willing to pay significantly more for properties if they are powered by renewable energy sources. Research from UCL shows that properties with an EPC rating of A&B consume around half as much energy as homes with a rating of E or lower. That could be a difference of several thousand pounds a year, possibly enough to convince a buyer to pay more for a property (reducing bills by several thousand a year will free up cash to maintain higher monthly mortgage payments).

Energy consumption is just one part of the property price puzzle. We also need to take into account factors such as stamp duty and the raft of first time buyer incentives. A first time buyer paying £300,000, will not pay any stamp duty. A buyer moving to a new property worth £600,000, will pay £20,000. In a tough economic climate, this is a significant expense many people are unlikely to want to pay.

First time buyers can also access mortgages with a 5% deposit with the government underwriting part of the loan. Other options such as discounts on newbuild properties, shared ownership schemes, and affordable property schemes can help first-time buyers get on the property ladder with lower financial barriers to entry than other purchasers.

The latest figures from the UK’s largest listed homebuilders seem to confirm this trend. They are all reporting strong order backlogs for new homes worth £300,000 or less.

Smaller, greener homes might buck the trend

So what does this all mean? It seems likely that house prices will come under pressure as interest rates increase. However, I wouldn’t write off every part of the market. Some sections of the market, such as energy efficient homes and property aimed at first time buyers might find support due to the financial incentives available for purchases and lower running costs.

In other markets such as London, which is seeing flat prices fall, but record rents at the same time, the financial incentives for investors are becoming more appealing by the day. And then there’s the prime part of the market where buyers are able to pay millions for a home. These purchasers are unlikely to be worried about energy prices, and they’ll have the money to retrofit properties for energy efficiency.

The parts of the market that seem most susceptible to a correction are those that have been so popular in recent years.

Buyers fought each other to get hold of larger homes outside cities in 2020 and 2021. As the cost of running these properties goes up and mortgage rates increase (a significant percentage of the buyers who purchased in 2020 on two-year mortgages are going to have to refinance in the next 12 months) we could see a correction here.

The holiday home market has also exploded over the past couple of years with demand for properties in coastal regions for outstripping supply. With holidaymakers now returning to international destinations, the demand for staycations may have peaked. With many locals now priced out of the market in these regions, sellers will have to drop prices significantly if they want to get out.

So overall, it seems to me that as interest rates increase, the UK property market as a whole is going to face some challenges. However, just as some companies may be able to navigate the current economic climate better than others, some properties may be able to buck the wider trend.

Rupert Hargreaves

Rupert was the former Deputy Digital Editor of MoneyWeek. He's an active investor and has always been fascinated by the world of business and investing. 

His style has been heavily influenced by US investors Warren Buffett and Philip Carret. He is always looking for high-quality growth opportunities trading at a reasonable price, preferring cash generative businesses with strong balance sheets over blue-sky growth stocks. 

Rupert has freelanced as a financial journalist for 10 years, writing for several UK and international publications aimed at a range of readers, from the first timer to experienced high net wealth individuals and fund managers. During this time he had developed a deep understanding of the financial markets and the factors that influence them. 

He has written for the Motley Fool, Gurufocus and ValueWalk among others. Rupert has also founded and managed several businesses, including New York-based hedge fund newsletter, Hidden Value Stocks, written over 20 ebooks and appeared as an expert commentator on the BBC World Service. 

He has achieved the CFA UK Certificate in Investment Management, Chartered Institute for Securities & Investment Investment Advice Diploma and Chartered Institute for Securities & Investment Private Client Investment Advice & Management (PCIAM) qualification.