Written By: Steven Winter – Corporate Finance
Average house prices in the UK have increased by a yearly rate of 6.2 percent in the year to January 2017 (up from 5.7 percent in the year to December 2016), continuing the strong growth seen since the end of 2013. However, this still remains below the average annual house-price growth seen in 2016 of 7.4 percent. Indeed, after the vote of June 23, 2016, in favour of the United Kingdom’s exit from the European Union raised many questions about the UK’s future as the world’s fifth-biggest economy, it seems that 2017 is beginning with some good news.
The graph of the House Price Index published by the Office for National Statistics reveals an upward trend for the beginning of 2017 that should put confidence back in the minds of investors.
Of course, when speaking of the United Kingdom, one should distinguish Scotland, Ireland and England. But referring to England, the following map shows encouraging evolutions in price in some regions.
In total, over one year, England saw an increase in real-estate prices of 6.5 percent and London 7.3 percent, according to the latest government publication.
Brexit has not yet caused a housing-market price collapse; however, volumes and mortgages are worrying.
The volume of sales strongly decreased in 2016; for instance in November 2016, the volume of sales in England was lower by 21.2 percent compared to November 2015. But the final statistics have not yet been officially published so there is a chance that November sales had been agreed on a few months before, right after the Brexit vote.
In its February 2017 Agents’ Summary of Business Conditions, the Bank of England wrote that housing-market activity had been sluggish overall and was expected to remain so over the coming year. And the Bank of England expressed concern about the level of debt of some landlords. The level of indebtedness of British households increased rapidly in 2016. Even if consumer credit is progressing more rapidly than mortgage credit, the Bank of England intends to take measures in case interest rates increase.
This unavoidable scenario of increasing rates in the future could put some households in great difficulty.
The Bank of England’s Prudential Regulation Authority recently introduced tougher underwriting standards and affordability assessments to ensure borrowers can cover the costs of their mortgages in the event of a rise in interest rates. Lenders are required to comply with the following main rules:
- They have to set a minimum borrower rate of 5.5 percent during the first five years of a buy-to-let mortgage contract when assessing the affordability of the borrower;
- They will also have to take into account annual rent rises of 2 percent when assessing whether a landlord can afford a property;
- Landlords with four or more rental properties will be subject to stricter checks on income and debt from September.
- Until now the rental amount should cover the mortgage costs with a minimum 125 percent ratio. This ratio will now be raised to 135 or 145 percent, depending on the lender.
The new regulations could impede existing borrowers’ ability to borrow fresh money for new mortgages. They could be stuck with their existing situations, within a context in which interest rates increase. In terms of amounts, £62.8 billion of new residential loans was advanced to individuals from October to December 2016. This was a very small decrease of 0.4 percent over the previous four quarters. The share of first-time buyers in new mortgage advances reached its highest level since the time series began in 2007, representing 22 percent of all new mortgages. Of course, the share of existing owners declined.
Prudential rules are not the only break for existing landlords.
Announced in 2015, the tax reform for buy-to-let landlords is probably going to moderate the appetite of the landlords; today UK landlords have to pay tax on the difference between rental income and mortgage interest. But now they will have to compute their tax on total rental turnover, less a fixed tax relief that will progressively decrease. Starting in April 2017, landlords will no longer be able to deduct 100 percent of their financial costs from their property income. They will instead receive a basic rate reduction from their income-tax liability. For instance in 2017 to 2018, the deduction from property income (as is currently allowed) will be restricted to 75 percent of finance costs, with the remaining 25 percent being available as a basic-rate tax reduction.
2017 will be a transformative year for the real-estate market in the UK. But it can probably count on some foreign investors to take advantage of the weakness of the British pound, the rising real-estate prices and the attractiveness of London for the wealthiest families and investors.