UK: House price affordability improving

Regular readers will know that I like to look at house prices in the context of a 15-18 year price cycle (see note at end). The chart shows real house prices (i.e. adjusted for inflation) and illustrates the cycle clearly, with peaks in 1973, 1989, 2007 and 2022. The real house price adjusted down about 10% between 2022 and 2024 but has started to climb again. An alternative measure, comparing house prices to incomes, suggests there has been a larger fall, about 15%, and it is still declining (see following chart).

Past bear markets (1973-77, 1989-1995 and 2007-13), lasted 4-5 years, and prices fell far more in real terms (33%, 29% and 26% respectively). So, there is a risk that the current correction is not over. However, those historical episodes saw very high unemployment, 8.4% in 2011and even higher last century, compared with 4.7% today.

Valuations down but not cheap

What about valuations? In relation to incomes UK house prices are still about 10% more expensive than in 2013, the low at the end of the last bear market, while in relation to prices, they are 20% above. There is a long-run up-trend in real house prices so the latter is not too concerning. The still-elevated level in relation to incomes, however suggests there could be more adjustment to come.

With CPI inflation likely to remain above 3% in the next year and wage growth likely to be around 4-5%, nominal house prices could rise slightly over the next year and still see a further correction in valuations. If nominal prices stayed constant for two years, valuations could decline by as much as 8-9% vs wages, which would lower valuations near to those at the trough of the last cycle. That said, the slump in the 2010's was doubtless worsened by the extreme pain of the GFC and then the renewed UK economic slowdown during the Euro crisis. Depending on the course of the economy in coming years, valuations might not fall as much this time.

Recent price trends

House prices have been soft over the summer, following a lift last winter when buyers took advantage of a temporary stamp duty holiday for lower-priced homes. The latest RICS survey suggests ongoing price weakness while major agents suggest stable or slightly-rising prices near term. This is on a nation-wide basis: there are regional and local variations of course, with the north of England, Scotland and Northern Ireland seeing rising prices while the South is generally weaker and the South West has seen falling prices.

Hopes for lower rates but this depends on lower inflation

Longer-term hopes rest on lower interest rates as inflation comes down, alongside a continuing economic upswing. However, while interest rates are likely to fall, they are unlikely to go back to pre-Covid levels. And Bank of England cuts depend on inflation and wage growth slowing, which will reduce the underlying potential for house price increases.

Difficult environment for investors

Meanwhile, the environment for investors remains difficult, with taxes and regulations less favourable than a decade ago. Also, with a Labour government, there is potentially the risk of rent controls, which exist already in Scotland. On the plus side (for investors), the less favourable environment has reduced the supply of rental housing in favour of owner-occupied housing, with the predictable result that rents are strong. High immigration in recent years as well as strong wage growth have had the same effect. However, wages have slowed as has immigration. Rental growth is slowing but should stay positive given very limited new supply.

Overall, the bear phase of the long cycle may have further to go, but there has already been a significant valuation adjustment and, with stable or slightly-rising prices in 2025-6, valuations will improve further. That should lay the basis for a new long upswing, potentially lasting for a decade or more, though if the inflation target of 2% is achieved, price gains will be steady rather than rapid.

A note on the long cycle

Obviously, the charts show only three cycles, hardly enough for a definitive pattern. But there is evidence of a cycle of a similar length in other countries too (e.g. the US, Canada, Germany and Hong Kong). The empirical claim for a long cycle goes back to Homer Hoyt writing in the 1930’s on Chicago land prices over the prior century. The theoretical basis is that, after a bust, it takes ten years or more for buyers and banks to regain optimism.