House prices are set to fall by 5% between now and the end of 2024, according to the latest research. Such a drop would reverse a fifth of the surge in house prices since the pandemic began.
The research, which is adjusted for the rise in interest rates, was conducted by independent economic research consultancy Capital Economics. The analysts correctly forecast that house price growth would be stronger than others anticipated this year, forecasting that house prices would rise by 5% in 2022 in September when the consensus was 1.6%. Even this prediction was cautious: house prices have already risen 4% this year to date, and given strong transactions and limited stock, Capital Economics have raised their Q4 2022 forecast to 9% y/y.
However, the report notes that lenders have been slow to pass on rising interest rates so far, so they expect a sharp rise in mortgage rates in the months ahead. For example, some banks are offering 60% LTV mortgages at 2.2%, in line with the 2-year interest swap rate. If Bank Rate were to rise as expected by financial markets, lenders would make no profit on such loans so it is inevitable that rates will rise further.
Therefore, Capital Economics expect the average rate on new mortgages to rise from 1.8% in Q1 to 3.3% by end-2022 and to a peak of 3.6% in 2023 as lenders rebuild their margins. That would be the sharpest rise in mortgage rates since 1990, consistent with an abrupt slowdown in house price inflation. (See Chart 1.)
Indeed, the first signs that the market is on the turn are already appearing, say Capital Economics. Google trends show that visits to property websites dropped back to their lowest level since May 2020 this month, and the Royal Institution of Chartered Surveyors (RICS) housing survey suggested that quarterly house price growth will cool to zero by Q3. Meanwhile, GfK consumer confidence plummeted to -38 in April, close to the all-time record low of -39 in 2008.
Despite this, the report makes clear that they are not expecting a repeat of either 2008 or 1990, when house prices fell by about 20%. First, while the house price-to-earnings ratio is roughly the same now as in 2007, a return to pre-financial crisis mortgage rates of 6% is not expected, so the cost of mortgage repayments will remain much less of a burden. Second, strong pay growth means a modest fall in prices will be enough to return the house price-to-earnings ratio to a more sustainable level.
The report concludes that despite the consensus forecast being a further small rise in house prices next year, it is expected that they will fall by 3.0% in 2023 and 1.8% in 2024. (See Chart 2.)