HBOS is predicting a fall in house prices of 2% in 2005.
This slight fall follows nine years of rising house prices when the average home has increased in value by almost 100,000, a 160% increase.
Beyond 2005, it expects the market to record modest price increases and affordability to improve, especially for first-time buyers, who it says will return to the market in larger numbers than in recent years.
The index says housing market fundamentals are sound. Past major housing market downturns have all been caused by a combination of economic recession, steeply rising unemployment and significant rises in interest rates directed at controlling retail price inflation.
However there is very little likelihood of a similar combination occurring over either the short or medium term, UK plc is in good shape.
HBOS also says there will be some variation in regional house price performance, albeit within a much narrower range than in the last few years. It expects Scotland, 3% and Northern Ireland, 4% to record the biggest price gains whilst the South East, -5% London, -4% and the South West, -4% will experience the most significant price falls.
The survey estimates that the value of housing assets exceeds the total value of outstanding mortgage balances by 2,400bn. Taking general price inflation into account, housing equity is at a record high, at 1,300bn in 1987 prices, and is 66% higher than in 1989.
It predicts the base rate will fall to 4.25% by the end of 2005, and believes that rates have now peaked at 4.75%, and expect the Bank of England to reduce rates by half a percentage point during 2005.
As a result, affordability will improve with the average mortgage servicing cost falling to 16% of earnings for new borrowers.
It says housing market fundamentals are sound. The economy’s strength, the high level of employment and low unemployment, together with the lowest interest rates since the 1950s, have been key factors behind the recent sharp rise in house prices.
Halifax research shows that employment is the strongest driver of house price movements and the level of employment is currently at a record high of 28.4m, 232,000 higher than a year ago.
Past major housing market downturns have all been caused by a combination of economic recession, steeply rising unemployment and significant rises in interest rates directed at controlling retail price inflation.
It says there is very little likelihood of a similar combination occurring over either the short or medium term.
It expects earnings growth to outstrip house price growth in 2005 for only the second time in ten years. Average earnings are predicted to rise by 4.2% in 2005: significantly ahead of house price inflation across most of the country.
As earnings growth outpaces house price inflation, the ratio of house prices to earnings will fall from a peak of 5.6 in mid 2004 to 5.2 at the end of 2005.
This reduction will begin to make it easier for first-time buyers to get onto the housing ladder. Affordability has been a key factor for first time buyers resulting in a sharp drop in their numbers over the past two years.
For example, first-time buyers account for for less than three in ten of all new mortgages in 2004. This is well below the longer-term average of almost one in two.
Affordability remains good and will improve in 2005. The expected modest reductions in both house prices and interest rates in 2005 are calculated to reduce mortgage payments as a percentage of earnings for new borrowers from its current 19%.
This is in line with the long-term average and well below the peak of 34% in 1990 to 16%.
Supply constraints, especially in the south of England, will underpin the market. Recent ONS household and population projections for the next 20-25 years show that the demand for additional homes will be even greater than previously believed.
The population in London and the South East is expected to rise by around 15% between 2003 and 2028 with an additional 1m people living in the capital.
Housing transactions are forecast to be lower in 2005. It expects property transactions in England and Wales to fall from 1.77m in 2004 to 1.5m in 2005, says official Inland Revenue statistics.
Changes to the collection of these figures in 2003 means that these figures are not directly comparable with historical levels of turnover.
In the medium term, the market will be underpinned by better affordability and generally good economic conditions. Earnings are expected to increase more rapidly than house prices, leading the ratio of house prices to earnings to decline from its current historically high level.
The housing market will be characterised by modest price increases and a steady improvement in transactions beyond 2005.
There will be some variation in regional house price performance, albeit within a much narrower range than in the last few years. Price rises outside the south of England have contributed over three-quarters of the rise in overall UK prices in 2004.
Those regions that have seen the biggest price increases over the past year, northern England, Wales and Scotland, are expected to experience a significant easing in house price inflation next year.
Prices, however, are predicted to rise by a small amount with the biggest gains in Scotland, 3% and Northern Ireland, 4%. These regions have the lowest prices in relation to earnings, suggesting that affordability issues, particularly amongst first-time buyers will be a lesser constraint on demand and therefore prices than elsewhere in the UK.
The South East, -5%, London, -4% and the South West, -4% and are expected to record the most significant price falls. We also predict modest falls in East Anglia, East Midlands and West Midlands.
These falls will return prices to the levels they were at either late in 2003 or in early 2004. Prices are expected to fall in those regions where house prices are highest in relation to earnings.
The north/south divide will narrow further. These increases would result in average house prices in the south being 1.6 times as high as in the north at the end of 2005, well below the peak of 2.2 in 2002 Quarter two.
Taking a longer historical persepective, the north/south divide would be slightly wider than ten years’ ago, 1.4 in 1995 Quarter four. In monetary terms, the gap would have widened by more than three and a half times with prices in the south almost 73,000 higher than in the north, on average, at the end of 2005 compared with a premium of 20,000 in 1995 Quarter four.
In real terms, housing equity is at a record high. The rapid rise in house prices over the past few years has resulted in a substantial increase in the amount of housing equity held by homeowners.
Halifax estimates that the value of housing assets exceeds the total value of outstanding mortgage balances by 2,400bn. Taking general price inflation into account, housing equity is at a record high, at 1,300bn in 1987 prices, and is 66% higher than in 1989.
The average level of housing equity per private dwelling has risen substantially in recent years, rising from 37,000 at the end of 1995 when prices began to recover following the fall in house prices in the early 1990s to an estimated 114,000 now.
This is more than twice as high as the average level of housing equity at the peak of the late 1980s housing boom.
The mortgage market is expected to slow in 2005 as a result of the lower level of housing market turnover and the slight fall in prices. Gross lending is predicted to total 270bn next year compared with 295bn in 2004.
Net lending is expected to fall to 90bn from 102bn this year. Despite this decline, mortgage lending is forecast to remain higher than in any year except 2003 and 2004, substantially exceeding the average annual level for the period 1995 to 2004 of 148bn for gross and 50bn for net lending.
The shape of the mortgage market will also change. In particular, it expects the proportion of first-time buyers to increase steadily from a record low of 28% in 2004 as affordability improves.
Remortgage activity, estimated at 42% of gross lending in 2004, is also expected to decline over the medium term, although there may be a modest increase next year.
Buyers have been putting down bigger deposits than in previous cycles. 83% of all new borrowers took out a mortgage of less than 90% of the house price in the third quarter of 2004, says the latest figures from the CML. This compared with 56% in 1989 and 1990.
The number of borrowers taking out 100% loans has also remained consistently low over the past few years, comprising only 5% of new borrowers in 2004 compared with 20% in 1989. Consequently, far fewer borrowers are at risk of suffering from negative equity in the event of a house price fall than in the late 1980s and early 1990s.
The proportion of those aged 25 and under buying their first home is historically very low. Those up to 25 account for just 5% of homebuyers compared with around 12% during the late 1980s and early 1990s.
Arrears and possessions remain low. For example, the number of properties taken into possession in 2003 was 7,830, around one-tenth of the total in 1991, which was 75,540.
Arrears and possessions should remain low over the next few years despite less buoyant housing market conditions than in the past few years. This is because levels of interest rates and unemployment, the two key drivers of arrears and possessions are set to remain low.
This is in stark contrast to the rapid rises in both unemployment and interest rates in the late 1980s and early 1990s, which triggered a fivefold increase in possessions between 1989 and 1991.
Economic growth is set to slow in 2005. Over the next twelve months, economic growth is likely to ease back from around 3% in 2004 towards the economy’s long-term trend growth rate of around 2.5%.
Slowing house price growth will contribute to a moderation in consumer spending growth, from 3.2% in 2004 to 2.5% in 2005, which will be a key factor behind an expected easing in economic growth back towards the trend rate in 2005.
The fundamentals for consumer demand, however, remain healthy. Post-tax incomes should continue to increase at a respectable pace, 3%, there are few signs of widespread financial fragility and household wealth is at record high levels. These factors should continue to support consumer spending, therefore preventing a sharp retrenchment.
The saving ratio is expected to increase from 5.9% in 2004 Quarter four to 6.4% in 2005 Quarter four as spending rises more slowly than income growth next year.
This will maintain the trend of the last few years as consumer spending has increased at a slightly slower pace than real incomes with an average annual rise in spending of 3.3% compared with average income growth of 3.6% over the last five years. The saving ratio has increased over this period from 4.8% to 5.9%.
Consumer spending’s failure to outstrip income growth since 1999 suggest that there is now a weaker link between consumer spending and house prices than in the past.
During the late 1980s housing boom, spending rose at a significantly faster pace than incomes as mortgage equity withdrawal fuelled sepnding. Contrastingly, recent high levels of equity withdrawal appear to have had a more muted impact on spending.
Base rates will fall to 4.25% by the end of 2005. The Bank of England’s modest tightening in monetary policy over the past year has successfully caused the housing market to slow.
The signs that overall economic growth has eased since the summer and that the housing market has weakend have alleviated the pressure on the Bank to raise rates further. The softening in economic activity, the continuing low level of inflation, which remains well below the Government’s 2% target at 1.2%.
The slowdown in consumer spending and house price growth, are expected to provide the Bank of England with the scope to reduce rates by half a percentage point in 2005. Base rates are predicted to end the year at 4.25%.
Martin Ellis, HBOS chief economist, says: “We expect the UK housing market to continue to slow with a slight fall in house prices likely in 2005. Sound economic fundamentals mean that the market will remain in good health, UK plc is in good shape.
“The will be better news for first-time buyers who will start to find it easier to get a foot onto the housing ladder.
“The softening in the housing market is expected to trigger a reduction in interest rates next year as the Bank of England acts to ensure that consumer demand and the housing market remain well underpinned.
“Over the medium term, we expect the housing market to enjoy a period of stability. House prices are forecast to rise at a modest rate following next year’s slight decline.
“The shape of the market will change with better affordability meaning that more first-time buyers will be able to purchase a home. The return of first-time buyers, along with generally good economic conditions in the UK, will generate a steady improvement in housing market activity beyond 2005.”