Most market observers now agree that the disruptions caused by the Covid-19 outbreak are likely to have a near-term impact on the UK’s economy and housing market. But numerous questions remain:
- What will the impact on UK GDP be?
- By how much will housing transactions fall, and when will they recover?
- What will the impact be on house prices?
- How is this downturn different from the ’08 / ’09 financial crisis?
- How will the development sector be impacted?
- Does it still make sense to lend in this environment?
These are some of the important inbound questions we are fielding from investors and developers. Whilst there is still of course a good deal of uncertainty as to the answers, we’ve tried to share some of our current thinking below.
The lockdown policies currently being implemented in the UK and elsewhere are having a large and immediate impact on real-time economic activity. Assuming these restrictions are eased towards the end of May, most economists have gravitated towards an annual GDP hit in 2020 of c. 4% y/y.
While this is a large decline – in-line with 2009 – there are some fundamental differences. Importantly, the ’08 / ’09 crisis was a recession fuelled by reckless sub-prime mortgage lending, high levels of consumer debt, and an over-leveraged banking system. So-called “balance sheet recessions” notoriously take years to crawl out of.
This recession, by contrast, has been largely “self-imposed” in response to a health crisis which hit an economy that was generally healthy, with a property market and banking system that were both on significantly firmer footing, and a policy framework that was primed to react with even greater speed and force than in the last recession.
So while it is still too early to determine the scale of the coronavirus impact, it is not expected to be as damaging or long-lasting as it was following the “GFC”. Indeed, many economists are predicting a “V” (or maybe “U”) shaped recovery, rather than the “L” of a decade ago.
As rating agency Fitch observes in a note dated 2 April:
On the assumption that the health crisis eases in 2H20, we should see quite a marked rebound in growth. The removal of lockdown measures should result in a discrete jump in activity – as now being witnessed in China – and some expenditure could be re-profiled from the first half of the year. Macro policy stimulus and inventory building should also contribute to a recovery. But the scale of the dislocation means we do not envisage GDP reaching pre-virus levels until late 2021.
UK Housing Market
So what does this mean for the housing market? It is worth noting that in Q1, the housing market was exhibiting very strong underlying momentum in the wake of the decisive general election results, with a sharp uptick in sales and price growth across the UK.
Rightmove reported that the number of sales agreed in the month ended Mar. 7 was up an astounding 17.8% y/y, with asking prices up ~3.5% y/y. Knight Frank noted that the number of prospective buyers registering in early 2020 was up >30% y/y, while the number of new listings was down >20% y/y, tightening supply / demand balances in the market significantly.
The arrival of Covid-19 and the government-enforced lockdown has put this recovery on hold, with sharp near-term reductions in activity expected.
Assuming again that the current lockdown is maintained through the end of May, with restrictions gradually eased in June, Knight Frank sees transaction volumes falling 38% in 2020 (from ~1.2m to ~735k), though they note that the contraction may be less if the lockdown does not persist until June.
Importantly, they see a sharp rebound in sales, with 2021 transactions well surpassing 2019 levels, due to a snap-back in GDP as well as a healthy level of pent-up demand. As Savills notes:
Suppressed transaction activity means we expect to see a build-up of latent demand. The experience of working from home for an extended period of time will drive many householders to move.
Given the historic low level of interest rates, the unprecedented amounts of liquidity being pumped in to the system, the healthier state of consumer and bank balance sheets vs. a decade ago, and the strong underlying fundamental for UK residential property, most are predicting a much more modest price decline than in the ‘08/’09 downturn, when UK-wide property prices fell ~15% peak-to-trough.
Knight Frank forecasts a meagre 3% drop in prices, while Savills predicts the decline could be in the 5-10% range (albeit on low volume), with prices not reaching “pre-Covid” levels until sometime in 2021. (This compares to a prior forecast that 2021 prices would average ~6% above 2019 levels).
Below, one industry observer explains why the price impact of the current downturn is likely to be well below that seen in ’08 / ’09:
Importantly for the housing market, these [dramatic fiscal and monetary] interventions – if successful – should ease the pressure on mortgages, preventing the kind of defaults that led to a glut of re-possessions and forced sales such as those that we see following the financial crisis. . . . Record low rates and the availability of cheap credit have been two big factors underpinning the property markets over the last decade and these moves suggest that this “lower-for -longer” environment will remain in place.
Over the past decade, the industry has fallen short of the government’s 300,000 unit / yr. housing delivery target to the tune of about 50%, despite incremental progress in recent years. Recent discussions with government bodies suggest mounting concern that the current crisis will be a further setback to housing deliver targets.
At a minimum, we know that many of the nation’s large house builders are voluntarily “hitting the pause button” on residential developments (though it is not currently mandated by the government).
And anecdotally, Hilltop has seen numerous instances in which large development lenders have recently pulled back from transactions “at the finish line” as they assess their current loan books.
The worry for the nation and the industry is that the funding gap facing housing developers (SMEs in particular) will widen further, driving their cost of capital higher.
At Hilltop, we see these dislocations as opportunities both to continue to support the growth plans of our development partners and to earn attractive risk-adjusted returns for our investors.
In the midst of a crisis, it can be hard to see the forest for the trees, and our natural fight-or-flight instincts often tell us to “run away”.
But in markets, this can often lead to poor analysis and decision making. By trying to “keep our heads while all about us our losing theirs”, we are trying to rationally assess the current situation and observe how it unfolds. Along with the risks and uncertainty will come, we are confident, great opportunities.
Hilltop remains committed to its role in supporting SME developers and helping the UK deal with its chronic housing shortage. In this respect at least, nothing has changed.
Partner & CFO