Why haven’t house prices collapsed?

If you are wondering why UK house prices continue to soar after the economy took a nosedive last year, you are not alone. Normally, these two correlate. But since the start of the pandemic, they have diverged markedly.

In the past year, economic output shrank at a pace unprecedented in modern history — and is now still 8 per cent below its pre-pandemic level. Following a brief dip during the first lockdown, annual house price growth has surged to a seven-year high. In February, the average property price was 8.6 per cent up year-on-year, according to official statistics, while the number of transactions in March — the non-seasonally adjusted estimate is currently 180,690 — was the highest recorded by HMRC since their statistics changed in 2005, as buyers rushed to beat the original deadline of the stamp duty holiday.

The UK is not an exception. House prices have risen in many western countries despite most of them experiencing severe economic downturns.

In the first quarter of 2021, the average annual nominal house price growth across the 37 advanced economies of the OECD accelerated to the fastest pace since 1990. In the US, the annual house price growth reached a double-digit rate, and in Australia, house prices recorded the biggest monthly rise in almost two decades in February.

So why is this happening?

The first reason is that incomes have been surprisingly resilient. In the UK, the current boom in housing is in contrast with past downturns when a fall in economic output resulted in a plunge in house prices as people tend not to buy properties when their incomes are being hit — or they fear that they will be.

In the year to March 2009, at the height of the financial crisis, the UK economy shrank by more than 6 per cent, resulting in soaring unemployment and a drop of nearly 16 per cent in the official house price index.

But during the pandemic, the government largely protected incomes with its furlough and business loan schemes, resulting in a largely stable unemployment rate. After dropping in the second quarter, by the third quarter of 2020, post-tax household income was already back in line with where it was at the end of 2019.

At the same time, richer households, who tend to buy properties, have actually increased their savings by an unprecedented amount as most higher-paid workers have kept their jobs and spending opportunities have been restricted by travel bans and the closure of bars and restaurants.

Kenneth Gibb, professor of housing economics at the University of Glasgow, says that “there is a strong distributional or unequal process going on here.” Those who did not lose out economically since March 2020 are “in a strong market position” and more likely to move house as a result of the shift to homeworking, while others “may have run down savings, taken mortgage holidays or are actually in arrears”.

The pandemic has also changed the type of properties that are most in demand. Cara Pacitti, economist at the Resolution Foundation, a think-tank, says that repeated lockdowns, which left many working from home, “appear to be turning buyers away from smaller, more crowded properties and setting their sights on spacious family homes.”

Research from Paul Cheshire, emeritus professor of economic geography at the London School of Economics, shows that house prices increased for detached, semi-detached and terraced houses across the wider London area, but fell for flats and maisonettes, reflecting increased demand for living and work-from-home space. In contrast, rents have fallen in areas where younger people in more insecure jobs are concentrated “as they have not on the whole been protected very much in terms of spending power,” Cheshire says.

At the same time, the UK government has been introducing measures to boost demand, chief among them being the stamp duty holiday, which waives the tax on the first £500,000 of any property purchase. Introduced in July 2020, and now expected to last until June, the measure has helped generate a pressurised “buy now before it is too late mentality,” says Cheshire.

The decision to extend the original deadline from the end of March until the end of June “poured petrol on an already hot market”, says Jonathan Hopper, CEO of Garrington Property Finders. The resulting competition is pushing up prices so fast that the average buyer is frequently paying a price premium well in excess of any tax saving provided by the stamp duty cut, he adds. The market has been heated further by the government scheme announced in March that allows buyers in England to obtain a mortgage with only 5 per cent of the property’s value put down as a deposit. The measure “is a rerun of the original help to buy model,” says Gibb “and is probably less benign in that it is likely to stoke demand-led house price inflation.”

So are we in a housing bubble? At the start of 2021, the average UK house price relative to earnings of first-time buyers — which indicates how affordable properties are — rose to almost record levels, according to Nationwide building society, causing some to speculate that prices could fall by as much as they did the last time that measure hit those heights in 2007, right at the start of the credit crunch

However, Andrew Wishart, property economist at Capital Economics, notes some difference between then and now. The average effective mortgage rate is currently below 2 per cent, down from about 6 per cent in 2007, lessening the chance of distressed selling. With interest rates expected to remain low and a brightening economic outlook post-pandemic, Wishart is expecting prices to grow in the medium term. “We think that there is scope for house prices to increase by around a further 17 per cent over the next four years,” he says.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, is less sure. He says that the surge in house prices “has not gone unnoticed by housebuilders”, leading to an increase in housing starts and completions at the end of last year. If the current imbalance between supply and demand is reduced, price growth will slow. The end of the furlough scheme in September and more properties coming into the market by vaccinated sellers less fearful of infection could also put the lid on price growth, but many experts forecast house price growth to continue to be strong for most of the year.

Nicky Stevenson, managing director at national estate agent group Fine and Country, says the UK is “a red hot” seller’s market that is going to continue to feel the effects of a hunger for more space, low rates and the looming end of Covid restrictions.

“Numbers like this won’t last for ever but the market may not begin to unwind until the busy summer season is out of the way,” he says.

Valentina Romei is an FT economics reporter