By Paul Cheshire and Christian Hilber
To speculate usefully about the effects of the
COVID-19 pandemic on Britain’s housing markets one needs a clear analytical
understanding of how our housing markets work and what forces cause them to
change. Given the extreme uncertainty about the impact and evolution of the
COVID-19 pandemic, anything in this blog is in some sense speculation, but we
hope informed speculation. A recent academic paper analysing the impacts on house prices and rents of
historic epidemics in Amsterdam and Paris found only relatively short lived and
localised reductions in house prices and smaller effects on rents than on
prices. While useful, we are cautious about trying to draw direct lessons from
such historic examples: not least because the extent of lockdown and economic
disruption now is an order of magnitude greater. COVID-19 is a true pandemic,
affecting the whole interdependent world economy at the same time: it is not
localised to Amsterdam, New York or Wuhan. Moreover, beyond its intrinsically lower fatality rate, modern medical understanding about the spread of disease and societal emphasis on saving lives are likely to mean much lower death rates from COVID-19 than from the Black Death or the cholera epidemic in 19th Century Paris: but disproportionately greater economic impact.
Apart from applying basic analytical tools it is
also probably useful to look at the impacts in terms of three time horizons:
the short term – over the next 6 to 9 months; the medium term -up to about
2024; and the long term – over the next ten-plus years. And, a warning, the
further ahead one looks the more uncertainty attaches to one’s predictions. But
we will do our best.
Britons have become conditioned to expect
rising house prices in real terms. After all they have increased fivefold since
the 1950s, faster than in any other OECD country. This rise has been driven mainly
by rising real incomes - over that period they increased threefold - and an
increasingly fixed supply of housing in large parts of the country, especially
where people want to live, within reach of good jobs. The supply of new houses
is so inflexible because our planning system is dysfunctional and our system of
local government finance provides virtually no incentives for local authorities
to permit development (see here, here or here). It is rising real incomes that fuel the
demand for ‘housing services’ (reflected in rents) but part of what fuels
the demand for housing as an asset is rising house prices relative to the price
of other assets. And this, in turn, given the nearly fixed supply of houses, may
fuel further price rises.
So this is the first pointer to what the
COVID-19 crisis will do to the British housing market. In the very short term,
it will produce stasis: buying and selling will all but stop. Indeed, they
already have – Zoopla reports a 40% drop in enquiries for late March. Even when
the lockdown is over and the market ‘unfreezes’, the transaction volume is
likely to fall substantially. In part this will be because households are loss
averse and not likely to want to realise a loss; but also because of the
probable ongoing economic disruption discussed below. As WHO spokesman David
Nabarro claimed on April 12, the ‘virus will stalk us for years to come,
changing behaviour for the foreseeable future’. So prices will tend to fall,
especially as incomes disappear for large numbers of people, triggering, in
some cases, real financial distress and near forced sales.
While construction of new houses will be
severely restricted, because new build homes are such a small fraction of the
total stock, this will make little difference to total supply, so will do
little to offset the fall in house prices. Moreover, the vast majority of
COVID-19 induced deaths - which could be anywhere in the region of 20,000 and 170,000 over the next few years, but is likely to be towards the upper end of that range[1] -
will be of elderly people, freeing up some existing stock and thus reinforcing,
slightly, the temporary downward trend in house prices. Overall, the supply
side effect of COVID-19 on house prices may be rather muted as the two effects
(on construction and freed stock) may largely offset each other.
Thus, in the short term three things mainly
matter:
1. How far will lenders be willing – even be able - to flex to minimise the number of forced sales? Forced sales quickly translate into falling house prices as we saw in 1991;
2. How catastrophically will borrowers’ incomes be hit and for how long?
3. How much and for how long will real incomes fall?
We are not medical experts so can offer no
professional forecast as to how long the epidemic will last, nor the length of
the severest disruption of normal economic activity resulting from the
lockdown. We can offer two depressing thoughts, however: despite reassuring
noises about renewed activity in China by the end of April, the Chinese, with
far stronger controls and draconian powers of enforcement, started the lockdown
in Wuhan on 23 January. In Britain, a far less effective lockdown started two
months later. The Chinese began a gradual easing of their lockdown from 8
April. So maybe the UK lockdown will continue till early June, two months after
the start of the easing in China. But even then the easing will be gradual and
the resumption of normal economic activity will take probably months. Moreover,
if the Spanish
flu-pandemic that lasted from January 1918 to December 1920 is any indication (see here and here), it is likely there will be a (deadlier)
second and possibly even third wave, depending on how quickly a vaccine can be
developed and made available.
The second depressing thought is that the
longer the lockdown lasts, the slower the recovery will be. The economy appears
to be in freefall. Official data is hardly yet available but there was an
ingenious review of current indicators in the Financial Times on 8 April: car sales down 44% in March; restaurant bookings on
Open Table – a sort of forward indicator – dropped to zero two days before the
official lockdown. The OBR 14th
April report was gloomy and emphasised that recovery from the
initial near catastrophic hit was dependent on businesses being able to re-set.
But it looks increasingly likely that many businesses
will not survive: think of all those empty restaurants, bars or theatres;
consider all those empty planes or hairdressers’ salons, think about how many
small construction businesses, car dealers or gyms are at a standstill. The
physical fabric will survive, but the government’s initiative to provide emergency
finance seems plagued by delay and, while loans do not come, more and more businesses
will go under. Recovery will be much slower if the businesses themselves have
to be re-invented and established anew. Demand may be there and so may the
workers but there have to be businesses to organise the process of production
and employment.
Turning to the medium term, we first note that
the longer the lockdown and the more businesses go under, the slower the
bounce-back may be. The slower the economic bounce back, the slower the
recovery in the demand for housing – driven by earnings – will be. And even
when earnings start to recover, the savings of many will have been depleted.
Would-be buyers will find much of what they had set aside for deposits will
have gone on essential supplies to keep the household afloat while incomes were
down. Buying a home will have to be postponed again even if prices appear to be
more affordable. It took till 1945 for real house prices to get back to their
1931 levels: it took till late 2001 to get back to 1989 real values. House
prices may have increased nearly fivefold since 1955 but there have been
prolonged troughs along the way. We would not be surprised to find real house
prices in 2024 well below present-day real values. The economic downturn
triggered by COVID-19 may even equal that of the Great Depression of the 1930s.
However, construction of social housing may have a bit of a revival.
Lower house prices will not improve
affordability in the medium term, however, since the cause would be lower
incomes and depleted savings.
So what of the long term? To 2030 and beyond.
Here we get even more speculative but we will assume that the pandemic dies
away and the economy eventually recovers. The pandemic could even trigger an
innovation boost e.g. in communication technology (which might damage the
recovery of airlines and ground transport) or medicine. And, although we have
long argued for radical reforms to those policies impeding building more houses
where people want to live (such as releasing Green Belt land around commuter
stations or reforming the tax system to incentivise local authorities to permit
development), we will reluctantly assume there are none, at least no meaningful
ones. One of the downsides of our expected prolonged depression in real house
prices is that it may take the pressure off politicians to reform our
dysfunctional housing supply.
If this is true, construction will stay well
below the level needed to satisfy demand, so prices will take off when incomes
finally recover. However, the structure of demand may change. Already there is
talk of how we will not go back to what we were doing before COVID-19 struck.
People may adjust to more home-working, including commuting to a central office
but far less frequently. This would have two implications (apart from those it
would have for the demand for office space): the first would be that people
would demand more space in their houses; the second is that commuting costs
might become less important. These would suggest a movement outwards to find
cheaper land and space, and accept the longer commute that implied. In fact
before COVID-19 struck there was already evidence of people jumping the
Green Belt so this would be a continuation of an existing
trend.
Although not strictly following (maybe we
should have another blog to explain the reasons) a further related trend might
be for higher-paid jobs to concentrate even more strongly in the first-order
cities, notably London, Manchester, Edinburgh, even Leeds, at the expense of
second-tier cities like Stoke-on-Trent, Derby or Coventry; and demand for
housing to relatively increase in smaller but well connected high-amenity cities
like Cambridge, Canterbury, Exeter, Harrogate, Hexham or Norwich, further
increasing house price pressures in these locations.
While there is huge uncertainty surrounding the
COVID-19 crisis - not just its impact on the real economy, the financial
markets and the rate of recovery but also longer-term political consequences or
the impact on globalisation - one thing is clear: COVID-19 is likely to have
lasting effects on both Britain’s housing markets and housing policies. Real
house prices (and rents) may fall in the short- and medium-term without making
housing less unaffordable. It will remain particularly unaffordable for the
young and those on lower incomes, especially in London and the South East, and
for those hardest-hit by COVID-19. When it comes to housing policies, Britain’s
policy makers (of all colours) would be well-advised not to jump on the
populist band-wagon. There needs to be a policy reaction reflecting the true
causes rather than the symptoms of the affordability crisis and the longer-term
reforms that are the only way of truly resolving our housing problems. We need
to learn from Germany, not just in terms of effective
testing for COVID-19, but also from their housing and
planning policies.
[1] Britain’s Chief Scientific Advisor mentioned a death toll of 20,000 as “a good outcome”. If 25% of Britain’s population were to eventually catch COVID-19 and 1% die, this would amount to a death toll of nearly 170,000. If half the population were to catch COVID-19, the death toll could in theory exceed 330,000. This however seems highly unlikely, not least because a vaccine is likely to become available prior to half of the population having been infected. Moreover, new medicine may lower the death rate to well below 1%.
