Observations on UK housing

A personal view from Debapratim De, Deloitte’s Chief Economist in the UK.

Observations on UK housing

We have been studying the drivers of UK housing market activity. Here are five observations.

House prices have held up despite interest rate rises

Inflationary pressures from the pandemic and Russia's invasion of Ukraine drove the Bank of England to raise interest rates to a peak of 5.25% in 2023. It has eased policy since but Bank Rate remains at 3.75%, well above levels in 2021. Yet, instead of falling, UK house prices have risen by 11% since late 2021. They haven't kept pace with inflation though, which has risen 24% over that period. But this is a better performance than after earlier episodes of rapid monetary tightening.

The fact that house prices have avoided outright declines is notable given the surge in mortgage rates and recent economic shocks. This relative resilience is down to several factors. The popularity of fixed-rate mortgages has delayed the impact of rate rises, tighter lending standards after the global financial crisis have meant borrowers are more resilient to shocks and a strong labour market has kept unemployment low and supported robust wage growth.

London has underperformed the rest of the UK

Housing markets in London and the south have underperformed the rest of the UK. London has been the worst hit, with house prices now 6% below the peak in late 2022, having lost over one-fifth of their value when accounting for inflation. The South East and South West of England have also underperformed in recent years, though the declines have not been as steep as in the capital.

Northern Ireland has been the best-performing UK nation or region, with house prices up by almost a third over the last five years. Its outperformance reflects relative affordability, with prices well below the UK average, limited supply and a strong labour market supporting demand.

London’s recent underperformance is tied to its stretched affordability, which makes buyers more sensitive to rising interest rates. Areas such as Kensington and Chelsea, known for their high-end properties popular among foreign investors, have been hit by the introduction of a stamp duty surcharge for overseas buyers, and the forthcoming High Value Council Tax Surcharge. House prices here are down by almost 25% since 2022.

Five million households still to refinance onto higher mortgage rates

As the Bank of England cut interest rates, mortgage rates had been falling gradually since 2024. But the outbreak of the war in Iran has meant markets expect higher inflation and, subsequently, higher interest rates. As a result, banks have raised mortgage rates, which jumped from an average 4% for a five-year fixed 75% loan-to-value deal before the war began to 4.6% now.

Higher mortgage rates and the lagged pass-through of earlier interest rate rises to household mortgage payments mean that an estimated five million households are set to refinance their mortgages onto higher rates by the end of 2028. However, for the average mortgagor rolling off a fixed rate in the next two years, monthly mortgage repayments are projected to increase by £45, significantly less than the median increase of £120 over the last few years.

Affordability has deteriorated

According to house price-to-income ratios, housing is now more affordable than at any time in the last ten years. The median house price to median earnings ratio was 7.6 in England and Wales last year, the lowest reading since 2015. With house prices rising by just 5% since the pandemic while average earnings are up by 25%, housing affordability seems on the rise.

Unfortunately, this analysis doesn’t account for higher mortgage rates and is, therefore, misleading. The ultra-low interest rate environment preceding the pandemic helped keep mortgage rates and monthly repayments low (and housing affordable), despite rising house prices. With the end of the easy-money era, two and five-year mortgage rates hover above 4.5% today, compared to 2% or less five years ago. Looking at average mortgage repayments as a share of income reveals that affordability has weakened significantly, to its lowest level in 18 years.

Housebuilding activity remains weak

The S&P Global purchasing managers’ indices for construction show that housebuilding activity has been contracting for much of the last four years, reflecting weak demand and cost pressures. Housebuilders have seen sharp rises in building costs, driven by higher energy and other raw material prices, costlier building regulations and skills shortages. Alongside that, higher mortgage rates have crimped demand.

The failure of housing supply to keep pace with a growing population is the root cause of the UK’s housing issues. The government’s pledge to build more new homes is an important step towards addressing this but the backdrop for housebuilding remains a difficult one.