Housing market begins to feel pressure from higher cost of living and interest rates

The housing market has so far remained resilient to increases in the cost of living and rising interest rates. In fact, house prices are still rising fast, with Halifax most recently reporting that the average house cost a record £294,845 in June, up 1.8% month on month (MoM) and up 13% in the first half of 2022, the fastest rate since 2004.

Halifax managing director Russell Galley explains: "This is partly because, right now, the rise in the cost of living is being felt most by people on lower incomes, who are typically less active in buying and selling houses. ... In contrast, higher earners are likely to be able to use extra funds saved during the pandemic".

In addition, supply chain disruption, higher costs of labour and raw materials, and increased cost of investment, have affected new-build housing orders, contributing to higher prices, while demand still exceeds supply in the second-hand market.

However, the housing market cannot remain insulated from the rising cost of living, rising interest rates, and the broader economic slowdown indefinitely. As Mr. Galley put it, "While it may come later than previously anticipated, a slowing of house price growth should still be expected in the months ahead".

Construction contracts

The housing construction sub-sector, which represents a key part of the supply equation and was the poster child for post-Covid recovery in Britain, is already tipping into contraction. 

Specifically, the UK construction PMI index for residential construction for June read 49.3 - a sub-50 score indicates a downturn, with this being the first contraction since May 2020, at the height of the first lockdown. Reasons include the usual suspects: rising interest rates, soaring inflation, recession fears, less fabourable economic/business conditions, a tight labour market, rising energy and raw materials costs, supply chain disruptions, and planning delays. 

Tim Moore, Economics Director at S&P Global Market Intelligence, said:

"House building has expanded more quickly than the rest of the construction sector over the course of the pandemic, but now finds itself as the worst-performing broad category so far in 2022. Moreover, the latest survey indicated an outright decline in residential work for the first time in just over two years. ... Measured overall, the degree of optimism across the construction sector is now the lowest seen since July 2020."

London-listed housebuilders have so far managed to push cost increases through to buyers, but heavy share price falls across the sector over the last year suggest the market is bracing for difficulties.

Correction unlikely

While housebuilders are facing challenges, including first time buyers struggling to finance new mortgages as affordability worsens, the current supply/demand imbalance is unlikely to result in a large-scale price correction across the market, according to Jason Tebb, chief executive of .

 ( ), a popular property portal, is well-positioned to gauge customer interest in the housing sector. Mr. Tebb cites the Company's June sentiment-based index, based on replies from over 100,000 consumers, which indicates 61% of all properties listed on the portal went under offer (subject to contract) within 30 days, an increase of 6% MoM. Additionally, 82% of sellers were confident they would sell their property in 3 months, and 75% of active buyers were confident they would purchase a property within 3 months.

Mr. Tebb partially credits pent-up post-pandemic demand in the sector, which is still working through the system. This is a view supported by the latest trading update from estate agency group Winkworth, which stated it was seeing a large volume of unfulfilled sales transactions being carried over to H2 2022. Winkworth reported H1 2022 gross sales income almost 50% higher than H1 2019, the last period to be unaffected by Covid measures.

And as Mr. Tebb points out, residential purchases, unlike the rest of the consumer space, tend to be guided by more than macroeconomic factors, noting that, when he was an estate agent, one of his busiest years was 2008, at the onset of the Great Recession and housing market crisis. "People need to move" he says, "often for emotional reasons". The timing of political events, seasonal and other trends, are significant factors as well.

For these reasons, while demand is likely to follow larger economic trends and level off, the slowdown is unlikely to be dramatic. However, Mr. Tebb is seeing what he describes as "subtle signs of a shift", pointing to new instructions, price reductions, and reavailable properties, which are all rising, indicating a rebalancing of the market in the next 6 months, and suggesting the possibility of lower or negative MoM increases.

Housebuilders still delivering

Mr. Tebb also suggests that although the government's Help to Buy scheme is coming to end, it is highly unlikely that an embattled Conservative government under a new leader won't deliver further stimulus for the all-important housing market. That would bring a welcome boost to housebuilders, a number of which have reported financial results recently, offering further insight into the health of the market.

 reported last Thursday lower H1 revenue YoY (£1.69bn compared to £1.85bn) due to fewer housing completions, but also noted higher forward sales and higher-than-consensus expected profits. The company said: "Demand across the UK remains strong. During the first six months of the year, the Group's average private weekly sales rate per site was around 1% ahead of that achieved during the same period in 2021. Customer enquiry levels are healthy and cancellation rates low."

, a low-cost builder, reported 2,000 home sales in the year ended 30 June, a 10% increase YoY. Revenue is similarly expected to be £357.3m, up 23.8% from last year, and pretax profit is expected to be up 18.9%. Therefore, the company expects FY22 results to be significantly above market consensus.  cited affordability of its homes, and lower energy bills for their customers due to superior insulation, as reasons for the increase in sales.

's H1 performance beat expectations at the start of the year, with forward sales up 16%. Total completions in H1 rose slightly, and the company expects full-year margins to exceed market consensus, with full-year pre-tax profit expected to come in at the high end of expectations. The company added "Whilst we are mindful of the wider economic uncertainties, we remain positive on our outlook".

Finally, materials supplier 's reported H1 revenue rose 10% to £33m from £29.9m last year. The company has a strong order book and is on track to meet annual expectations.  did mention higher inflation rate and energy costs as potential setbacks, but has been able to pass these on to housebuilders. "To protect our margins, we have remained focused on mitigating risks to our input costs as well as maintaining appropriate portfolio pricing" the company said.

View from Vox

All three of the builders - and  - reported good trading so far in 2022, with positive guidance for the rest of the year. However, the sector is trading on mid-single digit forecast PE ratios, suggesting that the market is pricing in some trouble ahead. New stimulus could see their fortunes turn, but headwinds remain, not least higher build costs and concerns over affordability.

While the overall housing market remains resilient for now, with house prices at a record high and still growing, the rate of growth is slowing and expected to taper off in the next 6 months due to higher cost of living and inflationary pressures. Those will in turn see mortgage rates rise alongside potentially lower mortgage availability.

These events should bring about a mild rebalancing of the housing market over the next 6 months, with price increases likely to flatten or turn negative, but large moves or significant divergence from the larger economy are unlikely. Lower-income first time buyers will be most affected by the changing conditions as they lack collateral against higher financing costs and cost of living, and have not benefited from soaring real estate prices in the past decade.