How will the housing market fare in 2023?

From the first lockdown in March 2020 to September 2022, house price growth totalled 23 per cent, largely driven by the pandemic-induced 'race for space', the low interest rate environment and, to some extent, the stamp duty holiday. 

But the mood changed in the autumn when it became clear that the Bank of England would need to raise interest rates more fiercely than previously anticipated to tackle high levels of inflation. 

This was exacerbated by the financial turmoil following September’s "mini"-Budget, but the abrupt change in the interest rate environment has been the real catalyst for the recent change in housing market conditions. 

There are several factors that should insulate the market from the risk of a bigger downturn.

Although inflation likely peaked in October at 11 per cent, it is not expected to fall back in a hurry. Current forecasts are that it will still top 4 per cent at the end of 2023 and not return to its 2 per cent target until mid-2024. 

Mortgage rates have also come down from their peak in October but are still far higher than they were last year and before the pandemic. 

As a result, house prices fell for the fourth consecutive month in December, according to the Nationwide house price index, down by 0.1 per cent, which leaves them 2.4 per cent lower than where they were in September. 

Looking ahead

The Savills research team’s view is that these price falls will continue, with the average UK house price expected to fall 10 per cent by the end of 2023. 

There will of course be some variation across the country. Markets where affordability is most stretched, such as London and the South East of England, are expected to see average values fall by slightly more than the national average, while more affordable, lower value markets in the Midlands and north of England are expected to hold up more strongly. 

The UK is predicted to be in recession for most of 2023.

On the assumption interest rates ease back gradually from the middle of 2024, values should begin to recover. Our forecasts, published in November 2022, anticipate that the average UK house price will rise by 18 per cent between 2024 and 2027, equating to net 6.2 per cent growth over the next five years. 

How does this compare to previous downturns? 

So far, so sobering. But there are several factors that should insulate the market from the risk of a bigger downturn, such as that seen after the global financial crisis. 

We know that a greater proportion of buyers in recent years have taken out fixed rate mortgages, with many opting for longer-term fixes at historically low rates. This will help insulate them until rates normalise, assuming they have the cushion of time before their fixed term expires. 

Borrowers coming off of a fixed rate deal will have had their affordability stress tested at 3 per cent, up until August 2022, meaning the shock to their finances may not be wholly unmanageable, albeit it will undoubtedly be uncomfortable for some, particularly given the prevailing cost of living increases.  

Tenants are having to commit to spending a higher proportion of their income on housing costs.

New buyer confidence will also be subdued by the wider economic outlook. The UK is predicted to be in recession for most of 2023, though the consensus amongst economists points to a shallow recession with a low impact on employment.

This, along with signs that lenders are looking to work with existing borrowers to help them manage their household finances, should limit the amount of forced-sale stock hitting the market this year, something we typically associate with more significant house price falls. 

Where does that leave transactions and rents? 

Mortgage approvals in November, which tend to be a good forward indicator for completed transactions, were down by 30 per cent when compared to November 2018-19. We anticipate that transactions will total 870,000 this year, a little under three-quarters of the levels seen pre-pandemic. 

Although this signals a more needs-based market, transactions will likely remain well above the 740,000 sales seen when they last bottomed out after the global financial crisis. 

Economic challenges and the increased cost of borrowing are likely to have a greater impact on outer prime London.

The two buyer groups expected to be most affected in the short term are first-time buyers and mortgaged buy-to-let investors. This in turn points to continued strong demand for privately rented housing but limited supply and that underpins our forecast for continued, if less dramatic, rental growth of 6.5 per cent this year (down from 11.6 per cent in the year to November 2022). 

Tenants are having to commit to spending a higher proportion of their income on housing costs but beyond 2024, rental growth is likely to slow further as renters return to spending a similar proportion of their earnings on housing costs as they did in 2014-15. Rental growth will also likely return to its long-term trend of performing in line with earnings growth. 

Prime markets look set to outperform 

Another differential will be that the top end of the housing markets, which tend to be more driven by equity than debt, will outperform the wider mainstream markets both in the short and longer term. 

Nowhere is this more the case than in prime central London where the relative value on offer (prices remain 18 per cent below their 2014 peak) combined with a currency play for equity-rich overseas buyers, should limit price falls in this particular part of the market. 

The legacy of the pandemic is also expected to continue to shape some demand for prime property in 2023. 

This is further evidenced by a record number of sales above £5mn across London in 2022. There were 606 sales above this threshold and activity remained strong right through to the year end. A total of £6.57bn was spent on these homes, 13 per cent more than in 2021, the previous high point for total spend. 

Meanwhile, economic challenges and the increased cost of borrowing are likely to have a greater impact on prime markets such as outer prime London, its suburbs and commuter zone where younger buyers looking for more space typically need to take on more debt. 

Some pandemic trends are here to stay

The legacy of the pandemic, which saw buyers being driven by lifestyle choices, is also expected to continue to shape some demand for prime property in 2023. 

Despite a return to offices and a normal social routine, our latest buyer and seller survey suggests that country living remains popular. When asked what type of location is most attractive, the majority of aspiring buyers opted for small towns, villages and the countryside. 

Buyers are also continuing to prioritise proximity to parks and open space, and family above transport, amenities and schools.

Only in London has proximity to the nearest train or tube station overtaken parks and open spaces, with proximity to family in fourth place behind shops and amenities – highlighting that Londoners still value connectivity and convenience.

Frances McDonald is an associate director in the residential research team at Savills