Predictions of 25% house price falls seem extremely unlikely

It sometimes appears as though there is an unspoken competition among commentators to see who can predict the most dramatic house price falls. House price predictions always grab attention; and the latest forecast from think tank, The Resolution Foundation, is no different.

Its aptly titled, ‘Peaked Interest?’ report examines the impact of higher interest rates on household wealth, suggesting house prices could plummet by 25% over the next five years if interest rates remain high.

It outlines a scenario where interest rates could reduce the house-price-to-earnings ratio from its 2022 peak of 8.9 to 5.6, a level not seen since the turn of the century. Were this adjustment to happen over five years, this would, it says, mean house price falls of around 25% in cash terms, resulting in the average house price falling from £287,000 to around £215,000.

While there is certainly some logic in its reasoning, many such reports often overlook the significant factor of the chronic housing shortage. Currently, we find ourselves in a worrying situation where planning permissions for housing projects have hit an all-time low - something which will undoubtedly put a halt to any significant house price falls.

In Q1 2023, the number of housing projects granted planning permission reached the lowest quarterly figure ever recorded, with only 3,037 projects approved, according to the Home Builders Federation (HBF). This marks a 20% decline compared to the previous year and an 11% decrease from the final quarter of 2022. It is worth noting that the number of approved projects in 2022 was already at its lowest level since data collection began in 2006.

Even major house developers like Barratt are feeling the impact of rising interest rates. It recently announced a projected decline of nearly 25% in completions for the upcoming financial year, citing a substantial drop in reservations. Its completion numbers are expected to decrease from 17,206 homes this year to between 13,250 and 14,250 homes next year, potentially representing a slump of around 23%.

These challenges faced by major house developers are likely to be even more pronounced for smaller ones. SME house builders recently delivered a letter to the Prime Minister Rishi Sunak, signed by almost 200 SMEs expressing their concerns and calling for action to save their businesses. They highlighted the increasing anti-development policy environment and the existential threat it poses.

It is estimated there are 85% fewer small house builders today compared with a generation ago, with the letter outlining some of the obstacles they face: inefficient planning processes, increasing costs and the removal of mandatory housing targets - all of which they say are putting a growing number of firms at risk. Worryingly, 78% of SME builders are considering scaling back their residential construction activities, according to the HBF, while 87% are contemplating changing their business’ direction.

While reports suggest the Prime Minister may reconsider plans to halt the construction of 145,000 homes due to concerns over the pollution of local rivers by Natural England, this alone is unlikely to motivate developers. Meaningful progress in housing development requires a more comprehensive solution. Until house prices increase, or the threat of their decrease is removed, developers are unlikely to be sufficiently incentivised to address the housing crisis and that will only happen once we see interest rates come down.

While we are likely to see slight drops in house prices this year, considering the latest Rightmove House Price Index shows only a 0.2% fall in June, I certainly wouldn't bet on declines of 25% given the chronic shortage of supply right across the board.