Homing in on the message – through the noise

The market for new homes remains, but mortgage applications show a slow patch

When analysing the construction market, indeed any business sector, it’s important to try to separate out changes caused by short-term influences from those that point to deeper underlying trends. The ripples from the waves, if you like.

For housing and house building this approach is probably particularly important. But it’s far from easy, especially recently.

No construction sector receives more attention from policy makers and the media than house building. It’s a wonder policy teams manage to find new titles for their interventions, as they exhaust the possible combinations of new, buy, first, start, home, help, build or right. The effect of all this ‘noise” is to cloud the underlying message.

For most architects, it’s crucial to have a clear idea of what’s happening in housing. It provides the backbone of their workload. The 2015 RIBA Business Benchmarking report suggests 55% of revenue comes from housing. Most is from one-off homes and extensions. So housing probably matters even more to smaller practices.

The market is complex, with numerous subsectors and varying regional factors to consider. But if you’re looking for a quick guide to how many new homes are going to be built in the basic market, a good place to start is data on mortgage approvals and residential transactions.

For the past 40 years or more the link between the number of new homes built and transactions has held extremely stable (see Chart 1). The rule of thumb says that for every 10 homes sold across the UK, one is generally a new-build private home. Mind you, these ratios do vary region to region.

Given that the social housing element is relatively small, the number of people buying and selling houses across the UK seems pretty much to have determined how many new homes have been built.

You might ask why. There are suggestions, but little hard research to underpin any theory. It’s a pattern that developed in the 1970s and seems to have held firm, so coincidence seems a bit of a stretch. For those particularly curious about this phenomenon, a similar pattern developed at about the same time in the United States. There the equivalent ratio was six to one.

There’s no telling whether this relationship will continue to hold against the latest barrage of housing policy interventions. Indeed, given the long-term decline in the level of residential transactions it must be hoped that it will break. Either way, as things stand, tracking market sales would seem to provide as good, if not better, insight into house building prospects than, say, planning or construction data. Not that these don’t have a story to tell.

An incidental but important point worth bearing in mind is that the dominance of the second-hand market casts house builders, in the main, as price takers, with their prices set against comparable homes nearby. It’s all too easy to forget the interplay of second-hand home sales when considering flux in the new-build sector.

The mortgage effect

So what’s happening to transactions and the mortgage approvals which tend to drive buying and selling for most people?

Well, residential transactions went bananas in March, not unexpectedly mind (Chart 2). Higher rates of Stamp Duty Land Tax coming into play in April on buy-to-let and second homes were expected to prompt a surge from potential buyers ahead of the deadline.

How this wrinkle in the time series will iron itself out is hard to predict. But looking at the underlying trend we see a steady upward rise in both mortgage approvals and transactions over recent years. (The gap, by the way, broadly indicates how many cash buyers there are – proportionately more since the recession.)

The latest RICS Residential Market Survey suggests the immediate effect post-surge has been a cooling in activity in April. A 22% net balance of respondents said new-buyer enquiries fell in April. This compares with a small positive number in March and a healthy +15% in February and +22% in January.

How sustained this lull might be is hard to gauge. But add to this effect the much-reported dip in confidence generated by the EU referendum and we may well see a noticeable slump in sales in the short term. The question on many analysts’ minds will be to what extent these two effects might feed on each other, creating a deep dent in market confidence and a consequent slump in work.

That’s hard to predict. But it’s discomforting that the latest two Markit/CIPS surveys point to housing activity growing at its slowest rate for three years, suggesting it had already lost some of its former mojo ahead of a potential sales slump. And there is much discussion about the collapse in prices in prime central London market rippling out and unsettling housing markets elsewhere.

Putting recent data in a wider context, despite a steady upward underlying trend for a few years, mortgage approvals and transactions (Chart 2, dotted lines) still remain well below the previous peak almost a decade on from the financial crisis.

Homes gap

Despite the huge social and political pressure to build more homes and more policy interventions than you can shake a stick at, there’s still a big gap between the number of new homes delivered today and a decade ago, as can be seen in Chart 3, which shows the standard quarterly house building series.

Responding to the pressure, house builders, via their Home Builders Federation (HBF), pledged this May to boost production of new homes and build one million in England by 2020 – an average of about 200,000 a year.

The figures can get confusing, not least because politicians play fast and loose with the numbers. So for clarity, the one million, while not explicitly stated, appears to be based on the annual new supply data. In the year to March 2015 these figures showed 180,300 homes were delivered, compared with 124,500 recorded in the DCLG house building figures used in Chart 3. The net supply data include other contributions including conversions.

Broadly, the HBF pledge requires lifting production to around 220,000 by 2020. To put that in context the comparable figure in the year to March 2008 was 228,000. One important element of its plan is more support for smaller builders, notably through a land exchange where plots on larger sites are sold to smaller builders. Good news, hopefully, for smaller practices.

However, taken as a whole, the house-building industry is seeking to step up from a very low base. If house builders manage to meet the pledge it will help lift growth in total construction activity, which otherwise may flag if the wider economy continues to weaken.

As Chart 4 shows that new housing has been a major driver of rising construction work over the past three years. Meanwhile, Chart 5 shows that while there has been a slight lull in the level of new orders in the housing sector, this came after a major surge of orders three years ago, much of which may well be from large sites and is still working its way through.

Despite constant and inevitable complaints over planning, the production barriers to delivering these homes don’t appear that daunting. The latest survey of HBF members shows constraints on production down significantly from this time last year. However, the survey found a rise in constraints on sales, which ultimately determine how many homes they build.

Back to planning

Turning to planning, the data supports a view that there is plenty of scope in the system to expand house building. Data provided by Barbour ABI shows a steady rise in residential planning applications, both in terms of projects and units (flats and houses mainly) over the past three years, as we see in Chart 6. This is a good sign of confidence among house builders. Anecdotal evidence also suggests that land isn’t a major problem.

What’s more, Chart 7 shows solid increases in planning applications across most regions in the year to March 2016 compared with a year earlier. The number of projects has risen across all but the North East, while in all but Wales and Yorkshire & Humberside there has been a substantial increase in the number of housing plots within the applications.

That the growth in units is more than in projects suggests sites for which planning is being sought are larger than a year ago.

Taking all the data together there seems strong evidence that the potential is there to boost house building. The question is more whether there are enough buyers prepared to buy. With social housing increasingly marginalised, it seems reasonable to assume that the market will continue to be the biggest factor determining how many homes are built.

We can expect the next months to be bumpy with the fallout from the stamp duty changes and the EU referendum. Underneath these ripples, however, there is a wave of need for new homes that will remain and exert pressure on the industry to boost production.

The tougher this proves to achieve in the face of an increasingly troublesome market the greater will be the demand for smart solutions. Step up the brightest architects.