Down but not out

While there is general acceptance that the housing market is experiencing a slowdown, confusion still reigns as to whether there will be a “soft” or “hard” landing. Hometrack’s view is that there will be a soft landing for headline prices, which we expect to be up 1% over 2008, but there will be a harder landing for transactions which we expect to fall by 17%. Given the sheer size of the market, there will be some areas and sectors that may register modest price falls although these are likely to be in asking prices rather than underlying values.

The new build market has come under scrutiny as a sector likely to be more exposed to the slowdown than others. Housebuilders’ shares have certainly taken quite a hit over recent months on reports of lower sales volumes and general market uncertainty. That said, new build reservations may be down significantly over the last year, but are broadly in line with the slowdown in mortgage approvals for the market as a whole.

The recent and projected drop in transactions will be the greatest short-term concern for developers whose business models are largely based on achieving a certain rate of sale per scheme. The shift towards high-density, capital-intensive flatted schemes over the last decade has compounded this reliance on rate of sale.

In the face of lower demand and falling reservations, developers tend to fight back with increased use of sales incentives which has been the case over the past six months. Chart 1 shows the balance of developers reporting a change in reservations and sales incentives over the last year. If the increased use of incentives does not support sales rates, then developers have two options – either 1) reduce the speed at which they develop or 2) reduce headline prices to achieve sales. For schemes of houses reducing the speed of development is a viable option and developers will look to reduce the rate of build to a level that supports underlying prices.

Some large, riskier schemes are being put on hold until the economic outlook becomes clearer

Cutting back production is harder in the case of flats as these schemes are generally built under single contracts. This means that pricing becomes more immediately exposed to a change in market conditions although the potential impact will vary between developments. A developer who has sold nearly all the units on a scheme may be more inclined to cut prices to achieve sales and take a modest hit on scheme profitability.

At the other end of the spectrum there have already been reports over recent months of some large, riskier schemes being put on hold until the outlook becomes clearer. The greatest challenges are likely to be faced on those schemes that are in the first half of their sales programme where it is hard to slow the build and there are many units still left to sell.

The net result is likely to be lower levels of housing starts which have already been seen over the last six months – see chart 2. The initial decline in output over 2007 appears to have been a move by developers away from riskier flatted schemes towards more house-orientated schemes. Overlaying the weakening in housing market conditions could well result in a further decline in starts over the first half of 2008 as developers ease back on production until the outlook becomes clearer. With many regeneration schemes reliant on the development of housing, it may well be that the national slowdown in the housing market impacts on the delivery of the wider regeneration agenda.