While there are strong arguments that the supply of property coming on stream has never been higher (as any trip to Devon, Cornwall or many parts of London would suggest), I think that the demand side of the equation could begin to shake the property market. 

The key factors behind property demand are population growth and affordability. In terms of population growth, clearly the UK population has grown materially over the last 10 years. According to the Office for National Statistics, the UK population has risen from 61.3 million to 65.6 million people in the last 10 years. That is a rise of just over 7%, or to put it another way, 4.3 million people. These people all need housing in one form or another. Any way you look at it, this growth would certainly push house prices upwards. It does seem – given the current climate – highly unlikely that population growth of this rate will be sustained over the coming decade.

Taking the second ‘demand’-side factor of affordability into account, we can start to see why the UK housing market has been so buoyant over the last decade. Since July 2007, interest rates have marched steadily downwards from the pre-crisis rate of 5.75% to 0.5%, where they have remained since 2009 (apart from a relatively brief spell at 0.25%). Most prime residential mortgages are now available at rates below 2% per annum versus 6-7% 10 years ago. The low interest rates have boosted affordability, which in turn have boosted the amount of money that homebuyers have been able to borrow and, hence, allowed them to increase their bids on property they want to buy.

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Why – given the above – do I feel that there is about to be a significant headwind for the UK property market? The answer is due to the sharp and dramatic increase in inflation and government bond yields in both the UK and the US. This increase in both inflation and bond yields will ultimately lead to higher mortgage rates, lower affordability and a significantly decreased demand from buy-to-let investors for UK property.

The macro data shows that the inflation rate has jumped from 0.9% in July 2016 to 2.7% in December 2017 in the UK and in the US – over the same period – from 0.8% to 2.1%. More worryingly, however, the yields on 10-year US treasuries have jumped from 2.2% last September to 2.84% last week. In the UK, over the same period, gilt yields have jumped from 1.1% to 1.6%.  

Make no mistake, these are huge movements. Government bond yields set the ‘risk-free rate’ for investment. In other words, lending to any other counterparty will price above government bond yields to compensate for the increased credit risk. To put this into perspective, given that many mortgage rates are now at 2% or below, the above increase of 0.5 percentage points in gilt yields represents a potential 25% increase in monthly mortgage payments for many people. This is a huge headwind for anyone thinking of upsizing.

Second, at present, buy-to-let yields are at an all-time low and returns are further being attacked by tax legislation. Much of prime central London yields a paltry 2% at present (which is a negative return in real terms, even if you ignore property maintenance costs). If gilt yields rise by 1%, then this would suggest – all other things being equal – that buy-to-let investors would demand at least 3% to purchase a new investment property. A rise in required yield from 2% to 3% is mathematically equivalent to saying, “house prices will fall 33%”.

The above market trends could potentially result in enormous headwinds for the UK property market and should be ignored at your peril.