AFFORDABILITY WATCHA Cushman & Wakefield London Markets Research Publication 2015

Affordability of housing is one of the hottest topics at the moment. The Mortgage Market Review (MMR) placed the issue firmly centre stage, requiring lenders to examine underlying spending patterns to ascertain that mortgage repayments are affordable both now and as interest rates rise.

"When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still af-ford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination.” (Financial Policy Committee June 2014)

Traditionally affordability has been measured looking at the relationship between income and house prices. This however, fails to provide a rounded picture of affordability, and house-hold’s ability to weather future interest rate rises. To gain a fuller understanding, and importantly how financially stretched households are, a look at the level of net income remaining after buying essentials is necessary.

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The Discretionary Spending Buffer 2

United Kingdom 4

London 6

Saving for a Deposit 8

Conclusion 9

2015 Outlook 9

CONTENTS

AFFORDABILITY WATCHINTRODUCTION

1

home

In order to assess the current affordability of housing and how it compares to the past, a range of scenarios have been considered. For this C&W have looked at three base cases; owner occupiers, long term renters and a renter looking to become a first time buyer. An assessment of the relative position of households with and without children was also undertaken.

What is Essential Spending?

To accurately determine the size of any disposable income buffer, a definition of what to include as essential spending needs to be determined. The decision of what to include in the basket of essential goods has a fundamental impact on the analysis carried out and any conclusions that can be drawn.

One thing to bear in mind is the changing nature of what is considered to be essential. An excellent example of this over the past 10 years is the internet. In 2005 very few would have considered having internet connectivity at home as being an essential, instead it was considered a luxury item. Fast forward to 2014, and the vast majority of the population would consider the internet as an absolute essential.

For the purpose of this analysis, the following items have been included in the definition of essential spending :

• Mortgage or rent

• Service charge and ground rent (for London owner occupier households only)

• Clothing

• Utilities – electricity, gas and water

• Transport

• Communication

• Internet (from 2011 onwards)

• Food and non-alcoholic drinks

The reason for this is that C&W believe that these are the only truly essential items, all others could be sacrificed if it was absolutely necessary. Over the past 10 years, the cost of this basket of essential goods (excluding rent and mortgage payments) has ris-en by 24% for the UK and 21% for London. Comparing this growth to wage inflation and to the surprise of many, and counter to much of commonly held wisdom, wages have grown at a similar rate.

THE DISCRETIONARY SPENDING BUFFER

2

All essential spending data is taken from the ONS Family Spending SurveyEstimated service charge taken from London Assembly’s

Highly Charged: Residential Leasehold Service Charges in London, March 2012

One of the reasons that this analysis runs counter to the commonly held view of households being poorer today than in the past can be put down to the difference in opinion of what counts as essential spending.

In fact C&W believe that what many would consider to be essential spending can more accurately be described as ‘lifestyle essential spending’. This expanded group includes items such as eating out, meeting friends for drinks and holidays. While these may be integral spending to sustain an individual’s chosen lifestyle they not really true essential spending; it is the choice of the individual to spend their disposal income in this way and, as our analysis shows, the rising costs of essentials cannot be solely blamed for the lack of income left to save.

Cost of essential goods has risen by 21% in London over the last 10 years”

“

21%

THE DISCRETIONARY SPENDING BUFFER

3

90.00

95.00

100.00

105.00

110.00

115.00

120.00

125.00

130.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Wage Essential Spending (ex Childcare)

UK NET WAGE GROWTH VS ESSENTIAL SPENDING

LONDON NET WAGE GROWTH VS ESSENTIAL SPENDING

90.00

95.00

100.00

105.00

110.00

115.00

120.00

125.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Wage Essential Spending (ex Childcare)

Source: ONS | 2005 = 100

Source: ONS | 2005 = 100

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Owner Occupier Renter

45.00%

47.00%

49.00%

51.00%

53.00%

55.00%

57.00%

59.00%

61.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Owner Occupier Renter

One of the key questions that arises when talking about affordability is whether someone would be better off owning their own home or renting. Looking firstly at the UK household without children it becomes immediately obvious that the owner occupier is in a much better position. At the end of 2014 they would have 57% of their net income remaining as a buffer, while if they rented they would have 51% remaining.

Despite these healthy positions, both scenarios have worsened over the year and both households are in a weaker position than they were at the end of 2013. This has been caused by the strengthening of both rents and house prices, rising by 4% and 8% respectively in 2014, according to Land Registry and Countrywide.

Looking back, renters were in a stronger position between 2005 and 2007, when rocketing prices and comparatively high interest rates—at least to the present market—saw mortgage repayments absorb 30% of incomes in 2007.

Although from 2008 onwards the position reversed and owner occupiers found themselves in a financially stronger position. This was due to the dramatic fall in prices and plummeting interest rates, which saw the cost of servicing a mortgage fall to 19% of incomes in 2014.

UNITED KINGDOM

PROPORTION OF NET INCOME REMAINING CHILDLESS HOUSEHOLD

PROPORTION OF NET INCOME REMAINING TWO CHILD HOUSEHOLD

Source: ONS, Land Registry, Countrywide, IPD, Bank of England

Source: ONS, Land Registry, Countrywide, IPD, Bank of England, Family Childcare Trust

4

PROPORTION OF NET INCOME REMAININGFIRST TIME BUYER IN RENTAL ACCOMMODATION

Source: ONS, Land Registry, Countrywide, IPD, Bank of England

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Renter - First Time Buyer

When you introduce the additional costs of childcare for two children, it is unsurprising to see that both renters and owner occupiers are in a significantly worse off position: the difference in long term average size of the disposable income buffers, drop from 55% and 53% to 10% and 7% for owner occupiers and renters respectively.

2014 was the fifth year in a row when the size of the financial buffer decreased for both households. This was caused mainly by the exponential rise in childcare, which has increased by 30% in the last five years and now accounts for more than half of net income.

Importantly for both owner occupier households, with or without children, their disposable income buffers are large enough to absorb the requisite 3% increase in interest rates on their mortgage stipulated by the MMR. Albeit the household with children would be left with only 0.4% of their net income.

Moving down the housing ladder, what does that landscape look like for hopeful first time buyer? Given the constant reporting to the contrary, it is perhaps surprising to note a UK renter looking to buy their first house would have nearly a third of their net income remaining after paying for essentials. This is down on both the high of 39% in 2009 and the long term average of 35%, but still remains a very healthy position.

The sharp fall in disposable income for owner occupiers over the past two years is almost entirely due to the exceptionally strong capital appreciation in the London market, which despite record low and falling interest rates, means that mortgage payments have crept up.

Similarly, the steady rise in rental values in the capital—rising by an average of 13% in the last two years—has been the primary driver behind the reduction in the size of the financial buffer for rental households.

UNITED KINGDOM

Homeowners with two children only have 5% of their income remainingafter childcare costsand essential spending

5

Perhaps most worrying is that for the first time in at least 10 years, the rental household with two children is having to spend one percent more than their net incomes on essentials.

PROPORTION OF NET INCOME REMAININGFIRST TIME BUYER IN RENTAL ACCOMMODATION

20.00%

22.00%

24.00%

26.00%

28.00%

30.00%

32.00%

34.00%

36.00%

38.00%

40.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Renter - First Time Buyer

30.00%

35.00%

40.00%

45.00%

50.00%

55.00%

60.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Owner Occupier Renter

Looking at the capital there is a very different story to the UK. Comparing childless households, the renting household is in a significantly stronger financial position, with over half of their net income left as a buffer, while the owner occupier has 35% remaining. These are however, both below the long term averages of 54% and 39% for renters and owner occupiers respectively.

The volume of disposable income remaining for both households is also on a downward trajectory, it is 9% lower for owner occupiers and 3% lower for renters at the end of 2014 than the year before and is the fifth consecutive year that it has decreased.

The sharp fall in disposable income for owner occupiers over the past two years is almost entirely due to the exceptionally strong capital appreciation in the London market, which despite record low and falling interest rates, means that mortgage payments have crept up.

Similarly, the steady rise in rental values in the capital—rising by an average of 13% in the last two years, according to Countrywide—has been the primary driver behind the reduction in the size of the financial buffer for rental households.

Mirroring the trend seen for the UK households, when including the cost of childcare the financial position of both London households deteriorates substantially. The rental household remains in a stronger position relative to the owner occupier household; however, both of them are in serious trouble as they are overspending, by 6% for the renters and 21% for owner occupiers.

The cost of childcare has risen substantially in London over the past 5 years. For two children in full time childcare it now accounts for 56% of the net income and is in fact the largest single cost facing families.

The high cost of childcare in London highlights the lifestyle choice

that many are forced to make when it comes to having children. This leads to hard decisions being made, such as moving out of the city in search of more favourable financial position, one half of the couple stopping work to undertake full time childcare or simply not having children.

Unlike the UK households, in London it is only the childless household that is in a sufficiently strong financial position at the moment to absorb a 3% rise in interest rates.

A single renter in London looking to get their foot on the housing ladder is in a surprisingly healthy financial position, with over a quarter of their net income left after paying for essentials. However, of concern is that 2014 is the fifth consecutive fall in the amount of money remaining, and considerably lower than the 2009 high of nearly 39%.

LONDON

PROPORTION OF NET INCOME REMAINING CHILDLESS HOUSEHOLD PROPORTION OF NET INCOME REMAINING TWO CHILD HOUSEHOLD

Source: ONS, Land Registry, Countrywide, IPD, Bank of England Source: ONS, Land Registry, Countrywide, IPD, Bank of England, Family & Childcare Trust

-25.00%

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Owner Occupier Renter

6

Source: ONS, Land Registry, Countrywide, IPD, Bank of England

LONDON

Renters in London have 50% of their net income after essentials those renting outside of London have 51% of their income remaining after essentials

In London, those with two children are over-spending regardless of whether they are a home-onwer or renter, with renters coming in slight-ly better at -6% than owner occupiers -17%

A UK renter looking to buy their first home has nearly a third of their net income

7

Childless homeowners in London have 40% of their net income reamaining after essentials, compared to 57% for those outside of London

Families in London with two children can expect to spend 56% of their net income towards childcare

£

P A Y S L I P

As detailed earlier in the report, first time buyers in both London and the wider UK are in a strong position to save for a deposit; however, the primary stumbling block is the size of the deposit that needs to be raised. Prior to the financial crisis there was a wide range of 95% LTV mortgage products available and in fact the interest rate premium attached to these was on average 0.3%, compared with a 75% LTV mortgage.

During the years immediately following the financial crisis, 95% LTV mortgages all but disappeared from the market, severely limiting the ability of first time buyers to get their first foot on the housing ladder. Over the past two years high LTV products have slowly started to return to the market, albeit in much smaller numbers and with much stricter lending criteria. They now also attract a much higher interest rate premium, which is now 2.8% higher than an equivalent 75% LTV mortgage.

Currently on average first time buyers put down a 20% deposit, with the interest rate premium for higher LTV mortgages providing an incentive to put down a larger deposit. As shown both a London and UK first time buyer is capable of saving 20% of their income, but for the average UK first time buyer it would take over 6.5 years to save enough money to buy a house, while the picture is more exaggerated in London, taking nearly 14 years without any outside assistance.

The announcement of the Help to Buy ISA in the 2015 Budget, while welcomed by some, will in reality provide little assistance to prospective buyers, especially in London, due to the cap in government support of £3,000 per person. This is a paltry amount compared to the £75,000 deposit a first time buyer in London is required to save.

SAVING FOR A DEPOSIT

AVERAGE MORTGAGE INTEREST RATE

8

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

95% LTV 75% LTV

Source: Bank of England

2015 OUTLOOK

CONCLUSIONS

In summary, 2014 saw the financial position for all households assessed worsen. This has been caused by wage inflation being outstripped by both rising rents and mortgage payments. The underlying trend for both the UK and London remained, with rents having greater disposable income rather than buyers in London and vice versa for the wider UK.

The main hurdle for first time buyers, especially in London, remains raising sufficient capital for a deposit. Due to another strong year of capital appreciation in London, first time buyers now face an extra 3 years saving before being in a position to buy a property than in 2011.

The Help to Buy ISA does little to help solve to primary problem facing affordability across the UK, the severe shortage of supply. Without any attempts to fix this problem any attempts to further stimulate demand will only serve to increase prices.

Despite the slight worsening of household finances during 2014, the most interesting point is the higher than anticipated discretionary buffer that many households enjoy, running counter to the narrative in both the national media and many people’s minds. This drives home the disparity between what is truly essential spending and what many people consider is essential in their lives.

The question that really needs to be asked is it finally time to lay to rest our obsession with owner occupation? Now is the time to grasp the opportunity at hand and create a more balanced and sustainable residential market.

LOOKING AHEAD, WHAT DOES 2015 HOLD IN STORE?

The year ahead holds a number of reasons to be positive for household finances. Wage growth is expected to outstrip inflation, making many people better off. The fall in oil prices is likely to have knock on effects on the cost of energy, reducing the cost of essential spending.

Although on the other hand, house price and rental inflation are expected to continue, especially in London where structural undersupply shows no sign of abating, which will place added strain to household finances. This is particularly true for those households in need of childcare, the cost of which are anticipated to continue to rise during the next 12 months. This could lead to a decline in the number of families in London, as they are simply priced out of the capital and forced to relocate.

The question will be to what extent these cancel each other out or extenuate each other?

9

CONTACT

10

Richard Valentine-Selsey Senior Analyst richard.valentine-selsey@eur.cushwake.com +44 207 152 5944

Jack Simmons Head of Residential Development & Investment jack.simmons@eur.cushwake.com +44 20 7152 5386

FOR FURTHER INFORMATION CONTACT