OCR F297 case study: impact of the economic environment on the housing market

In just the last few days we have learnt that the economy has entered a ‘double dip’ recession, with the economy essentially stagnant since the peak of the economic crisis passed in summer 2009. What does all this mean for the UK housing market – the central focus of the OCR F297 A2 case study?

This blog contains extracts from the F297 case study toolkit, as well as some extra comments, links and analysis.

A good place to get a quick snapshot of the current economic situation is from the BBC’s economy tracker, which includes a tab dedicated to following house price changes.

If you’ve had a look for further research background, you might have come across these excellent articles too:
- House prices: Will they fall or rise in 2012?
- House price rise is temporary, says Nationwide
- House prices up slightly in past 12 months

If you only have a chance to do some limited reading, check out the first article. It’s very helpful in identifying a whole host of ‘it depends’ factors that are crucial in determining what happens in the housing market. The bottom line is that no one really knows what will unfold in 2012, so any discussion you have is likely to score heavily on evaluation marks, if you understand and communicate this point.

What is certainly clear is that the “austerity” policies employed by the government (and others in Europe) have yet to yield any very encouraging results. The government’s determination to get on top of its debts by cutting spending and raising taxes is accused by some of causing our lacklustre economic performance. Even relatively small changes in government fiscal policy can have a big impact, like the decision to reinstate stamp duty (a house buying tax) on some types of purchases at the end of last month.

What follows is an edited extract from the F297 case study toolkit, shedding more light on these issues.

The economic environment is an especially important component of the SLSL case study, as “macroeconomic influences are a major factor” (line 45). Yet, in fact, perceptions of reality can be almost as important as the actual reality of the economic environment, as “activity in the property market is also driven by sentiment and confidence” (lines 46-47).

Perhaps the single most obvious observation you can make is that the economy is currently staggering – slowly – away from a deep recession in which GDP (the main measure of economic activity) took a big hit. That severe downturn has fed directly through to people’s confidence and behaviour. As people’s confidence influences the probability of them making major purchases, the housing market has been on the front line in the recession.

Some people might even argue that the housing market lead us into the recession. Over confidence and reckless borrowing is sometimes blamed for pushing house prices up in a speculative ‘bubble’. When the bubble burst, confidence evaporated, prices (and borrowing) plunged, leaving households with huge debts. Estate agencies like SLSL were hit very hard as commissions dried up.

There is a clear link between house prices and consumer confidence (falling house prices severely impact on consumer confidence, but in a complex twist, lower confidence almost certainly puts downward pressure on house prices too). It’s perhaps surprising to see Alistair describe this as “irrational” (56). At the same time, it’s unsurprising that “the closure of an RAF base (and all the jobs and income that represents six miles from Oakford caused a noticeable drop in market confidence” (lines 57-58). That news would be likely to cause property demand to fall, along with property prices. But Alistair is no fool. He recognises the importance of this data and “sends all staff an economic briefing and encourages everyone to keep up-to-date with local and regional developments and to feed these back to him” (lines 59-61).

What will happen next?

The data in Table 2 shows that interest rates have been ultra-low and stable since September 2010. In theory, that should mean that borrowing is encouraged, and saving is discouraged – both moves that should serve to strongly stimulate the housing market – “nearly all residential property is purchased using a mortgage of some kind” (line 48). But has this monetary policy worked?

The consumption and savings data shows that these monetary policy moves have, at best, had mixed success. Households have rediscovered an enthusiasm for saving, rather than spending. And banks have been reluctant to lend; “since the ‘credit crunch’ mortgage lenders have been far more cautious in their lending: hence, borrowers are increasingly expected to offer a substantial deposit and to show their credit worthiness. Consequently, new mortgages to first time buyers have declined, despite low interest rates” (line 48-51). This will have hurt the markets that SLSL operate in.

Data in Table 2 partially backs up this analysis. Gross mortgage lending dived in late 2010, but has recovered since 2011 (although we don’t know the extent to which these national figures are reflected by local conditions in SLSL’s markets). Time series analysis shows the overall lending trend from September 2010: it’s going back up. Time series analysis can be manipulated to ‘prove’ a point. If you only look at the data from 2011, the trend towards higher levels of borrowing – and presumably a recovery in the property market – looks even stronger. Perhaps a recovery in the property market is about to get underway…

The data in Table 3 does not point to the sort of recovery that SLSL will want to see. On the basis of the limited data available – and subject to the same time series analysis – the overall picture does not look bright. The trend continues to see house prices on a downward path, presumably continuing into the near future. Over the long term, house prices tend to travel on the same path as average earnings. Perhaps property prices will stabilise once they hit around 4 times average earnings. The precise value doesn’t matter: the point is that if earnings growth rapidly picks up, so will property prices. Is there any sign of rapid earnings growth?

The picture looks doubtful, and is pretty consistent. High levels of unemployment continue, and it may be 2-3 years into the recovery before they really start to fall. High levels of unemployment will continue to put downward pressure on earnings, crush confidence and encourage saving.

The economic environment: summary of its impact on SLSL

- Confidence is of crucial importance, both nationally and locally, in driving the housing market. There is unlikely to rapid increases in incomes in the near future that might result in a significant boost to property prices, and the commissions that SLSL can make from property sales.
- Lower interest rates have had a very limited effect on stimulating the market. And with interest rates so low, the only way they can go is up. On a positive note, general levels of mortgage lending are recovering strongly. However, all the evidence suggests we will not see a house price boom in the near future.
- The market for buying property has taken a battering, especially for new first time buyers. But “it has not escaped Alistair’s attention that there has been a commensurate rise in residential letting activity, particularly to young couples unable to access the housing ladder. Further, with low saving (interest) rates SLSL has seen a modest rise in properties bought for the buy-to-let (rental) market and enquiries from landlords asking whether SLSL offers letting management” (lines 51-55).

These trends are very significant for SLSL, possibly offering a strategic opportunity for the business to shift their focus from sales to the rental and management side of the property market.

You can order the entire toolkit here.