Why are rates of housebuilding falling?

Surging interest rates in late 2022 led to much speculation about the future of the housing market, including predictions of a housing market crash. In response, we published ‘Reboot: building a housing market that works for all’  in January 2023, which set out an assessment of the likely direction of travel for the housing market and how policymakers should therefore respond. 

The report stated that the most likely outcome was a small price correction and market stagnation: this is exactly what has happened over the last year:

The most likely initial scenario is one of stagnation in transactions and new supply, with modest declines in nominal house prices, though inflation means that real price falls will be deeper than many people realise.

Reboot: building a housing market that works for all

Higher interest rates have had a modest impact on house prices. Nominal prices are down around 6% from their 2022 peak although the correction has been much larger, around 13%, once we adjust for inflation. But the impact of this real-terms fall on affordability is only modest, as it comes after several years of rapid house price growth. The result is that real prices are only back to the levels of 2019 – when affordability was severely squeezed.

Instead of a major correction in prices, it is market activity that has suffered most. Mortgage approvals were 28% lower in 2023 than their pre-pandemic peak, while transactions (including those without a mortgage) were down 15% – the difference between approvals and transactions reflecting the growing importance of cash buyers in keeping the market moving at all. 

Housebuilders do not want lower prices

Housebuilders have responded to a market with lower transactions - and therefore lower sales - by cutting back on delivery. 

We warned in our 'Reboot: building a housing market that works for all’ report that with a large proportion of new housing supply dependent on market sales, a stagnant housing market could be disastrous for the construction of new homes. Since volume housebuilders are in a far healthier financial position than prior to the previous downturn, the immediate danger is that developers will simply cut back on delivery. This will start another cycle of housebuilding collapse, which will take years to recover from.

This prediction is holding true. Overall housebuilding volumes have indeed stalled and started to decline over the last year. Housing completion figures are beginning to track downwards, but there are time lags in this data so the current trend can best be seen in developers’ weekly sales rates:

While there are genuine supply-side reasons for the slowdown in housebuilding, such as political uncertainty about planning targets and regulations like ‘second staircase’ requirements, in the short-term the main driver is lower effective demand. Homebuyers are not able or willing to pay the prices developers want to sell at. 

Higher mortgage rates and the end of Help to Buy equity loans have created a negative shock to effective demand - despite the underlying need for more housing. Housebuilders don’t want to lower headline sales prices, as this might weaken market sentiment and put downward pressure on prices. They also worry that lower sales prices would prompt mortgage lenders to lower their valuations and the amount they would lend to buyers, triggering further price falls. Maintaining headline sales prices is therefore important for housebuilders seeking to keep market sentiment and profit rates up – even if this means selling fewer homes in the short-term. 

To encourage sales of homes they have already built while maintaining sticker prices, developers are resorting to alternative strategies – such as marketing directly to customers via Rightmove or offering incentives to buyers.  Developers might offer to put in new carpets, to upgrade kitchen appliances, to pay some or all of buyers’ Stamp Duty costs - as Taylor Wimpey are currently offering - or even to give ‘cash back’ on completion of a purchase.

On the whole pricing remains broadly stable although we have seen a slight reduction in Group private average selling price in the forward order book and an increase in the use of incentives.

Persimmon, 7 Nov 2023

Consequently, the prospects for maintaining recent levels of delivery, let alone reaching the target of 300,000 homes a year, are limited. Stalling supply has also begun to damage the long-term outlook as firms reduce or halt plans for future delivery – leading to fewer planning applications and permissions – and cut back on their capacity, leading to job losses and weaknesses in the construction supply chain. 

Social housing is a weaker lifeline than in previous downturns 

A more positive story can be found in social housebuilding. Counter-intuitively, the stagnating sales market and stalling private housebuilding means that we are also seeing a temporary surge in affordable housing output, as developers rush to finish current schemes with guaranteed buyers in the affordable housing sector. Some are also flipping some output planned for private sale into affordable tenures (helped by the recent introduction of some flexibility on grant rates), with the result that affordable supply rates are holding up and even rising. 

Despite this initially positive outlook for rates of social housebuilding, social landlords are also subject to their own financial pressures, which has left affordable supply more exposed to market risk and changing economic conditions. In 1991 87% of new affordable homes were for social rent and 13% were for low-cost homeownership. Twenty years later that balance had reversed, with 87% of affordable housing supply being in tenures more directly linked to the market (mainly shared ownership and affordable rent) and only 13% being for social rent. Most social landlords are now cutting their own development plans, and many report that the future pipeline of homes built by private developers and sold to them under ‘Section 106’ planning deals is drying up.  A recent survey showed that England’s largest developing social landlords plan to shrink their pipelines by an average of 22% in the coming years.

Therefore, this initial uptick in social housebuilding is just the surge before the drop, as developers work through current schemes before retrenching.

We must support new methods of delivery 

A year ago, we called for Government to respond to stagnation by funding the conversion of more of the private supply pipeline into affordable tenures. This is even more needed now: 

• the Government should provide sufficient grant to enable social landlords to acquire stalled and slowing private developments and reprofile them as mixed tenure schemes, especially as social rented housing 
• given the healthy profit margins they have made and are still making on new homes sales, developers must be willing to accept lower prices on any units and sites acquired under a government-funded acquisitions programme
• affordable housing grant should also be made available to councils and housing associations alike, to enable them to convert affordable rent, shared ownership and market sale units to social rent.

But tenure conversion must be done carefully, learning the lessons from responses to previous downturns to avoid public money being used to buy the wrong homes or propping up prices artificially: 

• quality standards must be rigorously enforced, by redesigning schemes and raising specifications if necessary, and reflecting these costs in further reductions in prices paid.

Providing sticks as well as carrots to encourage developers to build out sites or release them to those who can would mean: 

• councils being empowered to levy Council Tax and Business Rates on unbuilt schemes with planning permission, after a reasonable period for construction
• the compulsory purchase of stalled schemes and development sites, at prices reflecting the true market value of the planned homes, may be required to get some schemes into construction and incentivise developers to either build out or sell voluntarily
• enabling compulsory purchase at true market value will require legislation to reform the 1961 Land Compensation Act, removing ‘hope value’ from the compensation paid to landowners. 

Looking beyond the immediate response, current market fluctuations are indicative of a broken system, marked by volatile build costs, a lack of innovation and a market dominated by a speculative business model. 

Intervention now must do more than patch up the current model. Instead, it must support a longer-term shift to a more sustainable housebuilding system, with funding and policy support from Government to ramp up social and affordable supply alongside market supply. 

This would offer many benefits for construction sector capacity and innovation, with counter-cyclical social and affordable supply smoothing out the booms and busts of cyclical market supply, and so helping to maintain and increase overall capacity across housing market cycles. This is vital to rebuild skills and procurement pipelines, and to underpin demand for new, greener building technologies which are needed to reduce capacity pressures and improve build quality over the long-term. 

Read our updated housing supply analysis for more information.