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Will UK house prices go up in 2025?

By James Sproule, UK Chief Economist

Published: 20 December 2024
Reading time: Two minutes

Mortgage approvals are at the pre-pandemic average, but will that demand lead to an increase in house prices? Our UK Chief Economist gives his analysis. 

There are four key things which drive house prices – what we call the wealth effect, supply and demand, affordability, and investment yield.

How wealthy a society is clearly matters to the general level of house prices, although this does tend to be one of those longer term backdrop issues. What is clear is that as people grow wealthier, they are inclined to put ever more of this additional wealth into nicer housing. As to supply and demand, the UK’s population is similar to that of France, yet they have 37 million homes against the UK’s 30 million. This government has made it a priority to see this problem fixed, but then so did the last government. 

The affordability question

Looking to more immediate drivers of prices, we have to consider two things on that list: affordability and yield.

Affordability is largely about what's happening to earnings and interest rates. Looking first at earnings. The spike in inflation in 2022 took real earnings down to minus two percent in real terms, enough of a shock to hit house prices. Whilst earnings have subsequently recovered in real terms, the forecast is that as a result of the October Budget, real earnings growth is again set to move just into negative territory in 2025. 

Interest rates are also a key driver for housing demand. With inflation well down from its peak, there is ample scope to reduce interest rates over the coming year, even if some residual sticky, wage-inspired inflation means that interest rates are likely to settle a bit higher than many first thought, around 3.75%. These lower rates equal falling costs of financing, which will clearly be a help to housing affordability.

What about yields?

Then there is the question of yield. From the point of view of a property investor, property must give a premium over a risk-free government bond (gilt) to be worth taking on, if only to compensate for the risk inherent in potential periods where the property is empty, there are difficult tenants, or there are unforeseen repair and maintenance charges. Historically this yield has been 4% for residential property and 5% for commercial property. When interest rates shot up as inflation rocketed in 2022, gilt yields responded immediately. 

Because the property market is far less liquid than the gilt market, the change in gilt yields took the premium on property down towards 1%.

Clearly two things needed to happen:

  1. Rents needed to rapidly increase; and/or 
  2. Capital values needed to adjust to provide a more realistic investment yield. 

Much, but not all, of this adjustment has taken place. Rents are up by 7% since summer 2021 and capital values have fallen by 15% in real term over the same time. 

Our view is that there is further to go to reach an investment yield which properly compensates property investors for the risk, and that achieving that equilibrium is going to be achieved by property prices rising by less than inflation for the next couple of years.

2025 housing market challenges

It’s worth remembering that over the course of this next year, we're likely to experience two additional headwinds. The first will be a rise of stamp duty, which will come in in April. This is likely to result in people pulling forward house sales, so please do not confuse a good spring with a sustained recovery. Longer-term raising the cost of buying into a market will have a negative effect on the number of people going into that market. 

Secondly, there are considerations around the broader health and wealth of the economy. Both business and consumer confidence and tax levels have been impacted by the recent Budget and Handelsbanken’s forecast for the UK economy Opens in a new window as a whole is for moderate growth over the  coming 12-18 months. 

Dull as it may be, moderation in the broader economy is going to be reflected in house prices overall as well.

Read more about our relationship approach to mortgage lending.

You can catch James each Monday on our podcast. See the link below.