The report found that income multiples are now back to pre-financial crisis levels in London, with homeowners taking on ever larger mortgages.
Caution on the part of borrowers and lenders should prevent a serious problem developing, but the report warns that policy makers should be monitoring this trend closely and be prepared to take action if this key indicator of market stability continues to escalate.
The EY ITEM Club favours macro prudential intervention over higher interest rates, so the Bank of England’s Financial Policy Committee (FPC) would need to play a central role.
If it decides to intervene it should be to impose a formal limit on income multiples.
Andrew Goodwin, senior economic advisor to the EY ITEM Club, said: “House prices across most of the country remain well below their pre-crisis peaks and there seems little danger of a bubble developing.
“But London, which is suffering from a combination of strong demand and a lack of supply, is increasingly giving us cause for concern.”
“Some have suggested that Help to Buy should be altered or cancelled but this is a red herring. The scheme has only a very limited impact on the capital and withdrawing it could risk choking off the recovery in housing transactions across the rest of the UK without solving any of London’s issues. The FPC should instead be looking to limit income multiples.”
The EY ITEM Club forecast shows average UK house prices growing by 8.4% this year and 7.3% in 2015, before cooling to around 5.5% a year thereafter, as Help to Buy (HTB) comes to an end and interest rates steadily increase.
By 2018, the average house price in London is expected to reach nearly £600,000 – some 3.5 times the average price in Northern Ireland and more than 3.3 times the average in the North East.
Outside of London and the South East, the regions with the highest levels of house price growth are expected to be the South West and East of England, both set to grow by 6.2% from 2013-18.
In contrast, the North East is expected to have the lowest level of price growth (4.2%), with Scotland (4.5%) and the West Midlands (4.6%) not far ahead.
Goodwin added: “The regional outlook points to stronger job creation and income growth in the Southern regions, not least because of their lesser exposure to the public sector cuts.
“And with supply problems also at their most acute in the South, these regions are likely to have the strongest price growth indicating a widening gap between the South and the rest of the UK.”
Dean Hodcroft, head of EY’s real estate, hospitality and construction team, said: “However, even in London there are local variations between mini markets which warrant some exploration to determine whether taking a targeted ‘London only’ approach to market cooling measures could be effective.
“Bursting a bubble at the luxury end of the market, which continues to attract interest from international cash buyers with the seemingly irresistible global draw of London’s X-factor, may prove tricky.”
According to the report, housing transactions will continue to be boosted by HTB, which is levelling the playing field for households that were previously locked out of the market, making it easier to establish chains and supporting demand in markets outside of the South where the economic fundamentals are also less supportive.
Housing transactions are expected to rise by around 5% a year, with over 1.36 million people predicted to move home in 2018, according to the EY ITEM Club. This figure would be well short of pre-crisis peaks, but is nevertheless a clear indication that the housing market is functioning normally once again.
Goodwin said that whilst recent trends had been very encouraging, it would also be advisable for the government to do more to ensure that the pickup in housing supply continues.
He said: “The government should be doing more to resolve rigidities in the planning system, with a particular focus on ways to increase supply in and around the London area.
“The government still owns a sizeable amount of brownfield land which could be sold off to house builders more quickly than it is currently.
“On a larger scale there is also a case for the government to use its own low borrowing costs to fund a programme of house building. Large public sector building programmes have been pursued in the past, but in recent years local authorities have built only a couple of thousand properties a year.”