Thinking of buying a new-build home? You might be bowled over by the clean layout and brand new fixtures and fittings, but your mortgage lender may not be so impressed. Banks and building societies are less willing to lend to borrowers with small deposits who are buying new than to those buying existing homes. In 2019, around a quarter of mortgages lent against existing homes had a loan-to-value ratio of more than 85 per cent. For new-build, it was just 13 per cent.
New-build homes — like new cars — tend to be more expensive than older homes. And like for new cars, that premium disappears. The concern for lenders is how the price of new homes holds out over time.
Since 2013, the Help to Buy equity loan scheme — where the UK government lent homebuyers up to 20 per cent of the cost of the property (40 per cent in London) — helped bridge the gap between lenders’ concern and buyers’ demand for new-build homes.
However, after being limited to first-time buyers in April this year, the scheme is due to end completely in March 2023. Without an appropriate replacement, there could be a fall in housing supply if developers end up building fewer homes as a result.
The case for the new-build premium is clear. Many people buying older homes will need to pay for repairs and refurbishment. But critically, this money comes from a separate pot, not from their mortgage. For new-build buyers, it’s all wrapped up in the price. Also included in the price of new-builds might be incentives that developers like to give away for “free”: a stamp duty waiver, for example, gratis gym memberships or a year’s “free” service charge.
How big the premium is can be hard to measure. Different data providers have different estimates, typically ranging from 10-20 per cent. However, this can vary by location and property type. It might also depend on how you measure it.
For example, the price of a new-build house might seem in line with the local market when you see it online. But when you come to view it, and possibly lie on the bedroom floor (as I’ve been known to do), you may find that it’s smaller than its older neighbours. Here, the new-build premium is found in the price per square metre rather than headline price. Perhaps by coincidence, that’s the metric that matters most to developers, who want to make a profit on the whole site rather than individual homes.
To assess the new-build premium, mortgage lenders tend to rely on valuations based on other comparable homes and automated processes. That may help identify any inconsistencies in price at the point of purchase but, after that, who knows? To understand what happens to the price of new-build homes as they age, some colleagues and I tracked the sales price of thousands of new-build homes from when they were first sold by developers through subsequent sales as they gradually joined the existing housing stock and lost their new-build lustre.
Our findings suggest that mortgage lenders’ concerns are well founded. Over the short-term (three years or less), new-build homes tend to sell for a higher price than suggested by local price trends. But this reverses rapidly in the following years.
Our research finds that new-build homes sold seven years after they were built had, on average, underperformed the local benchmark by around 10 percentage points. So, if house prices in the local market had risen by 30 per cent over the period, then the price of an average new-build home had only risen by 20 per cent. But this varies by location, possibly reflecting the type and quality of both new and existing homes in the local market.
The results are more concerning when you filter by property type. For some homes, typically houses, the underperformance appears as a one-off discount to the market, reflecting the disappearance of the new-build premium over seven years or so. However, for flats, there is evidence of a sustained discount — which is perhaps why lenders are much stricter about low-deposit mortgages on new-build flats compared with houses. They are much riskier, even before you factor in the other issues facing new-build flats such as cladding and ground rents. For example, flats built in Leeds at the turn of the century had underperformed the local benchmark by 25 percentage points when sold in 2010, years after completion. By 2020, that difference had risen to 40 percentage points.
Buyers of new-build homes may not build up equity as quickly as their peers in a market with rising house prices — and would be more exposed to negative equity in the event of house price falls. But buying any home comes with risk and, for many people, buying new-build will still be the right choice, especially if it helps them avoid large refurbishment costs or they value the better energy efficiency.
Our research also highlights why the Help to Buy equity loan scheme is so important to the new-build sector. It supports about one-third of all new-build sales, providing the lenders with the reassurance that, if house prices fall, borrowers and government will take most of the risk.
With the Help to Buy equity loan due to end in less than 18 months, the private sector has launched its own insurance-based scheme, called Deposit Unlock, in an attempt to fill the gap. Developers will pay insurance premiums to cover any loss suffered by lenders in the event of house price falls. That may appear to be good news for everyone involved but hopefully the insurance providers have done their homework on the risks presented by the new-build premium — or there could be some difficult conversations with the lenders in the event of a house price crash.
So the next time you’re viewing a new-build home, take a lie down on the bedroom floor — you might need it when you work out how much premium you could be paying.
Neal Hudson is housing market analyst and founder of the consultancy BuiltPlace