UK house prices: (much) more downside

UK house prices remain substantially overvalued because rental yields have not kept pace with the rise in real yields on competing inflation-protected assets.

• UK house prices have fallen relative to rents since 2022, but the rental yield is projected to rise only from 4.0% at end-2022 to 5.2% by end-2026, assuming stable prices over the rest of 2026.
• The rental yield averaged 6.0% over the past 36 years, covering two complete housing cycles; reaching that level with current rents would require prices to fall another 14%.
• Index-linked gilts provide a comparable inflation-protected alternative, and the historical average rental-yield premium over five-year-plus index-linked gilts was 4.8 percentage points.
• The current premium is only 3.1%, so restoring the historical spread would require a 37% house-price decline, assuming the current rents and real gilt yield remain unchanged.
• At end-2022, low rental yields were not necessarily evidence of housing overvaluation because index-linked gilt yields were still negative, but the subsequent rise in rental yields lagged the increase in gilt yields.

Takeaway: UK housing has become more expensive relative to index-linked gilts despite higher absolute rental yields, with the estimated overvaluation now comparable to the start of the crash phase of the previous 18-year housing cycle.