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The UK housing market is quite volatile. In the past few decades we have seen two major booms and busts.  This is a look at factors that influence the housing market and house prices.

• Economic Growth. Demand for housing is dependent upon income. With higher economic growth and rising incomes people will be able to spend more on houses; this will increase demand and push up prices. In fact, demand for housing is often noted to be income elastic (luxury good); rising incomes leading to a bigger % of income being spent on houses. Similarly in a recession, falling incomes will mean people can’t afford to buy and those who lose their job may fall behind in their mortgage payments and end up with their home repossess.
• Unemployment. Related to economic growth is unemployment. Clearly when unemployment is rising, less people will be able to afford a house. But, even the fear of unemployment may discourage people from entering the property market.

• Interest Rates. Interest rates affect the cost of monthly mortgage payments. A period of high interest rates will increase cost of mortgage payments and will cause lower demand for buying a house. High interest rates make renting relatively more attractive to buying. Interest rates have a bigger effect if homeowners have large variable mortgages. For example, in 1990-92, the sharp rise in interest rates caused a very steep fall in UK house prices because homeowners couldn’t afford the rise in interest rates. Continue Reading →

Readers Question: Why is house price inflation considered good while other forms of inflation are considered bad? Or are all forms of inflation bad for the economy?

House price inflation has a mixed impact on the economy depending upon the extent and timing of the rise in house prices.

This graph shows house price inflation in the UK since 1981. It shows the volatility of house price inflation in the UK.

Benefits of Moderate House Price Inflation

• A rise in house prices increases the wealth of householders. This can lead to increased consumer spending. Householders can take equity withdrawal from the increased value of their house.
• House price inflation doesn’t reduce the value of savings like ordinary inflation. For homeowners, wealth actually increases.
• House price inflation doesn’t indicate the economy is at full capacity and overheating, it just reflects demand is greater than supply in this particular market.

Problems of House Price Inflation

Rising house prices are good for homeowners, but it can reduce living standards for those who don’t have a house. In the UK house price inflation has made homes unaffordable for many first time buyers – see: House price to income ratios. Rising house prices have also had an impact on increasing rents. House prices inflation, in the UK, has increased inter generational inequality; those buying houses in the 1970s and 80s have done very well, but young people facing a very difficult housing market.

House Price Inflation and Boom and Busts

The most serious problem of house price inflation is that in booms, the rise in house prices often prove to be unsustainable. In the 1980s, rising house prices contributed to an economic boom – rising consumer spending and rapid economic growth. However, this economic growth and rise in house prices both proved unsustainable. When interest rates were increased to reduce inflation, it caused a collapse in house prices. This fall in house prices left many with negative equity. The subsequent fall in house prices was a factor in contributing to the recession of 1991. Volatility in house price inflation has a big impact on economic instability. Similarly falling house prices post 2008 (as a consequence of the overheating in house prices) has been a big drag on the US and European economies.

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Readers Question: What is the impact of debt on the housing market in the UK? If the UK is in such a debt crisis, what impact has this had on the housing market.

Firstly, a debt crisis could imply both government debt and household debt. The UK is facing a combination of both (see: total UK debt)

Since the financial crisis started in 2007, UK house prices have fallen. One of the main reasons for the initial fall of 20% was the drying up of mortgage finance. After the credit crisis, banks became short of liquidity and so reduced the amount of available mortgages. The number of approved mortgages fell rapidly leaving lower demand for housing, pushing down prices.

After the credit crunch, banks required homeowners to save a bigger deposit. (Remember before the crash 100% mortgages were available. Now, many banks require a 25% or 10% deposit). This deposit requirement meant that many first time buyers were priced out of the market and unable to buy. In 2008, the UK savings ratio was very low. This indicates that households had taken on more debt and had low levels of savings for a deposit. This was a factor in depressing house prices.

In the aftermath of the financial crisis, both financial institutions and households have been seeking to reduce debt levels and improve their reserves. This is why banks are more reluctant to lend and why households have increased their savings ratio.

Sharp increase in savings after 2008.

In addition the economic recession also reduced demand for buying. This was due to the rise in unemployment, decline in consumer confidence and threat of losing your job.

Government debt levels have caused the government to announce spending cuts. Since 2010, the economy has stalled due to austerity measures and problems in Europe. This second recession could cause further problems for the housing market.

House Price Falls Limited

The most recent data, suggests house prices have fallen by less than we might expect. UK house prices have fallen by less than countries, such as Spain and the US. House price to income ratios are still above long term trends. There has been a stagnation in house prices since 2009. Despite the economic recession, house prices have not fallen. This is because

• Low interest rates have cushioned the impact of recession and debt levels. Mortgages may be scarce, but at least mortgage payments are relatively low, unlike the 1990s. Interest rates are likely to remain low as economic growth is as fragile as it is at the moment.
• Limited supply keeping prices high. Unlike other countries, the UK has not had a housing building boom. The financial and economic crisis have curtailed further house building schemes and helped prevent excess supply

Could Debt Crisis Cause Second Fall in House Prices?

Some analysts fear that if the Eurozone breaks up and Europe enters a deep recession, the UK could see further falls in house prices. The UK has already entered a double dip recession and a further rise in unemployment could lead to less demand. If banks lose money from debt default in Eurozone, mortgage availability could dry up again.

Despite the longest recession since the 1930s, UK house prices have started to rise again. They are now close to 10% higher than their lowest point. Rising house prices are often seen as a good thing, at least by those who own a house. But, is it healthy for the economy to have rising house prices – especially at this particular point in the economic cycle?

Benefits of Rising House Prices

• Rising house prices encourage homeowners to spend and have greater confidence in the economy. In a recession, this boost to consumer confidence and consumer spending will help the economy recover. Falling house prices may prolong the economic downturn.
• Bank Balance Sheets. Rising prices helps to limit negative equity and therefore limits potential bank losses from home repossession. This improvement in house prices may encourage banks to resume more normal lending practises.

Problems of Rising House Prices

1. House prices are rising from an unsustainable level. According to an Economist survey of global house prices, UK house prices are still 31% overvalued. The house price-to-rent ratio still outstrips its long-term average by nearly a third. (link)
2. Wealth Inequality. Rising house prices are good for those who own a house (often older generation) It is bad news for those trying to get on the property ladder. It means they have to devote a high % of their income to saving for a deposit and paying a mortgage.
3. The rise in house prices doesn’t reflect strong, sustainable demand, it reflects a shortage of supply in the market, therefore it is misleading as a sign of the underlying strength of the housing market.
4. The rise in house prices could easily be overturned if there was a strong rise in interest rates or house building programme.
5. Geographical immobility. Expensive house prices makes it more difficult for people to move around the country.

From a short term perspective it is good that house prices have stopped falling. The modest rise in house prices will give a boost to the economic recovery. This is important. However, from a longer term perspective the continued unaffordability of house prices leaves economic problems.

Related

• Why House Prices have stopped falling
• Overvalued housing markets
• Why UK House prices have risen so much

To many people’s surprise, UK house prices have risen quite strongly in the past 12 months.

If we look at the experience of Japan, United States, Ireland or Spain, it seems the experience of Britain is unusual. Countries like Japan and the US had a boom and bust in  house prices, similar to the UK. However, the fall in house prices has been more pronounced and longer lasting in other countries.

Given the weak state of the UK economy and financial sector, it is perhaps surprising house prices have recovered so strongly.

Several Factors would normally be lowering house prices

• House price to earnings ratios are still above long term averages.

• Unemployment is rising
• The economy is very slowly recovering from its deepest recession since the 1930s
• Banks are still reluctant to lend mortgages because of lack of finance.

Yet, despite these factors, figures from Rightmove suggested the annual rate of house price inflation was 6.1%. Prices rose 3.2% in the month to February alone. Rightmove measure asking prices, though other house price surveys such as Nationwide paint a similar picture.

There is every possibility that house prices could stop rising and start falling again – especially if the recession lengthens and there is significant job cuts in the public sector.

Yet, at the moment, the combination of – low interest rates and a relative shortage in supply is pushing house prices higher.

It is this shortage in supply that I feel is the main the reason for fact British house prices have stopped falling. In Spain, US and other countries, the boom in house prices, led to a boom in house building. Therefore, they have depressed demand and excess supply. – which hopefully all students would know is a recipe for falling prices.

In the UK, demand is still relatively weak, but, the excess supply is not there – a legacy of the UK’s strict planning regulations.

In the long term, what it suggests is UK house prices will remain expensive – meaning people who want to buy a house will have great difficulty saving for a deposit.

Related

• Why Have house prices stopped falling?

In a recent post, we suggested that after two years of falling prices, the market has turned and now prices are starting to rise. – house price rise

This rise in house prices may prove short lived, and looking at this graph we can see why. Although house prices have fallen 25% from their 2007 peak, they are still relatively expensive. This graph shows the ratio of house prices to earnings for first time buyers. At a ratio of 4.0, this is considerably higher than the post 91 slump when the ratio fell to a little over 2.0.

Low interest rates are helping to make it attractive to buy a house because mortgage interest payments are relatively low. Also, prices are being kept high, by a relative shortage of properties on the market. – This is in contrast to countries like Spain, Ireland and US – where a glut of unsold properties are pushing prices down further.

House price to earnings Ratio over past two decades

Of course, the house price to earnings ratio doesn’t have to fall to historical averages. A continued shortage of supply and low interest rates could mean house prices rise, despite the fact they are still unaffordable for many.

All of this will come as no comfort to those hoping to be able to buy a house at an affordable price.

UK House Prices

When Nationwide began its survey of house prices in 1952, the average house price was £1,891.

If house prices had grown inline with inflation. Average house prices today would be worth £43,711.

However, despite recent 25% slump in house prices, average UK house prices stand at over £150,000.

Many predicted that this year, UK house prices would continue to slump by 10-40%. But, rather unexepectedly, prices have begun to stabilise.

This could just be a temporary pause before the downward trend is continued. On the other hand, some feel that the shortage of housing in the UK could keep prices high, despite the gloomy economic situation.

House prices are certainly not rising because of a surge in demand. In fact for many first time buyers, housing affordability remains poor. The ratio of house price to earnings is far higher than at the end of the last boom.

I wrote a detailed post with graphs and commentary on – Why House Prices have stopped falling – and whether this is likely to be temporary or permanent.