Some Economists and housing analysts argue house prices are significantly overvalued and are due to fall in the near future. Some paint a doomsday scenario of falling house prices leading to recession. Should we be concerned about a decline in the housing market?

Effect of Falling House Prices.

If house prices fall, it will lead to a decline in household wealth, and an increase in negative equity. The effect on consumer confidence is likely to be more significant than for rising house prices. People expect rising house prices, therefore, if house prices fell it would be a real shock, and could adversely affect consumer spending.

Many people have taken out expensive mortgage deal, in the hope that they will be able to remortgage after rising house prices. If house prices fall this will not be possible and they could face negative equity.

Therefore, falling house prices will reduce AD and lead to lower economic growth; It could cause a recession - a period of negative economic growth for 2 quarters.

However, if house prices do fall, it will reduce inflationary pressure in the economy. Therefore the Bank of England will be able to cut interest rates; this reduction in interest rates may maintain positive economic growth. However, it may be that falling house prices reduce confidence so much, that lower interest rates will be ineffective in stimulating demand.

It is worth remembering that in 1991, house prices fell 15% and this was a major factor in the recession of 1991-92.

A significant factor will be whether house prices fall gradually or fall sharply. If house prices stagnate there is unlikely to be a recession; however, if they fall dramatically in a short space of time, a recession is much more likely.


Related

• Effects of Falling US House Prices
• Boom and Bust in US housing Market
• Effects of Rising UK house Prices
  

Labels: Housing Market, UK housing Market

The UK housing market has a significant impact on the UK economy because:

1. 78% of households are privately owned. Home ownership rates are amongst the highest in Europe
2. Housing is the biggest form of wealth in the UK.
3. Mortgage debt accounts for the largest section of UK debt. Average mortgage debt is £21,000 per person.
4. House Prices have a significant effect on consumer confidence and expectations. (house prices and house price predictions are often front page news)

Effect of Rising House Prices.

Those who own houses will see an increase in their wealth. This is likely to increase their confidence, thereby causing higher levels of consumer spending.

In addition, if house prices rise, consumers can increase spending by remortgaging. This means they take out a bigger loan, against the value of their house. This means that the difference between, the current price and their buying price, is available for spend. Mortgage equity withdrawal has been a significant determinant of consumer spending in the UK

Higher levels of consumer spending lead to rising Aggregate Demand and therefore higher economic growth. Consumer spending accounts for 66% of AD, therefore, the effect of rising house prices can be quite significant in determining economic growth.

Higher house prices may cause inflation. This is because, if AD increases then the economy may get close to full capacity, and grow faster than the long run trend rate.

However rising house prices no not necessarily cause inflation. Firstly, it depends upon other factors affecting consumers. For example, if real wages are growing very slowly, or taxes have been increased, then consumer spending will be moderated. Since 2001, House prices in the UK have doubled, however, this has not caused inflation; the reason is that other inflationary pressures have low. For example:

• Independent MPC target low inflation, they have raised interest rates to moderate demand where appropriate
• Real wage growth has been low, (especially in public sector.)
• Low global inflation - helped by cheap manufacturing imports from China, and low commodity prices.
• Improved supply side policies increasing competitiveness of the UK economy.
• UK manufacturing sector in recession.
• UK economic growth close to long run trend rate.

Note: in the 1980s, rising house prices did contribute to inflation (inflation reached over 10% in 1990), because it was combined with loose monetary policy, and buoyant levels of consumer confidence.


Rising house prices are likely to cause a current account deficit. This is because rising house prices increase consumption and therefore consumers will spend more on imports from abroad. Equity withdrawal tends to be spent on luxury imported goods. The UK has a marginal propensity to import. The UK current account deficit recently increased to 3.5% of GDP.

Slump in Housing Market effect on Circular Flow

A fall in house prices will have the opposite effect. Falling house prices will reduce consumer wealth, creating a negative effect on consumer spending and consumer confidence. Therefore, there will be a fall in AD and a reduction in injections into the circular flow. This will lead to lower economic growth, unless other factors override this.

1. Why House prices may continue to rise?
2. How do House Prices effect Consumption
   

Labels: UK economy, UK housing Market

Why House Prices in the UK have risen by 165% since 1992.

In the past 15 years, house prices in the UK have risen much faster than general inflation, and real incomes. The rise in house prices have confounded many industry experts, who have been predicting house price falls for several years.

Economic Reasons for House Price Rises include:

1. Long period of economic expansion.

Economic growth has been close to the long run trend rate of 2.5% for 15 years. This has increased incomes and confidence in the economy. However, it explains only part of the increase; this is because prices have risen much faster than incomes.

2. Low Real Interest Rates.

This is the nominal interest rate minus inflation. Since leaving the ERM in 1992 real interest rates have been very low. Interest rates fell as low as 3.5% in 2005. Since the bank of England was made independent people expect both lower inflation and consequently lower interest rates. Interest rates increase by only 0.25% at a time. This creates more stability for homeowners. Interest rates are much lower than pre 1992. This has been a significant factor in increasing demand for houses, especially in UK where most mortgages have variable interest rates.

3. Increasing number of households.

Demographic factors have increased the number of households (by a faster rate than the population). These include:

• Increase in divorce Rate.
• Marriage rates declining
• Aging population - more single old people.
• Immigration - has helped to boost population, especially in London.

4. Increase in Number of People buying second homes.

In London many houses are being bought by foreigners, for example, Russians and Arabs.

5. Increased availability of Mortgages.

The ratio of house prices to incomes has increased. Banks have sought to lend larger amounts than before. They have introduced new types of mortgages such as interest only, 50 year mortgages; banks have also relaxed lending criteria making it easier to borrow higher salary multiples.

6. Buy To Let Market.

This is the sector of the market where people buy a house and rent it out. The buy to let market has been buoyant because of rising rents. Buy to let buyers hope to get both income and capital gains. This sector of the market is more susceptible to speculation. This means people are buying houses in the hope of making capital gains.

7. Fundamental shortage of Supply.

The fundamental reason for rising house prices is the underlying shortage of supply. Demand has been increasing faster than supply. 1960s houses are being knocked down, and the number of new houses being built is at an all time low. There are many restrictions on building new houses. This is unlikely to be solved in the near future.

Related:

• House Price Rise fastest in 4 years
• UK Housing Market
• Why House Prices have risen in UK
• Effects of Falling US House Prices
• House Price Crash - are UK house prices doomed?

Labels: UK housing Market

Recent evidence from the UK Housing Market suggest that despite recent rises in interest rates, house prices continue to rise above expectations.

According to the website Rightmove the average asking price of a UK home rose by 3.6 per cent - or £8,307 - in the month of March. This is the largest monthly increase since April 2002. This means the average asking price was £236,490. a yearly increase of 15%.

Miles Shipside of Rightmove, said: "Sellers' asking prices provide one of the earliest indicators of which way the market is headed, and while a boost is to be expected around Easter, £8,000 in a month is the largest amount we have ever recorded. Every region saw large increases, with the minimum jump being £3,000."


Why House Prices in UK don't Fall but continue to Rise



1. Fundamental shortage of Supply.

The Demand for houses continues to grow at a faster rate than supply. The government has a target to build 200,000 homes per year, however this target is not being met. In the UK the planning process for building new houses is quite slow. There are many obstacles, especially in the South East; there is a lack of available land and many potential areas are protected by green belt land. Furthermore existing homeowners and councils usually have a vested interest in preventing new houses being built. An increase in supply of houses leads to lower house prices, increased congestion and increased pollution. The shortage of supply in the UK is unlikely to be solved in the short term or even medium term. Whilst this shortage of supply continues house prices will continue to remain high.

2. Low Real Interest Rates.

Although interest rates have risen 3 times since August 2006, real interest rates are still quite low by historical standards. Real interest rate is nominal (base rate) - Inflation. Thus with interest rates at 5.25% and inflation at 2.7% real interest rates are 2.55%. This makes borrowing still relatively attractive. Buy to let is also still giving relatively good gains.


3. Strong Economic Growth

High levels of economic growth and low unemployment continue to create a feel good factor within UK workers. This is increasing willingness to borrow and spend more on houses. In the South East and London demand is being increased by city workers who are getting higher bonuses.

4. Wealth Effect.

The rise of house prices in the UK has created a generational gap between those who bought a house 20 years ago and those who are struggling to get on the property ladder. However many parents are using their increased wealth to help their children get on the property ladder, through giving a suitable deposit.

5. Increased Availability of Mortgage Finance

Mortgage lenders are increasingly willing to lend higher income multiples. They are also willing to promote riskier mortgage products like interest only mortgages and self certification mortgages. This means that although house prices have increased faster than earnings people are still able to get a mortgage.


See also:

Why House Prices may fall in UK soon


Will House prices drop ?

House Prices set to drop

Labels: UK housing Market

For several years the UK government has frequently stated its desire to see an increase in the number of houses built. Yet despite its stated desire to increase the stock of housing. The number of houses being built is lagging behind the number of households being created. The effect is to exacerbate the UK housing bubble and make house prices even less affordable.

The advantages of Increasing the Supply of Houses.

1. Demand is Greater than Supply.

The number of households in the UK is estimated to be rising by about 200,000 per year [1]. This is because of

Rising population

Increasing numbers of immigrants (esp. from eastern Europe)

More people living alone; e.g. higher divorce rates, people living longer. However the number of new houses being built is less than 165,000 per year which is one of the lowest figures since 1924 [2]

2. House Price Volatility.

Shortage of Housing makes the housing market more volatile. Because supply cannot respond to changes in demand it means that even a small change in demand causes a proportionally bigger change in price. This is one reason for the rapid increase in house prices in the UK. However if demand were to start falling then it would cause a similarly large fall in price, causing problems of negative equity. If there wasn’t such an acute shortage of housing, the UK housing market would be less volatile.

3. Shortage of Key Public Sector workers.

The shortage of housing is more acute in some areas rather than others. It means that in areas of the South East, especially London many key public sector workers are unable to afford to buy a house. Therefore they prefer to work in areas of the north where housing is more affordable. This adversely effects the London economy and could harm the performance of public services like teaching, police e.t.c in the Long term.

Problems of Increasing House Supply

1. The Current Planning procedure is notoriously long. A lot of power rests in the hands of local authorities who are able to delay and block housing proposals.
2. Shortage of Land. In many areas of the country, especially the south East, it is difficult to build new housing without encroaching on green belt land. Thus there is a trade off between economic forces and also environmental forces. To some extent this could be overcome by making better use of brown-belt land.
3. Time Delays. Because of the problems in planning and building. New housing policies designed now will not have an effect for several years. It is possible that 5 years down the line demand for housing will not be increasing so much.

[1] Supply of housing - BBC Report

[2] Supply of Housing - PDF report

Labels: supply of housing, UK housing Market

Will a falling Stock Market adversely effect the US and UK Housing Market?

With Global Stock Markets suffering their biggest fall for a decade, it is worth considering the economic effect of a fall in stock markets.

First of all it depends on the severity and length of the stock market fall. For example the stock market crash of 25% in 1987 didn’t cause any significant economic problems in the UK or US. Share prices soon recovered and in the UK the late 1980s saw a remarkable period of high economic growth. This was partly because; in response to falling shares, the UK govt cut interest rates and taxes to boost demand. There then followed a rise in economic growth and a rise in house prices.

However other experiences show us that falling share prices can have an adverse effect on the economy. Most notably the great depression was caused by the wall street crash of 1929. What happened in 1929 was that the fall in share prices was so big and prolonged that it caused a general decline in economic confidence and collapse of certain financial institutions. (especially medium sized banks in America) with a fall in confidence, firms reduced investment and consumers reduced incomes. This caused the initial fall in economic growth and rise in unemployment. These effects were magnified by an adverse multiplier effect. As people were made redundant they in turn spent less, causing further falls in AD and economic growth.

Furthermore a fall in share prices causes a fall in consumer wealth. There is a link between wealth and consumer spending. For example rising house prices often increases consumer spending because people can remortgage their houses. However generally wealth held in the form of shares is not directly linked to consumer spending. This is because most people who own shares do not base their consumption on the value of shares. Shares are seen as speculative investment. So even with wild fluctuations in the price it may have little impact on overall consumer spending. (It is also worth noting only a small % of the population have significant savings in shares).

Therefore a fall in share prices won’t necessarily affect the UK housing markets in an adverse way. Consumer spending and growth need not be derailed by a 5% fall in the Dow Jones. However a fall in share prices may make a contribution to a further decline in economic confidence. In America the US housing market is already in decline, with house prices falling. There is also persistent concern about the size of the US current account deficit and levels of debt. Therefore a falling stock market may further undermine economic confidence and make the prospect of a recession in US even more likely.

Labels: Stock Market, UK housing Market, US housing Market