In recent years, we have had a devastating global credit crunch, the longest and deepest recession since the 1930s and then the impact of Covid. Yet, despite this financial and economic upheaval, UK house prices have bucked the trend, avoided a major collapse and now exceeded pre-crash levels. The economics of Covid have even made house prices (outside city centres) more expensive and the feasibility of working from home increases.
It is true that in the first years of the credit crunch, UK house prices did fall 20%. But, this proved a temporary blip and the ratio of house prices to earnings continue to rise.
According to the ONS the average house price in the UK was £278,000 in March 2022. (ONS)
Average selling house prices according to the Nationwide
According to the Nationwide, house prices are now well above their 2007 peak.
This graph shows that since the 1970s, house prices have risen significantly – even adjusted for inflation.
More worryingly, the ratio of house prices to income continues to remain above long-term trends.
This shows the ratio of house price to incomes for all buyers. House price to income ratios are more than double levels seen in the mid-1990s.
It is also worth noting there is a sharp north-south divide. House price rises in London are particularly unaffordable.
What explains the continued lack of affordability for the UK housing market?
1. Relatively Low-Interest rates
Low interest rates have definitely helped increase house prices. Low-interest rates make buying a house more attractive than renting. Also, low interest rates mean that buying a house can give a better rate of return than buying other forms of investment, such as shares. An investor looks at the return on housing (rentable income) vs cost of buying a house (mortgage interest payments). Very low interest rates increase the attractiveness of buying a house as an investment.
Since 1992 interest rates in the UK have fallen from 15% to 0.5%, making the cost of getting a mortgage much lower.
During a period of high inflation (as we see in 2022) it also makes it attractive to buy a house as during periods of high inflation, houses (a real asset) will hold their value better than cash in a bnk.
This shows the affordability of mortgages – despite rising prices, low-interest rates have kept buying relatively affordable.
To highlight the importance of interest rates on house prices, In a recent paper by the Bank of England, Miles and Monro calculate that:
“Over time, a 1 per cent rise in real interest rates from their present level would push real house prices down by nearly 20 per cent.”
Bank of England Staff Working Paper No. 837, Dec. 2020.
Basically, the era of very low interest rates has been a key factor in pushing up house prices.
2. Constraints on House Building/supply
Because of the growing number of households and growing demand for housing, the government estimate we need to build 250,000 new houses a year, just to keep pace. However, despite many politicians talking about the necessity of building homes, in practice, we have a reluctance/inability to build houses. House building is at its lowest level since the second world war. In 2012, only 107,000 houses were built – much less than the 250,000 the government feel is necessary to keep pace with a rising population.
There are many constraints on the building of houses:
- In the most popular areas, there is a shortage of supply. It is difficult to find new land around greater London
- Environmental cost. The British have a strong attachment to preserving “greenbelt land” Many areas are protected from further housing development.
- Not in my back yard. People are usually in favour of more homes being built, as long as they are not in their local area. Increasing supply of houses leads to more congestion, crowded amenities and loss of greenbelt land.
- Vested interests perhaps most importantly increased supply reduces the value of your existing home. Therefore, existing homeowners have a vested interest in keeping the supply as low as possible in their area.
- Lack of Social Housing. Since Mrs Thatcher encouraged the sale of council housing, the number of new social housing (a euphemism for council housing) has been very low.
The consequence of this growing demand compared to limited growth in supply, is that there is strong economic pressure on house prices.
UK Housing market has often seen demand increase at a faster rate than supply, causing price to rise.
When Ireland and Spain experienced a housing boom, they also built 400,000 homes a year. When the bubble burst, there were numerous unsold properties. This excess housing stock dragged down prices. The UK never had this excess supply, which explains why prices didn’t fall as rapidly.
3. Demand is growing
A very simple economic truth: if demand increases faster than supply then prices will rise. Despite some short-term fluctuations, demand for housing has been rising at a faster rate than the supply. The UK population continues to grow (52 million in 1960 to 63.23 million in 2012). The forecast is for 71 million by 2033. Also, the number of householders is growing at a faster rate than the population. Demographic changes, such as higher divorce rates, and more single people living alone, have meant an increase in the number of households.
4. Strong demand for homeownership
In recent years, the % of first-time buyers has fallen. The number of people able to buy a house has fallen, due to the decline in affordability. However, there is a strong cultural and economic desire to own your property. Increasingly common is for parents to help their children to buy a house, with a deposit or even putting the mortgage in their name. This has enabled first-time buyers to overcome the impossible income multiples and buy despite the expensive prices.
5. Speculation / Buy to let
Despite the volatile nature of the housing market, housing has increasingly been seen as a good investment. The returns on buying a house have consistently outperformed the stock market. This has encouraged a new generation of buy to let investors, this has helped to increase demand further. In London, there has been a lot of demand from foreign nationals such as Russians and Arabs. Some argue this speculative increase in demand means the high house prices are unsustainable and are liable to fall. But, it also shows that the housing market is highly regional with London prices strongly outperforming other regions, especially in the north.
6. Renting is also expensive
The alternative to buying a house is renting. But, the cost of renting has also risen faster than incomes. If you are paying £800 a month, it makes sense to try and get a mortgage where you will be paying £900 a month, even if it means borrowing up to 6 or 7 times your income. The increased price of renting reflects the fundamental imbalance in demand and supply. It is true that the price of housing is now rising faster than renting, but it still makes economic sense to buy rather than rent. This means people are increasingly looking towards unconventional mortgages to help them buy a house.
The expensive nature of the UK housing market raises significant concerns such as – lack of geographical mobility, wealth and income inequality, an economy vulnerable to boom and busts in house prices. But, it doesn’t look like changing in the near future.
7. The Covid Effect
In March 2021 the Covid shutdown led to an unprecedented fall in GDP, with many workers losing income or their jobs. Despite GDP still being below the pre-crisis trend there has been no let up in the rise in UK house prices. Whilst those on furlow may struggle with rent, Covid has ironically made buying a house even more attractive. There is likely to be a long-term shift towards buying a house. Therefore, a good living space becomes even more desirable. This is shown in the contrast between growth of prices in city centres and in the suburbs.
8. Wealth inequality
There is substantial wealth inequality in the UK. With inheritance enabling some to get on the property ladder and afford seemingly ‘unaffordable’ prices. But, the inheritance effects makes it even harder for those who do not benefit from their parents.