1. A shortage of supply means prices will never fall. Often people will say because of high demand a shortage of housing in London, prices will always be high and never fall. This is not true. House prices in London may always be higher than elsewhere in the country but there is nothing to stop house prices falling in London.

2. House Prices will keep rising. Perhaps the most dangerous myth of all. Yes there is a shortage of housing in the UK, but there are many factors that may cause house prices to fall in the future. E.g. Rising interest rates and a fall in confidence.

3. Housing is not subject to speculation because people live in them. It is true that many households buy a house to live in rather than as a financial investment. If house prices fall they wouldn’t start selling, like if they had a commodity. However there is a significant section of the market that is driven by an element of speculation. For example people who buy to let are often hoping that equity gains will enable them to make a profit. If house prices stop growing or even start falling this section of the market will see a significant drop in house prices.

4. House prices are doomed to fall because prices have risen faster than incomes. The ratio of house prices to income has risen to an all time high. People see this as proof that house prices are unsustainable and are doomed to fall. However this is not necessarily the case. It appears demand for houses is quite inelastic. In response to rising prices people have found more ways to get bigger mortgages. Banks are willing to lend higher multiples. First time buyers are borrowing deposits from their parents. Lower long term interest rates make mortgage payments relatively more affordable than they were in the past. Basically there is no reason why the ratio of house prices to income cannot rise permanently.

The above graph shows house price to earnings ratios. After the 2008 crash, house price to earning ratios didn’t fall as much as might be expected. House price to income ratios are still above the mid 1990s when there was a much bigger fall in house prices.

5. You will be paying the same high mortgage payment for 30, 40 years. Many people quote the saying that a mortgage is like a weight round your neck, you will still be paying when you’re near retirement. However many people forget that mortgage payments are highly likely to fall in real terms. Assuming interest rates stay the same your monthly payments could be say £800 for 30 years. However in 30 years time assuming inflation and a rise in real wages (which has happened in the past) then the mortgage payments will become a relatively smaller % of income and much easier to pay. For example if you got a mortgage on a house in 1980. Your mortgage payments may have been £200 a month, then that would have been a high % of income, but now it is relatively low. If you don’t get a mortgage but continue to rent. The price of renting is likely to rise with inflation.

6. It’s impossible for most first time buyers to get on the mortgage ladder. True it is difficult but there are ways around it. But, if you are really determined there are ways to get a mortgage. These can include saving a substantial deposit, borrowing from parents, taking help from government initiatives. More information on different Help on getting mortgage on low income
7. We need to Build New houses on Greenbelt land. One of the great challenges of the UK housing market is trying to build an estimated 250,000 new houses to keep up with demand. Yet, the problem is that building new houses often means losing precious greenbelt land. However, there are alternatives to building on greenbelt land.
   Making use of empty homes.
   Making use of brown field sites in city centres.
   Increasing housing density in certain key areas.

 Related

• Why are house prices so expensive in UK?

Wealth Effect.

A rise in house prices creates an increase in wealth for householders. As a consequence of this increase in house prices, householders will generally:

• Be more confident about spending and borrowing on credit cards.
• Equity Withdrawal. A rise in house prices enables homeowners to take out a bigger mortgage. Banks can lend more on the basis of increased wealth. Households could use this bigger loan to spend on other items. This can create a significant increase in consumer spending. For example, in 2006, with rising house prices, equity withdrawal added an extra £14bn to consumer spending. In 2008, with falling house prices, equity withdrawal was -£7bn

Importance of Housing

• Housing is the biggest component of most household’s wealth. Therefore it has a big impact on the economy. The UK has one of the highest rates of property ownership in the UK.  in 2006, it was roughly 77% compared to 50% in France. However, in recent years, the % of first time buyers owning a house has declined because it has been more difficult to get a mortgage. Home-ownership rates have declined to 72%, meaning the importance of the house prices is slightly reduced.

Effect on Economic Growth (Real GDP)

• If house prices rise, then the wealth effect is likely to cause an increase in consumer spending. This will cause higher Aggregate Demand (AD) and is likely to cause an increase in Real GDP, and a higher rate of economic growth.

Multiplier Effect

If there is an increase in Aggregate Demand from rising house prices, there may also be a multiplier effect which causes the increase in Aggregate Demand to be bigger than the initial effect.

How A House Price Crash Affects the Economy

When there is a fall in house prices, there tends to be a negative wealth effect, and a negative impact on economic growth.

• Because households see a fall in house prices, their main form of wealth declines, this reduces their confidence to spend. They are more likely to devote a higher % of their income to trying to pay off their mortgage early.
• Falling house prices causes more to be trapped in negative equity (when house is worth less than outstanding mortgage). This causes a fall in spending, and precludes opportunity for equity withdrawal.

Examples of Falling House Prices

In the 1990 house prices crash, there was a sharp fall in consumer spending and this caused the recession of 1991-92. Falling house prices wasn’t the only factor (high interest rates and high value of Sterling) was also important. But, falling house prices was definitely a factor.

In 2008, falling house prices also occurred at same time as deepest recession since 1930s. Again, there were many other reasons for the recession, but falling house prices was bad news for both consumers and banks.

Inflation

• If the economy is close to full capacity and already growing strongly, then a rise in consumer spending due to rising house prices could contribute to inflationary pressures. For example, in the late 1980s, the rise in UK house prices and consequent boom in spending was a key factor in causing inflation of 10% by 1989.
• However, in the house price boom of 2000-2007, inflation remained relatively muted, and close to the government’s inflation target.

Impact on Interest Rates

• An increase in house prices will cause an  increase in the cost of  mortgages and therefore will lead to an increase in the RPI. Also the increase in AD could cause demand pull inflation, However again it does depend upon the slope of the AS curve and other factors in the economy.
• The Monetary Policy Committee of the Bank of England is responsible for setting interest rates. The MPC are committed to keeping inflation within the government’s target of CPI 2% +/-1.
• If they felt, rising house prices was causing inflation to go above the target, then as a result they may decide to increase interest rates. Higher interest rates will reduce the rate of economic growth and moderate inflationary pressure.
• However, note, the MPC are very unlikely to increase interest rates just because house prices are rising at a rapid rate. The MPC primarily consider headline inflation and economic growth. They can’t use interest rates just to target moderate house price growth. For example, in 2000-2007, there was a housing boom, but the MPC didn’t change interest rates because they were focused on inflation and economic growth.

• House prices are only one factor affecting monetary policy

Housing Prices and Banking Sector

House prices have a habit of changing the lending practises of banks. When house prices are rising rapidly, banks see an improvement in the value of their assets. They feel more confident in increasing bank lending and reducing their reserve ratio. The long housing boom of 1995-2007, was one factor that encouraged bank lending to increase. Some former building societies like Northern Rock and Bradford & Bingley were so keen to lend, they were borrowing money on money markets to lend more mortgages. This bank lending proved unsustainable when the credit crunch hit.

• It should how a boom in house prices (asset) can distort economic behaviour especially in the financial markets.

Geographical Inequality

• High House prices could cause some workers to be unable to afford to but houses. High property values has caused a shortage of workers in London and the South East.

• Increased Supply of Houses: With High house prices there is a greater incentive to build new houses. Therefore house-building firms will do well.

Related

• Housing Statistics

In 2011, UK house prices were broadly flat. There was a mixture of news with house prices almost undecided which way to go.

In 2012, UK house prices are likely to fall because:

• Double dip recession. Economic growth stagnant and high unemployment
• House prices still unaffordable for many first time buyers
• Ongoing credit crunch, limiting mortgage availability.

However, like 2011, house price falls are likely to be small because:

• Low interest rates likely to remain.
• Continued shortage of supply in housing. Lowest number of house builds since 1930s.

Average House Prices

At the end of 2011 (Q3) , average UK house prices were £166,587 (Nationwide)

During 2011, the biggest rise in house prices occured in London, helped by strong overseas demand.

north v south house prices

House Price to Earnings Ratios

House prices continue to be very high compared to earnings, especially in London and the south

 Mortgage / Renting

Tight mortgage conditions and continued high house price to income ratios has seen a decline in % of housing owned with a mortgage.

Housing building in UK fell to record low levels. – Well below the governments target for home building of 250,000 a year.

House Price Growth in the UK in the past 15 years.

After experiencing a fall in house prices of 25%, UK house prices look to be stabilising, however, they are stabilising on thin levels of housing transactions.

Many homeowners and the government will be hoping for greater sustainability in the housing market rather than the boom and bust growth which has characterised house prices in recent decades.

If there remains an underlying shortage of housing in the UK, house price growth may continue to keep house price to earning ratios high.

A dramatic graph showing how much house prices in UK are falling.

Despite a radical cut in interest rates to 3%, house prices are likely to keep falling in 2009.

Why are House prices falling so much

• Economic recession – rising unemployment increases number of home defaults. – People don’t want to buy with so much economic certainty
• The snowball effect – No one wants to buy when house prices are dropping so much. It makes sense to wait and ride out the storm
• The Credit Crunch – Banks are trying desperately to improve their balance sheets. They don’t want to lend mortages. Furthermore, with falling house prices, there is the danger of negative equity. Therefore, banks are wanting a big deposit.
• People can’t afford to buy a house.

• Factors which determine house prices
• Why UK House prices are subject to Boom and Bust

The main house price surveys include:

Halifax Price Index. Halifax is one of the UK’s leading mortgage lenders. This gives it an insight into the UK Market.

Nationwide Price Index. The longest running house price index. See: Nationwide historical house price index

Royal Institution of  Chartered Surveyors RICS. This is a survey of market confidence. They ask surveyors and estate agents about whether they expect prices to rise or fall in the future. Although this is less scientific it can give a useful guide to future trends.

Government House Price Survey. The government produce a monthly price survey of house price transactions. It is generated from 50 mortgage lenders through the survey of mortgage lenders. Government House price survey

Land Registry. The land registry takes into account all property transactions. It is able to compare the price of a house bought and then later sold. This gives an accurate insight into how much prices have risen, because it is comparing the same house, rather than average house prices. They produce a quarterly survey and monthly report.

Rightmove. Rightmove.co.uk is a property website which tracks the asking prices of houses. Note, selling prices may differ from asking prices, especially in times of rising or falling house prices. Rightmove also give access to the Land registry data, which includes all actually selling prices.

Hometrack. Hometrack.co.uk is another property website. They collect info on the state of the market by surveying 3,000 estate agents about whether prices are rising or falling

Search Land Registry archive for house prices at www.houseprices.co.uk

• Nominal House prices increased by 1,672% or £174,000
• Real terms house prices increased by £119,085 or 164%

Note there is a much bigger change in nominal prices than real prices. It also means that with house prices falling now, the real effect is even greater. If house prices drop by 10% in nominal terms, it means in real terms for drop is closer to 13%.

The data is collected by the Nationwide one of the UK’s largest mortgage lenders. Nationwide

See historical data of UK house prices

The only benefit of a recession, as far as the UK housing market is concerned, is that it could lead to lower interest rates. IN a recession, inflation usually falls and this means the MPC will be able to cut rates. However, this particular recession may not be straightforward as we currently have a slowdown and higher prices e.g. rising oil and food prices. If a recession is accompanied with a stubborn inflation rates, interest rates may not fall, further reducing the demand for the housing market.

On the other hand, people who buy second homes may bring wealth and spending power into the area. It depends how long they spend in their second house. If it is only 2 or 3 weeks a year then the area will not benefit. If they rent the house cheaply to local people in the intervening years it will be less damaging.

It also depends whether supply can increase to meet the demand for second houses. The problem in the UK is that it is often difficult to build new houses, especially in these tourist areas most affected by people buying second houses.

The motives for buying a second home are often split into:

• Desire to have holiday home / 2nd house.
• Desire to make capital Gains from rising house prices. With change in fortunes of UK housing market, there may be less demand in forthcoming years.

Forecasts for Second Homes in the UK

In addition to tourist areas. Demand for second homes is also increasing in University towns, where parents can sort out accomodation for their children and have the potential for capital gains. Towns like Bradford and Manchester have the best potential for future capital gains.

Popular Areas for Second Homes in the UK

London, Snowdonia, Birmingham

This is probably the biggest factor at the moment. Since the credit crisis of 2007, when many US subprime mortgages were defaulted on, there has been a shortage of available finance. Because banks lost money lending in America they are reluctant to lend to new homeowners. British Banks are asking for bigger deposits and are charging higher interest rates. Therefore, many people who would like to get a mortgage are unable to find a deal in the current climate. This means many first and second time buyers are having to rent rather than buy. This is causing a big fall in the number of people able to buy.

2. The ratio of house prices to incomes increased to an unaffordable level.

The long term average for house prices to income ratio is about 2.5 – 3. Currently it stands at 5. This means the average worker needs to take out a mortgage upto 6 or 7 times their salary. However, banks will no longer lend this amount of debt. Therefore, many, especially first time buyers simply can’t afford to buy.

3. Expectations of Falling House prices.

People are now pessimistic about the prospect of the UK Housing Market. They expect falling prices and so buy to let investors have less incentive to enter the market; they have a good incentive to sell. These negative perceptions are becoming self fulfilling.

4. Slowdown in the economy.

The UK economy is still growing, but, the growth rate has fallen and unemployment is likely to increase. Therefore, people are more cautious about buying. People’s living standards are also being squeezed by rising oil and food prices; leaving less discretionary income for spending on the housing market.