Factors That affect House Prices in UK
House prices are affected by a combination of supply and demand factors.
Demand Side Factors:
1. Economic Growth / Real income.
Rising incomes enable people to spend more on buying a house. Traditionally, there was a mortgage ratio of 3 times your salary. Basically if you earnt £20,000 the building society would lead £60,000. Therefore rising incomes enable house prices to rise.
However, the ratio of house prices to income can vary considerably. For example, between 1995 and 2007, the ratio of house prices to incomes have increased significantly. see: House Price to Incomes ratios
If the economy goes into a recession and unemployment rises, the demand for buying houses would fall significantly.
2. Interest rates.
Interest rates affect the cost of paying for a mortgage. Interest rates are very important as mortgage repayments are usually the biggest part of a homeowner's monthly spending.
- In the UK, the majority of homeowners have a variable mortgage which means an increase in rates will cause the cost of mortgages to rise, detering people to buy.
- People on fixed rate mortgages will be insulated from fluctuating rates for 2-10 years. Therefore changes in interest rates can have a time lag of upto 18months before there full effect is noted on demand for housing.
- It is also important to consider real interest rates (interest rates-inflation)
- The Bank of England set base rates and these usually affect all commercial rates. However, sometimes the Bank of England cut interest rates, but, commercial banks don't pass these cuts onto consumers. In the first half of 2008, the Bank of England cut rates by 0.5% from 5.5 to 5.0%, but the cost of mortgages is still rising.
3. Consumer confidence
During times of high consumer confidence, people are more willing to take out risky mortgages to be able to buy a house. For example, in the period 2001-07 100% mortgages and interest only mortgages were quite common. In the early 00s, people were optimistic about the housing market and so took out mortgages with a higher debt to income ratio.
4. Availability of Mortgage Finance
In the 50s, 60s and 70s, there were stringent restrictions about the availability of finance. However, with deregulation of the banking sector increased competition has seen a rise in the number of mortgage products. Products such as interest only, self certification mortgages and mortgages up to 6 times income have enabled people to get more mortgages, thereby increasing demand for housing. However, during the credit crunch of 2008, the number of mortgage products on offer fell due to a shortage of finance in the money markets.
5. Demographic factors
There has been a rising number of households in the UK. The number of households can rise faster than the population if the average family size decline and there are more single people living alone.
Demand for housing in the UK has been increasing for various reasons such as:
- an increase in divorce rates
- an increase in net immigration from Eastern Europe.
- Increase in life expectancy and more old single people
- Children leaving home early
- Less marriage
6. Speculation
Not everyone buys a house to live in it. An increasing number of property investors buy houses to try and make both capital gains and income from renting. This buy to let investor is typically more volatile, they will buy when house prices are rising and sell when the market appears to turn. This makes house prices more volatile because speculators will buy in a boom and sell in a bust. The number of buy to let investors in the UK has risen in the past decade.
However, there are quite high fixed costs in selling a house, such as stamp duty and estate agent fees. It is not like dealing in shares where you can easily buy and sell. Many buy to let investors claim they are in in for the long term.
The price of rented accommodation
Although UK house prices have increased faster than inflation, renting has also become expensive which is the main substitute to buying a house
7. Inherited wealth.
Many people use inherited wealth to buy houses. This might explain why there has been rising ratios of house price to incomes. It is also becoming more common for parents to lend children a deposit to help get their first house. In other words higher house prices are not detering people from buying a house - people are finding ways around it.
8. Unemployment
Low unemployment is often associated with rising demand for houses.
Supply side Factors
- In the short run Supply of housing is fixed because it takes time to build houses. Therefore in the short run demand affects prices more than supply
- However if the supply of housing is inelastic then an increase in demand will lead to a big increase in price.
Long Run Supply
In the long Run the supply of housing is affected by many factors:
- Availability of planning permission. This is difficult to obtain in rural areas
- Opportunity cost for builders e.g. are there better returns from other types of investment
- Existing houses may be knocked down because they are deemed unfit to live in.
- An increase in the cost of building new houses will shift supply to the left
- In the UK, it is argued there is a significant shortage of housing is this explains why house prices have risen much faster than inflation and earnings. However, in the US, the supply of housing increased in the period upto 2008 and therefore, the excess supply and falling demand led to a big fall in demand. However, it is important to note that house prices can still fall, even if there is a shortage of supply. In 1992, house prices in London fell over 20%, even though we can say supply is inelastic. A shortage of supply just means they will be on average higher. It doesn't mean they are incapable of falling.
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