A look at the main factors that cause house prices to rise and fall, and why UK house prices tend to be quite volatile.
In the UK, the supply of housing is fairly inelastic; this means it is unresponsive to changing prices. The number of houses being built is relatively low, therefore, supply increases only slowly. This means that changes in demand for houses will be influential in determining house prices. A small rise in demand will cause a significant rise in price. But, also a small fall in demand will cause a significant fall in prices. (It is a myth that areas with shortage of supply cannot see falls in prices)
What Determines Demand for Housing?
- Incomes. Economic growth and rising incomes means people can afford bigger mortgages so demand for housing rises. In a recession, with rising unemployment, people are much more reluctant to take on the risk of getting a large mortgage.
- Interest Rates. Higher interest rates increase cost of mortgage repayments and reduce demand for buying. If interest rates are low, demand for buying rather than renting will be high.
- Number of Households. Rising population leads to increased demand. Also, the number of households can increase faster than the population. For example, in recent years have seen an increase in the % of single people households. Social factors such as rising divorce rates can influence demand for housing. Also net immigration has caused a rise in demand, especially in the South East.
- Speculation. An increase in the number of buy to let investors mean that more homeowners are buying houses for the capital gains. Therefore in a property boom demand from speculators will rise. When prices start to fall, they will be keen to sell. This makes the housing market more volatile and contributes to a boom and bust nature of the housing market.
- Availability of Mortgages. If unconventional mortgage are freely available it enables people to take out bigger mortgages. This supports a rise in the house price to income ratio. However, in a credit crunch there is a squeeze placed on mortgages leading to a sharp fall in the number of first time buyers who are able to get mortgage funding.
- Affordability. If house prices increase faster than incomes, then it tends to limit the amount of people who have the capacity to get a mortgage. See: Ratio of house prices to incomes
Why House Price Fell 1991-1995
After several years of very rapid growth in the 1980s, UK house prices fell significantly between 1990 and 1995. Reasons included:
1. Higher interest rates.
A key factor was the decision by the government to increase interest rate to try and tackle inflation. Home-owners saw their mortgage payments nearly double, meaning many had to sell. Higher interest rates also discouraged others from buying. The rapid rise in interest rates was a key factor in the drop in house prices.
2. Recession
During the 1980s, the UK economy was booming, with record levels of economic growth. However, this changed in 1991 as the economy fell into recession and unemployment rose close to 3 million.
3. Change in Expectations
The boom years of the 1980s, encouraged optimism about the future direction of house prices. Buying a house seemed a good way to increase wealth; this encouraged the investor and speculator to get involved in housing market. But, with high interest rates, and a plunge in prices, this changed radically – encouraging people to try and get out of property market.
4. Over-valued
One reason house prices fell so rapidly is that by the end of the 1980s, house prices were increasingly expensive and unaffordable, it required a high % of your income to buy a house.
Why House Prices Fell in 2008
Again in 2007-08, UK house prices had become expensive. House price to income ratios, were close to record levels. In 2008, there wasn’t an increase in interest rates. But, the global credit crunch caused banks to become much stricter with mortgage lending. Banks cut back on the amount of mortgages available, and demanded a bigger deposit. This limited the numbers who could get a mortgage.
- Also, a deep recession discouraged people from buying.
- House prices recovered in 2010 – quicker than in 1990s, this may have been due to the fact interest rates were very low, meaning mortgage payments were reasonably affordable.
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Great piece, well put. That’s what we will essentially be looking at very closely over the next few months. The state of the property market will be determined by interest, unemployment rates and how the government plans to balance the deficit