Why House Prices are Falling in the UK

Since the peak in July 2007, UK house prices have fallen considerable. The main reasons for falling house prices are:

  • Difficulty of getting mortgage due to credit crunch.
  • Low affordability (high house price to income ratios)
  • Economic recession and rising unemployment
  • Nobody want to buy when house prices are falling.

11 In depth Reasons Why House Prices are Falling

1. Shortage of Mortgage Finance

At the moment, the lack of mortgage finance is one of the most significant factor in falling demand for housing. The Council of Mortgage Lenders suggest that mortgage approvals have fallen to the lowest levels since 1991. Upto July 2007, mortgage lenders were very competitive and eager to attract customers with mortgage products such as 100% mortgages and high income multiple mortgages. However, the credit crisis has led to banks struggling to raise finance, therefore they have had to reduce their mortgage lending. To ration mortgages, they have removed many mortgage products, especially ‘subprime’ products. They have also increased the cost of many other mortgages (see: credit crisis explained). In particular, mortgage lenders are requiring large deposits. This makes it difficult for first time buyers to get a mortgage.

2. The ratio of house prices to incomes has risen to an all time high.
In the UK the ratio of house prices to incomes is 50% higher than the long term average (1975-2005) Source : Economist (1) This means that many potential buyers are struggling to be able to get a mortgage. This problem has been exacerbated by the credit crisis.

3. House Prices Unaffodable for First Time Buyers.

In particular, it is becoming increasingly difficult for first time buyers to get on the property ladder. This is mainly due to the rise in house price to earnings ratio. In the past this problem was got around by banks being willing to offer ‘generous’ mortgages (e.g. interest only, self certification, 100% mortgages). For example, in the past, the Abbey National lent 5 times a borrowers salary. This increased generosity in lending helped to keep the market buoyant without addressing the underlying problem of overvalued house prices. The Credit crunch has now made this difficult. Mortgage lenders are sticking to traditional lending models of three times income. Many young people in 20s and 30s need either help from their parents or they can’t buy.

4. House Prices can Fall – even with limited Supply.

For those who believe house prices can never fall, it is worth remembering the case study of Japan. In the 1980s there was a similar boom in house prices in Japan. But since the peak of 1991 house prices in Japan have fallen for 14 consecutive years, leading to considerable economic problems such as lower consumer spending. House Prices have also started to fall in the U.S.A. US prices have now fallen considerably since their peak in 2007. Nevertheless, the shortage in UK housing supply means that the fall in house prices is less than it otherwise would be.

5. Speculation in UK Housing Market.

Traditionally, the view of the housing market is that it is not just an asset, but a place to live. Therefore, unlike the stock market, house prices won’t rise and fall due to speculation. However a lot of demand for UK housing is coming from buy to let investors. Many buy to let investors are in the market for the long term; however, now that prices are falling, some of these speculators are likely to leave the market causing a significant drop in demand.

6. Herding Effect of UK Housing Market.

In a research paper Alex Hamilton argues that much of the housing market is dominated by herding behaviour. (Source 2) This means that a lot of the rise in demand is caused by market sentiment rather than economic fundamentals. Now the market sentiment has changed people are less confident about buying. In a recent paper, the OECD stated that 15% of UK house prices were not reflected in economic fundamentals but ‘froth’ and ‘speculation’. As house prices fall, there is no incentive to buy. Many are waiting for house price falls to end.

7. Volatility of UK Housing Market.

The UK housing market suffers from severe supply constraints as a % of the total housing stock. The number of new houses built is relatively small. Therefore a change in demand magnifies any change in price. It only takes a small rise in demand to increase prices. But similarly it could only take a small fall in demand to cause significant price falls as in 1991.

8. UK Sensitive to any Change in Interest Rates.

There are record levels of consumer borrowing in the UK. This is a combination of mortgage borrowing and personal debt like credit cards. The total level of debt is £1.168 trillion. Source (3) Therefore even a modest rise in interest rates could have a very adverse effect on consumer confidence and spending. Therefore the housing market is particularly vulnerable to any rise in interest rates that may occur. – even if it is only through an increase in bank rates (as opposed to base rates). Also, even though the Bank of England have cut interest rates, many homeowners are not seeing these rate cuts passed onto them. Mortgage costs have been stubbornly high.

Bank SVR have remained high

  • Living costs are also been squeezed by oil, electricity and food prices.

9. Predictions for House Prices UK.

Many economists predict significant house price falls. For example Mr Calverley, argues in his book, ‘Bubbles and how to survive them’, that house prices could fall by 50%. Former advisor to Gordon Brown David Miles also predicts falls in house prices. He points that much of the rising demand for housing is speculative. As David Miles states:

“However, one third to one half reflects changes in expected house price inflation – that is a speculative element of demand, which is likely to be volatile,”

10. Sub Prime Mortgage collapse

The problems in the US Housing Market have adversely affected investor confidence. Therefore, it is becoming more difficult to sell mortgage debt. It is likely banks will become more conservative in mortgage lending.

11. Weak Economic Growth

Since the 2008-09 recession, the UK has struggled to recover. Growth has remained well below the long run trend rate, leading to higher unemployment. This sense of economic gloom has discouraged people from buying.