Major Causes of Rising House Prices in the UK - Research Paper Example

Analysis of Major causes of rising house prices in UK Introduction The median house price in the UK is around £157,107. This has considerably pushed up the annual house price inflation rate to nearly 3.3%. Demand for housing in UK continues to grow. In spite of this demand for housing, there is considerable evidence that housing shortage exists in the UK, but it is very complex. The housing market is known for its volatility. While supply of existing housing stock fails to meet today’s expectations, current housing output is insufficient to meet demands. Also there is a need to replace outlived existing stocks. 62% of housing stock was built before 1965 and 35% of them were built before the Second World War. Over the last thirty years the housing prices in UK have increased in real terms by nearly three percent a year. This is in contrast to other countries like France, Sweden and Germany where real estate prices have remained broadly constant or even declined. Housing-Some basic facts The determination of prices in local and regional housing markets is a classic example of microeconomics in action. Each housing transaction in the UK depends on the price the seller is willing to sell his property and on the price the buyer is able to pay for it. Buyers place offers for a property that the seller can either accept or reject. A Sellers Market When the market demand for properties in a particular area is high and when there is a shortage of quality properties (i.e. supply is scarce) then the seller has the upper hand. This is because there is likely to be excess demand in the market for good properties. Sellers can wait for offers on their property to reach (or exceed) their minimum selling price. Often multiple offers fuel an increase over and above the asking price. A Buyers Market When demand both for new and older housing is weak and when there is a glut of properties available on the market, then the power switches to potential buyers. They have a much wider choice of housing available and they should be able to negotiate a price that is lower than the asking price. Demand and Supply Parameters that affect housing prices When the demand for houses in a particular area increases due to say, an increase in population into the area, or a rise in incomes due to job growth etc., there is upward pressure on market prices. Often the supply of available housing in the market is relatively static. This is because there are time lags between a change in price and an increase in the supply of new properties becoming available, or other homeowners deciding to put their properties onto the market. When demand shifts outwards and supply is inelastic the result is a large rise in market price and a relatively small expansion of the quantity of houses traded. As supply becomes more elastic over time, and demand for housing is stagnant, the housing prices take up a downward trend, and slowly create equilibrium in the number of houses bought and sold. Herd mentality is a characteristic of the housing sector. This can be the way consumers react by “following the crowd”. Often when prices drop or rise, the general consumer market reacts impulsively contributing to a sudden change in the scenario. When housing prices drop, there is panic selling which triggers a further price drop due glut of properties in the market, while, a price hike, influences people to buy before any further rise, creating a further demand which causes spiralling of prices upward. House prices are also dependent upon the purchasing ability of the people which create a demand and fuel the housing prices in the market. These are in turn dependent upon Lower Borrowing Interest rates: The most obvious reason cited for the increase in housing prices has been the lower interest rates which especially appeal to first-time buyers. This enables them to “put their foot in the door” as it helps them to borrow based on long term repayment capabilities. These lower initial rates help them to start off paying their mortgage more easily. The Nationwide pointed to August's cut in UK interest rates as one reason for the recent boost to the market. Interest rates at 3.5% in 2002, their lowest level since 1955 was one of the major factors attributed to the boom. It also induces more people to “upgrade” making use of the low interest rates. But lower borrowing rates also influence the buyer to over mortgage themselves. Initially it is easy but as the difficulty to sustain the payment increases, owning a home seems less appealing and lot of the people get out of the market. Suddenly there is surplus of properties for sale triggering a price drop leading to an economic collapse. In March 2005, the International Monetary Fund (IMF) warned that over stretching of loans and the runaway house price rises could threaten the UK's hopes for an economic recovery. Income Growth Increased affluence among the purchasing demographics causes an increase in the urge to purchase homes. As average living standards rise, the total demand for housing expands, as does the demand for more expensive properties as people look to “Upgrade” or move first time into owning a house. All this fuels the price increases due to demand. Confidence in the real estate market Confidence plays a vital role in housing prices. This consumer confidence in the future appreciation of the real estate prices often encourages purchases driving up the prices. If expectations for the future performance of the economy deteriorate and people become less optimistic about their own financial circumstances, they are hesitant to venture in to home purchases and often postpone or give up their search for a new home for an opportune time later in the future. Robust economical growth When the economy is showing robust growth this is generally related to the prosperity of the general public as a whole. A healthy economy puts more money into its tax payers. The consumer has more money to spend and more and more people move towards becoming home owners. In general, a healthy economy shifts the power in to the seller’s hands due to the increase in demand and this serves to increase the housing prices. Jobs The ability to pay the mortgage is an important determinant of moving in to house ownerships because financing a house purchase involves making a long-term commitment through a mortgage lender. The growth of employment in the country causes a significant change in unemployment levels. This in turn exerts a significant impact on housing demand. For example, in areas where unemployment remains persistently above the national average, average incomes are likely to be lower and confidence among buyers will be negatively affected. This will cause a fall in demand for house ownership and hence a fall in pricing of available houses. The slump in housing in the UK in the 1990’s has been mainly attributed to unemployment and job losses. Investment opportunity We think of a house purchase, as a major financial investment that will provide substantial capital gains in the long run. Certainly in the UK in the 1980s the housing sector boomed because of a strong speculative demand for properties. People often find that, when the real estate market is very active, rising house prices seem to offer a better return on investment for them in addition to being able to enjoy the comfort of the investment. Especially when interest rates are low on other investment options, investing in a property seems like a sound decision and this urges people to enter the housing market fuelling an increase in the prices. Housing taxes and subsidies Government policies affect the housing sector in a number of ways. These may benefit taxpayers from waiver of taxes on a percentage of the interest paid or other different exemptions which make purchasing or investing in the housing sector appealing. Throughout most of the 1980s and 1990s the government offered home buyers an explicit subsidy in the shape of mortgage interest relief at source or MIRAS. MIRAS has now been phased out. The effect has been to dampen down housing demand, but did not substantially stop house prices rising. Having considered the demand for housing, let's now look at the supply of houses. The supply of houses depends on several factors: The number of new houses being built, the number of existing houses being renovated and refurbished then offered for sale, and the number of existing house owners who would consider to sell their house. Overall when the demand for housing is more than the supply, then this causes an increase in the housing prices due to lack of availability. UK has a relatively slow responsiveness to the supply requirements in the housing sector. Internationally, UK housing completions are relatively low compared to the existing housing stock. At the current replacement rates, a new house built today would need to last at least 1200 years. UK has one of the lowest investments of GDP in housing among the European nations. This lack of supply against a strong demand for housing translates into rising costs of housing in the UK. The reasons for poor housing availability are manifold. Lack of suitable land to build is a main issue. Industrial constraints like the competitiveness of the house builders, constraints of finances, availability of skilled workforces and the role of governmental regulations and policies etc. often offer bottlenecks in the housing completions thereby causing a shortage and directly feeding the demand for housing into higher prices. Using up the available land may also trigger environmental concerns and loss of the local flavour being preserved and cause objections. All this had led to stagnation in supply causing a severe shortage of housing. All this triggered a demand for the existing limited available properties fuelling a high priced market in the early 2000’s. Current housing market The housing prices in UK have started to cool down once the interest rates were raised by one and a quarter points in 2004. The Nationwide index rose by 5.5% in May 2005, down from 20% growth in July 2004. But once again, other surveys offer a gloomier picture. The Royal Institution of Chartered Surveyors (RICS) reports that prices have fallen for ten consecutive months, with a net balance of 49% of surveyors reporting falling prices in May 2005, the weakest number since the previous house-price bust in 1992. The volume of sales has slumped by one-third compared with a year ago as both sellers and buyers have lost confidence in house valuations. The rate rises have also acted as a brake on the runaway housing market. House price inflation has slowed to its weakest pace in nine years, according to official data from the UK Land Registry. The figures, which record prices when sales are completed, show that property prices rose by 0.8% in the second quarter, taking the annual rate of inflation down to 5.4%, which is the lowest level since September 1996. For the first time, The Bank of England is contemplating cut the interest rate from 4.75% to 4.5 % to kick start the economy and give it that boost. Conclusion Housing has a huge impact on the individual’s quality of life and living in a sheltered and pleasant environment is a fundamental wish. This continuous urge to achieve the dream house keeps the volatile housing market going influenced by a multitude of factors. The demands and supply are often cyclic but continue to be dynamic contributing to the economy. Sources Miles, D. (2004), “The UK Mortgage Market: Taking a Longer-Term View” Final Report Muellbauer, J. and Murphy, A. (1997), “Booms and Busts in the UK Housing Market”, Economic Journal, Vol 107. 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