Determinants of House Prices

House prices are determined by demand and supply. If demand rises or if supply falls, the equilibrium prices (the price at which demand and supply are equal) prices of houses will rise. Similarly, if demand falls or supply rises, the equilibrium prices will. So why did house prices rise so rapidly in the 1980’s only to fall in the early 1990s and then rise rapidly again in the late 1990s and early 2000s? The answer lies primarily in changes in the demand for housing. Let us examine the various factors that affected the demand for houses. Incomes (actual and anticipated). The second half of the 1980s was a period of rapidly rising incomes. The economy was experiencing an economic ‘boom’. Many people wanted to spend extra incomes on housing: either buying a house for the first time, or moving to a better one. What is more, many people thought that their incomes would continue to grow, and were thus prepared to stretch themselves. Financially in the short term by buying an expensive house, confident that their mortgage payments would become more and more affordable over time. The early 1990s, by contrast, was a period of recession, with rising unemployment and much more slowly growing incomes. People had much less confidence about their ability to afford large mortgages. The mid-1990s onwards saw incomes rising again. The desire for home ownership. Mrs Thatcher (prime minister from 1979 to 1991) put great emphasis on the virtues of home ownership: a home-owning democracy. Certainly, the mood of the age was that it was very desirable to own one’s own home. This fuelled the growth in demand in the 1980s. The cost of mortgages. During the second half of the 1980s, mortgage interest rates were generally falling. The meant that people could afford large mortgages, and thus afford to buy more expensive houses. In 1989, however, this trend was reversed. Mortgage interest rates were now rising. Many people found it difficult to maintain existing payments, let alone to take on a larger mortgage. From 1996 to 2003 mortgage rates were generally reduced again, once more fuelling the demand for houses. The availability of mortgages. In the late 1980s, mortgages were readily available. Banks and building societies were prepared to accept smaller deposits on houses, and to grant mortgages of 31/2 times a person’s annual income, compared with 21/2 times in the early 1980s. in the early 1990s, however, banks and building societies were more cautious about granting mortgages. They were aware that, with falling houses prices, rising unemployment and the growing problem of negative equity, there was an increased danger that borrowers would defaults on payments. With the recovery of the economy in the mid-1990s, however, and with a growing number of mortgage lenders, mortgages became more readily available and for greater amounts relative to people’s income. Speculation. In the 1980s, people generally believed that house prices would continue rising. This encouraged people to buy as soon as possible, and to take out the biggest mortgage possible, before prices went up any further. There was also an effect on supply. Those with houses to sell held back until the last possible moment in the hope of getting a higher price. The net effect was a rightward shift in the demand curve for houses and a leftward shift in the supply curve. The effect of this speculation therefore was to help bring about the very effect that people were predicting. In the early 1990s, the opposite occurred. People thinking of buying houses held back, hoping to buy at a lower price. People with houses to sell tried to sell as quickly as possible before prices fell any further. Again the effect of this speculation was compounded by worries about falling stock market prices. May investors turned to buying property instead of shares. By the mid-2004, the boom in house prices seemed to be coming to an end. With interest rates rising, people were becoming increasingly worried about taking on large mortgage debt. And with house price inflation slowing down, speculation could go into reverse. It seemed unlikely that there would be a house price crash, however, with interest rates edging lower. CASE STUDIES: UK HOUSE PRICES. If you are thinking of buying a house sometime in the future, then you may well follow the fortunes of the housing market with some trepidation. In the late 1980s there was a housing price explosion in the UK: in fact between 1984 and 1989 house prices doubled. After several years of falling or gently rising houses prices in the early and mid-1990s, There was another boom from 1996 to 2004, with house prices rising by 26 per cent per year at the peak ( in the 12 months January 2003). For many, owning a home of their own was becoming a mere dream. In the late 1980s house price inflation was very high, reaching a peak of 23.3 per cent in 1988. in their rust to by a house before prices rose any further many people in this period borrowed as much as they were able. Building societies and banks at that time had plenty of money to lend and were only too willing to do so. Many people, therefore, took out very large mortgages. In 1983 the average new mortgage was 2.08 times average annual earnings. By 1989 this figure had risen to 3.44 After 1989 there followed a period of falling prices from 1990 to 1995, house prices fell by 12.2 percent. Many people now found themselves in a position negative equity .this is the situation where the size of their mortgage is greater than the value of their house. In other words, if they sold their house, they would end up still owing money. For this reason many people found that they could not move house. Then in 1996, house prices began to recover and for the next three years they rose moderately- by around 5 per cent per annum. But then they started rising rapidly again, and by 2002 house prices inflation had returned to rates similar to those in the 1980s. Was this good news or bad news? For those who had been trapped in negative equity, it was good news, it was bad news for the first-time buyer.