Description
Real estate economics is the application of economic techniques to real estate markets. It tries to describe, explain, and predict patterns of prices, supply, and demand. The closely related fields of housing economics is narrower in scope, concentrating on residential real estate markets as does the research of real estate trends focus on the business and structural changes impacting the industry.
Analysing UK housing market from 2006 to 2012
Explaining the factors that determine demand and supply of houses in the UK during the above period Last 6 years trends in house prices and market (before and after recession)
Table of Contents
1. Introduction ............................................................................................................................. 2 2. Concept of Price in a Free Market ............................................................................................. 2 2.1 Demand Factors ............................................................................................................................ 3 2.1.1 Income Effect ......................................................................................................................... 3 2.1.2 Population Level..................................................................................................................... 4 2.1.3 House Future Price Expectations (in short run) ..................................................................... 5 2.2 Supply Factors ............................................................................................................................... 6 2.2.1 Prices of Housing Factors of Production ................................................................................ 6 2.2.2 Number of Housing Suppliers ................................................................................................ 7 3. Impact of Government Policies on House Prices ........................................................................ 7 3.1 Supply-side Policies ....................................................................................................................... 8 3.1.1 Subsidies to Private House Builders ....................................................................................... 8 3.1.2 Public House Building ............................................................................................................. 9 3.1.3 Relax Regulations ................................................................................................................... 9 3.1.4 Tax Concessions or Grants ..................................................................................................... 9 3.2 Demand-side Policies .................................................................................................................. 10 3.2.1 Changing Deposit Requirements.......................................................................................... 11 3.2.2 Changing Interest & Mortgage Rates ................................................................................... 11 4. Trends in UK House Prices ...................................................................................................... 12 4.1 Fluctuating House Prices ............................................................................................................. 12 4.2 House Price Volatility .................................................................................................................. 13 4.3 House Price Bubbles.................................................................................................................... 13 0|Page
4.4 Regional Variations ..................................................................................................................... 14 5. Conclusion ............................................................................................................................. 15 References......................................................................................... Error! Bookmark not defined.
1|Page
1. Introduction
The UK housing market is known as monopolistic market where each firm, up to some extent, has differentiated products. This means that entry and exit barriers are very limited in this market. The UK housing market is divided into four main parts: privately owned (occupied apartments and houses), privately rented, local authority, and housing associations. Figure 1.1 illustrates the detail of UK dwellings in millions where it is shown that most of the UK housing market i.e. 17.8m is privately owned followed by privately rented.
Figure 1.1 – The UK housing market
Source: Communities.gov.uk
According to Thomas and Carson (2011), demand and supply forces are the key determinants of prices in a free market where the sellers and buyers argue offered prices before the actual transaction. This paper mainly investigates the factors that determine house prices in a free market. In addition, it is also examined that how and which different government policies affect the house prices. For this purpose, the United Kingdom’s housing market is taken as a case study and the trends in house prices of the last six years are examined in detail.
2. Concept of Price in a Free Market
There are several key factors that affect the prices in the UK housing market without the intervention of government. In a free market, demand and supply model is primarily used to set house prices where the buy or sell decision of stakeholders is based on market demand
2|Page
and supply analyses. Several factors that can be used to examine the change in demand or supply of houses in the UK market are given below:
2.1 Demand Factors
2.1.1 Income Effect
The income effect is an important factor that has great influence on the consumption level of consumers. It is a well known theory that if the income of people will increase then their spending will also increase with the exception of the type of income (Grant and Vidler, 2000). Therefore, the income level of buyer can reflect the decision of buying houses today or later. The income effect is evident in figure 1.2; when incomes of people went down in 2006 and then in 2010 due to recession effects then they were not able to buy houses which consequently affect the demand of the houses in the UK.
Figure 1.2 – UK per Capita Income
Source: data.worldbank.org The ups and downs in the income of UK people in the past six years consequently affected the demand of the houses. Figure 1.3 shows a shift in demand curve at right (upward) with an increase in the income of the people. This is because if the income of people will increase then more people will be able to buy houses and demand will be increased automatically. On the contrary, figure 1.4 illustrates a shift in the demand curve at left (downward) with a
3|Page
decrease in the income of the people because the fall in income will cause to decrease demand of houses.
Figure 1.3 – Change in housing demand with increase of income
Figure 1.4 – Change in housing demand with decrease of income
2.1.2 Population Level
A considerable change in the level of the population also has significant impact on the demand and supply of houses. An increase in the population will consequently increase the demand of the houses (Gillespie, 2001) because more people will require apartments and houses to live in. The impact of population level is low in the UK but it has been increased slightly over the past two decades due to the arrivals of expatriates (Brown, 2012) as shown in figure 1.5.
Figure 1.5 – Growth of UK population
Source: data.worldbank.org
4|Page
The impact of population growth on demand of houses is presented in figure 1.6 where the demand curve shifts right with an increase in the population. But in case if the population shrinks then the demand curve will move left because the demand of houses will be decreased (see figure 1.7)
Figure 1.6 – Change in housing demand with population growth
Figure 1.7 – Change in housing demand with population shrink
2.1.3 House Future Price Expectations (in short run)
The fluctuations in the house prices result in to fluctuating demand of houses as well (Higson, 2011). Considering the case of the UK and several other countries, if it is predicted that house prices may increase or decrease in the future, then the demand of houses will automatically increase or decrease at present time (Hall and Lieberman, 2009). With an expectation that house prices will increase in future, the demand curve will move right (D1), and conversely, with an expectation that house prices will decrease in future, the demand curve will move left (D2) as shown in figure 1.8.
Figure 1.8 – Changes in housing demand due to future price expectations
5|Page
2.2 Supply Factors
2.2.1 Prices of Housing Factors of Production
The changes in the prices of houses are also primarily based on housing factors of production i.e. land, labour, and capital. In the UK, high costs of labour usually affect the prices of houses. The low cost of labour for a particular period tends to increase the supply. The figure 1.9 shows that the labour cost in the United Kingdom has been increased dramatically over the last six years.
Figure 1.9 – Increase in labour cost in the UK
Source: Office of National Statistics (2012)
6|Page
In the above figure, the labour cost was low during 2006 and 2007 so the supply of houses was more as compared to the supply of houses between 2010 and 2012 when the labour cost was high. Figure 1.10 shows changes in the supply curve due to changes in the labour cost. The right shift of supply curve (S1) shows an increase in supply due to low labour cost in 2006 and 2007 whereas the left shift of supply curve (S2) demonstrates a decrease in supply due to high labour cost between 2010 and 2012.
Figure 1.10 – Changes in housing supply due to labour cost
2.2.2 Number of Housing Suppliers
The impact of changes in number of housing suppliers is low in the UK because UK is a monopolistic market and entry and exit barriers are minimal. But an increase in the number of suppliers will tend to increase housing supply and supply curve will move right (S2) and in contrast, decrease in number of suppliers will cause to decrease housing supply and curve will shift to left (S1) as shown in figure 1.10.
3. Impact of Government Policies on House Prices
The impact of government policies on house prices is different when the government enters into the free market system in order to make it more equal and ethical for the stakeholders. When government get involved in a free market system, the businesses and housing associations are forced to reduce the selling prices of houses by imposing various rules and
7|Page
regulations on them. The government policies and laws that affect house prices in the UK are discussed here.
3.1 Supply-side Policies
When government use different methods to control aggregated supply of houses, it is called ‘supply-side policies’ (Donahue and Nye, 2002). The UK government uses several methods (see subsections) to control the aggregate supply of houses. A successful supply-side policy of government will shift supply curve to the right as shown in figure 1.11:
Figure 1.11 – Change in supply curve due to supply-side policies
3.1.1 Subsidies to Private House Builders
In order to aggregate the supply of housing, the government can give subsidy to private house builders in the some particular areas i.e. London where people are currently facing housing shortage. However, private house builders may require more time to find out suitable land areas for planning, design, and construction (Grant and Vidler, 2000). It is illustrated in figure 1.12 that the government subsidy to producers will cut equilibrium price from P2 to P1 so people will spend more due to this lower price. The producer will ultimately get P1 plus the subsidy (P1P3). On the other hand, the amount that government spent on the subsidy will be (P1P3) at Q1.
8|Page
Figure 1.12 – Demand and supply of houses before and after subsidy
3.1.2 Public House Building
The local or central government may plan to aggregate the supply of houses by constructing more public houses. The inexpensive and economical social housing is the immediate requirement of large cities such as London and Wales. However, the lack of availability of land hinders the efficacy of this option. Recently, the UK government launched a scheme to give a subsidy of nearly £75,000 to over two million dwellers of social housing (Gavaghan, 2012).
3.1.3 Relax Regulations
The government can give relaxations to home building regulations to promote the aggregated supply of houses. One of the common relaxations is to provide them easier planning permission. In order to boost up the economy, the UK government has recently instructed planning officers to give relaxation on constructing larger extensions on houses- up to 8m long for detached homes in England (BBC News, 2012).
3.1.4 Tax Concessions or Grants
Higson (2011) suggests that government can offer special tax concessions or grants to builders to construct houses on Greenfield sites which can encourage aggregate supply of houses. The UK local government and councils are making tax reforms to consider Greenfield sites for housing (Doward, 2011). The impact of increase or decrease in government taxes or relax in regulation on housing sector is depicted in figure 1.13. The
9|Page
government cut in taxes will cut equilibrium price from P2 to P1 so people will spend more due to this lower price. The producer will ultimately get P1 plus the subsidy (P1P3). On the other hand, the amount that government spent on the subsidy will be (P1P3) at Q1.
Figure 1.13 – Demand and supply of houses before and after tax
3.2 Demand-side Policies
Different methods that government use to control the demand of houses are called ‘demandside policies’ (Donahue and Nye, 2002). The UK government uses several methods to control the regulate demand of houses. A successful demand-side policy of government will shift demand curve to the right as shown in figure 1.14:
Figure 1.14 – Impact of government’s demand-side policies on demand
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3.2.1 Changing Deposit Requirements
The buyers are normally required to give at least 10 to 25 percent deposits when they buy a house in the United Kingdom. The larger deposit will hinder the sub-prime buyer to enter into the market. In order to boost up the demand of houses, the government can alter the deposit requirements. One such example is the recent scheme of the UK government which offers buyers to purchase a £500,000 home with just 5% deposit in large cities of the UK (Gavaghan, 2012).
3.2.2 Changing Interest & Mortgage Rates
Increasing or decreasing interest rates can have deep impact on the demand of houses as they contribute the general deflation or inflation in the housing market. Generally, the Bank of England does not openly address housing sector in altering the interest rates. The bank only address housing section in altering the interest rates when they are seen as central to the wider inflationary picture. This was happened due to the 2008 economic crisis when the Bank of England decreased the interest rates to boost up the housing market activities (Sá et al, 2008). The figure 1.15 presents fluctuations in the interest rates due to inflationary pressures during the recession from 2006 to 2008. The interest rates declined at record level in July 2009 and then became stable after the recession period.
Figure 1.15 – Changing interest and mortgage rates
Monthwise Base Rate VS Mortgage Rate Since 2006
9.00%
8.00%
7.00%
Base & Mortgage Rates
6.00%
5.00% Base Rate Mortgage Rate 4.00%
3.00%
2.00%
1.00%
0.00%
Ja n0 Ap 6 r-0 Ju 6 l-0 O 6 ct Ja 06 nAp 07 r-0 Ju 7 l-0 O 7 ct Ja 07 n0 Ap 8 r-0 Ju 8 l-0 O 8 ct Ja 08 n0 Ap 9 r-0 Ju 9 l-0 O 9 ct Ja 09 n1 Ap 0 r-1 Ju 0 l-1 O 0 ct Ja 10 n1 Ap 1 r-1 Ju 1 l-1 O 1 ct Ja 11 n1 Ap 2 r-1 Ju 2 l-1 2
Months
11 | P a g e
In fact, interest rate is a significant determinant of housing demand. A small decrease in the rate of interest can boost the demand of houses. Similarly, lowering interest rate will lead to decrease mortgage rates as well, and as a result people with excess funds will search for new houses for investment purpose. This additional demand will cause to increase house prices. The impact of decrease in interest rate on demand of housing is shown in figure 1.16.
Figure 1.16 – Impact of decrease in interest or mortgage rate on demand and supply curves
4. Trends in UK House Prices
The trends in the UK house prices can be explained under four major headings as follows: ? Rising average house prices; ? House price volatility; ? House price bubbles; and ? Regional variations
4.1 Fluctuating House Prices
In the UK, a long-run increase in the house prices is triggered by rising housing demand exceeding the housing supply. The United Kingdom house supply is way below the demand since 2003 when it was estimated that the UK requires nearly 39,000 houses each year (BBC News, 2003). The fluctuations in demand and supply occur due to dramatic changes in the prices of the houses over the past decade.
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Figure 1.17 – UK average house prices
Source: ONS (2012)
The above diagram clearly illustrates how prices increased from 2006 to mid 2007 and then a sudden decrease in the prices occurs due to the emergence of the financial crisis. The prices resumed again in mid 2008 and according to the latest study they are expected to increase 0.8% per year in the future (King, 2012).
4.2 House Price Volatility
The prices of houses in the UK have been crashed two times in the last two decades; first between 1990 and 1992 and then between 2007 and 2009. The house prices resumed after the recovery from recession in 1992 and continue to increase next 15 years. During this period, the prices increased well exceeding the general rate of inflation producing a substantial wealth effect. However, the house prices started to decelerate again in mid 2000s and began to fall in 2007 and continued to decrease throughout 2008. The prices resumed again after 2008 (see figure 1.4).
4.3 House Price Bubbles
The property investment is considered as a secure deal for all the stakeholders including investors, property developers, homeowners, and asset managers. This is more true when there are no alternative opportunities for investment especially during the financial crisis
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when share prices, profits and interest rates are low. The house price bubbles and consequent price crashes in the UK mainly occurred due to a general housing shortage (Forrest and Yip, 2011). The figure 1.18 demonstrates quarterly fluctuations in the UK housing market in the last six years.
Figure 1.18 – Quarterly changes in the UK housing market
Source: Nationwide (2012)
The above diagram clearly states that how house prices in the UK during 2008 crashed due to the burst of bubbles of real estate when sellers were cutting house prices to meet the expectations of buyers.
4.4 Regional Variations
The prices of houses vary significantly all across the United Kingdom where the average prices are higher in London and South East and lower in North. Figure 1.19 illustrates a comparison of UK house prices in London, North, and the UK from 2006 to 2011.
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Figure 1.19 – Comparison of UK house prices
Source: Nationwide (2012)
The regional differences in the above diagram can be described in terms of demand and supply conditions. A number of factors account for higher average prices in London. These factors include: limited housing stock, high employment rate, high incomes, and migrations. On the other hand, more house stock, low employment rate, easier planning, and lower incomes are the factors that influence on the demand and supply of houses in other regions of the UK as evident in figure 1.19.
5. Conclusion
A number of factors can examine changes in housing demand where income effect, level of population, and future house price expectations in short run are most influencing factors. The demand curve with an increase in demand due to these factors will shift right (upward) and similarly, a decrease in housing demand will move the demand curve to left (downward). On the other hand, factors like labour cost and changes in number of suppliers may affect supply of houses. The supply curve with an increase in supply due to influencing factors will shift right and similarly, a decrease in housing supply will move the supply curve to left. The government can adopt supply-side policies (e.g. subsidies, relax regulations, tax concessions) to control the aggregate supply of houses which will shift the supply curve to right (downward). Similarly, in order to control demand of houses, the government can adopt
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demand-side policies (e.g. changing deposit requirements, interest rates, and mortgages). A successful demand-side policy of government will shift demand curve to the right (upward). It was found by analysing the six year trends in the UK housing prices that since 1992 the house prices have increased well exceeding the general rate of inflation producing a substantial wealth effect till 2007. However, the house prices started to decelerate again in mid 2000s and began to fall in 2007 and continued to decrease throughout 2008 due to financial crisis (see figures 1.17 and 1.18). It was also found that regional differences in the UK and the entire world account for high or low prices and consequently can affect the demand and supply of houses.
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doc_209935624.docx
Real estate economics is the application of economic techniques to real estate markets. It tries to describe, explain, and predict patterns of prices, supply, and demand. The closely related fields of housing economics is narrower in scope, concentrating on residential real estate markets as does the research of real estate trends focus on the business and structural changes impacting the industry.
Analysing UK housing market from 2006 to 2012
Explaining the factors that determine demand and supply of houses in the UK during the above period Last 6 years trends in house prices and market (before and after recession)
Table of Contents
1. Introduction ............................................................................................................................. 2 2. Concept of Price in a Free Market ............................................................................................. 2 2.1 Demand Factors ............................................................................................................................ 3 2.1.1 Income Effect ......................................................................................................................... 3 2.1.2 Population Level..................................................................................................................... 4 2.1.3 House Future Price Expectations (in short run) ..................................................................... 5 2.2 Supply Factors ............................................................................................................................... 6 2.2.1 Prices of Housing Factors of Production ................................................................................ 6 2.2.2 Number of Housing Suppliers ................................................................................................ 7 3. Impact of Government Policies on House Prices ........................................................................ 7 3.1 Supply-side Policies ....................................................................................................................... 8 3.1.1 Subsidies to Private House Builders ....................................................................................... 8 3.1.2 Public House Building ............................................................................................................. 9 3.1.3 Relax Regulations ................................................................................................................... 9 3.1.4 Tax Concessions or Grants ..................................................................................................... 9 3.2 Demand-side Policies .................................................................................................................. 10 3.2.1 Changing Deposit Requirements.......................................................................................... 11 3.2.2 Changing Interest & Mortgage Rates ................................................................................... 11 4. Trends in UK House Prices ...................................................................................................... 12 4.1 Fluctuating House Prices ............................................................................................................. 12 4.2 House Price Volatility .................................................................................................................. 13 4.3 House Price Bubbles.................................................................................................................... 13 0|Page
4.4 Regional Variations ..................................................................................................................... 14 5. Conclusion ............................................................................................................................. 15 References......................................................................................... Error! Bookmark not defined.
1|Page
1. Introduction
The UK housing market is known as monopolistic market where each firm, up to some extent, has differentiated products. This means that entry and exit barriers are very limited in this market. The UK housing market is divided into four main parts: privately owned (occupied apartments and houses), privately rented, local authority, and housing associations. Figure 1.1 illustrates the detail of UK dwellings in millions where it is shown that most of the UK housing market i.e. 17.8m is privately owned followed by privately rented.
Figure 1.1 – The UK housing market
Source: Communities.gov.uk
According to Thomas and Carson (2011), demand and supply forces are the key determinants of prices in a free market where the sellers and buyers argue offered prices before the actual transaction. This paper mainly investigates the factors that determine house prices in a free market. In addition, it is also examined that how and which different government policies affect the house prices. For this purpose, the United Kingdom’s housing market is taken as a case study and the trends in house prices of the last six years are examined in detail.
2. Concept of Price in a Free Market
There are several key factors that affect the prices in the UK housing market without the intervention of government. In a free market, demand and supply model is primarily used to set house prices where the buy or sell decision of stakeholders is based on market demand
2|Page
and supply analyses. Several factors that can be used to examine the change in demand or supply of houses in the UK market are given below:
2.1 Demand Factors
2.1.1 Income Effect
The income effect is an important factor that has great influence on the consumption level of consumers. It is a well known theory that if the income of people will increase then their spending will also increase with the exception of the type of income (Grant and Vidler, 2000). Therefore, the income level of buyer can reflect the decision of buying houses today or later. The income effect is evident in figure 1.2; when incomes of people went down in 2006 and then in 2010 due to recession effects then they were not able to buy houses which consequently affect the demand of the houses in the UK.
Figure 1.2 – UK per Capita Income
Source: data.worldbank.org The ups and downs in the income of UK people in the past six years consequently affected the demand of the houses. Figure 1.3 shows a shift in demand curve at right (upward) with an increase in the income of the people. This is because if the income of people will increase then more people will be able to buy houses and demand will be increased automatically. On the contrary, figure 1.4 illustrates a shift in the demand curve at left (downward) with a
3|Page
decrease in the income of the people because the fall in income will cause to decrease demand of houses.
Figure 1.3 – Change in housing demand with increase of income
Figure 1.4 – Change in housing demand with decrease of income
2.1.2 Population Level
A considerable change in the level of the population also has significant impact on the demand and supply of houses. An increase in the population will consequently increase the demand of the houses (Gillespie, 2001) because more people will require apartments and houses to live in. The impact of population level is low in the UK but it has been increased slightly over the past two decades due to the arrivals of expatriates (Brown, 2012) as shown in figure 1.5.
Figure 1.5 – Growth of UK population
Source: data.worldbank.org
4|Page
The impact of population growth on demand of houses is presented in figure 1.6 where the demand curve shifts right with an increase in the population. But in case if the population shrinks then the demand curve will move left because the demand of houses will be decreased (see figure 1.7)
Figure 1.6 – Change in housing demand with population growth
Figure 1.7 – Change in housing demand with population shrink
2.1.3 House Future Price Expectations (in short run)
The fluctuations in the house prices result in to fluctuating demand of houses as well (Higson, 2011). Considering the case of the UK and several other countries, if it is predicted that house prices may increase or decrease in the future, then the demand of houses will automatically increase or decrease at present time (Hall and Lieberman, 2009). With an expectation that house prices will increase in future, the demand curve will move right (D1), and conversely, with an expectation that house prices will decrease in future, the demand curve will move left (D2) as shown in figure 1.8.
Figure 1.8 – Changes in housing demand due to future price expectations
5|Page
2.2 Supply Factors
2.2.1 Prices of Housing Factors of Production
The changes in the prices of houses are also primarily based on housing factors of production i.e. land, labour, and capital. In the UK, high costs of labour usually affect the prices of houses. The low cost of labour for a particular period tends to increase the supply. The figure 1.9 shows that the labour cost in the United Kingdom has been increased dramatically over the last six years.
Figure 1.9 – Increase in labour cost in the UK
Source: Office of National Statistics (2012)
6|Page
In the above figure, the labour cost was low during 2006 and 2007 so the supply of houses was more as compared to the supply of houses between 2010 and 2012 when the labour cost was high. Figure 1.10 shows changes in the supply curve due to changes in the labour cost. The right shift of supply curve (S1) shows an increase in supply due to low labour cost in 2006 and 2007 whereas the left shift of supply curve (S2) demonstrates a decrease in supply due to high labour cost between 2010 and 2012.
Figure 1.10 – Changes in housing supply due to labour cost
2.2.2 Number of Housing Suppliers
The impact of changes in number of housing suppliers is low in the UK because UK is a monopolistic market and entry and exit barriers are minimal. But an increase in the number of suppliers will tend to increase housing supply and supply curve will move right (S2) and in contrast, decrease in number of suppliers will cause to decrease housing supply and curve will shift to left (S1) as shown in figure 1.10.
3. Impact of Government Policies on House Prices
The impact of government policies on house prices is different when the government enters into the free market system in order to make it more equal and ethical for the stakeholders. When government get involved in a free market system, the businesses and housing associations are forced to reduce the selling prices of houses by imposing various rules and
7|Page
regulations on them. The government policies and laws that affect house prices in the UK are discussed here.
3.1 Supply-side Policies
When government use different methods to control aggregated supply of houses, it is called ‘supply-side policies’ (Donahue and Nye, 2002). The UK government uses several methods (see subsections) to control the aggregate supply of houses. A successful supply-side policy of government will shift supply curve to the right as shown in figure 1.11:
Figure 1.11 – Change in supply curve due to supply-side policies
3.1.1 Subsidies to Private House Builders
In order to aggregate the supply of housing, the government can give subsidy to private house builders in the some particular areas i.e. London where people are currently facing housing shortage. However, private house builders may require more time to find out suitable land areas for planning, design, and construction (Grant and Vidler, 2000). It is illustrated in figure 1.12 that the government subsidy to producers will cut equilibrium price from P2 to P1 so people will spend more due to this lower price. The producer will ultimately get P1 plus the subsidy (P1P3). On the other hand, the amount that government spent on the subsidy will be (P1P3) at Q1.
8|Page
Figure 1.12 – Demand and supply of houses before and after subsidy
3.1.2 Public House Building
The local or central government may plan to aggregate the supply of houses by constructing more public houses. The inexpensive and economical social housing is the immediate requirement of large cities such as London and Wales. However, the lack of availability of land hinders the efficacy of this option. Recently, the UK government launched a scheme to give a subsidy of nearly £75,000 to over two million dwellers of social housing (Gavaghan, 2012).
3.1.3 Relax Regulations
The government can give relaxations to home building regulations to promote the aggregated supply of houses. One of the common relaxations is to provide them easier planning permission. In order to boost up the economy, the UK government has recently instructed planning officers to give relaxation on constructing larger extensions on houses- up to 8m long for detached homes in England (BBC News, 2012).
3.1.4 Tax Concessions or Grants
Higson (2011) suggests that government can offer special tax concessions or grants to builders to construct houses on Greenfield sites which can encourage aggregate supply of houses. The UK local government and councils are making tax reforms to consider Greenfield sites for housing (Doward, 2011). The impact of increase or decrease in government taxes or relax in regulation on housing sector is depicted in figure 1.13. The
9|Page
government cut in taxes will cut equilibrium price from P2 to P1 so people will spend more due to this lower price. The producer will ultimately get P1 plus the subsidy (P1P3). On the other hand, the amount that government spent on the subsidy will be (P1P3) at Q1.
Figure 1.13 – Demand and supply of houses before and after tax
3.2 Demand-side Policies
Different methods that government use to control the demand of houses are called ‘demandside policies’ (Donahue and Nye, 2002). The UK government uses several methods to control the regulate demand of houses. A successful demand-side policy of government will shift demand curve to the right as shown in figure 1.14:
Figure 1.14 – Impact of government’s demand-side policies on demand
10 | P a g e
3.2.1 Changing Deposit Requirements
The buyers are normally required to give at least 10 to 25 percent deposits when they buy a house in the United Kingdom. The larger deposit will hinder the sub-prime buyer to enter into the market. In order to boost up the demand of houses, the government can alter the deposit requirements. One such example is the recent scheme of the UK government which offers buyers to purchase a £500,000 home with just 5% deposit in large cities of the UK (Gavaghan, 2012).
3.2.2 Changing Interest & Mortgage Rates
Increasing or decreasing interest rates can have deep impact on the demand of houses as they contribute the general deflation or inflation in the housing market. Generally, the Bank of England does not openly address housing sector in altering the interest rates. The bank only address housing section in altering the interest rates when they are seen as central to the wider inflationary picture. This was happened due to the 2008 economic crisis when the Bank of England decreased the interest rates to boost up the housing market activities (Sá et al, 2008). The figure 1.15 presents fluctuations in the interest rates due to inflationary pressures during the recession from 2006 to 2008. The interest rates declined at record level in July 2009 and then became stable after the recession period.
Figure 1.15 – Changing interest and mortgage rates
Monthwise Base Rate VS Mortgage Rate Since 2006
9.00%
8.00%
7.00%
Base & Mortgage Rates
6.00%
5.00% Base Rate Mortgage Rate 4.00%
3.00%
2.00%
1.00%
0.00%
Ja n0 Ap 6 r-0 Ju 6 l-0 O 6 ct Ja 06 nAp 07 r-0 Ju 7 l-0 O 7 ct Ja 07 n0 Ap 8 r-0 Ju 8 l-0 O 8 ct Ja 08 n0 Ap 9 r-0 Ju 9 l-0 O 9 ct Ja 09 n1 Ap 0 r-1 Ju 0 l-1 O 0 ct Ja 10 n1 Ap 1 r-1 Ju 1 l-1 O 1 ct Ja 11 n1 Ap 2 r-1 Ju 2 l-1 2
Months
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In fact, interest rate is a significant determinant of housing demand. A small decrease in the rate of interest can boost the demand of houses. Similarly, lowering interest rate will lead to decrease mortgage rates as well, and as a result people with excess funds will search for new houses for investment purpose. This additional demand will cause to increase house prices. The impact of decrease in interest rate on demand of housing is shown in figure 1.16.
Figure 1.16 – Impact of decrease in interest or mortgage rate on demand and supply curves
4. Trends in UK House Prices
The trends in the UK house prices can be explained under four major headings as follows: ? Rising average house prices; ? House price volatility; ? House price bubbles; and ? Regional variations
4.1 Fluctuating House Prices
In the UK, a long-run increase in the house prices is triggered by rising housing demand exceeding the housing supply. The United Kingdom house supply is way below the demand since 2003 when it was estimated that the UK requires nearly 39,000 houses each year (BBC News, 2003). The fluctuations in demand and supply occur due to dramatic changes in the prices of the houses over the past decade.
12 | P a g e
Figure 1.17 – UK average house prices
Source: ONS (2012)
The above diagram clearly illustrates how prices increased from 2006 to mid 2007 and then a sudden decrease in the prices occurs due to the emergence of the financial crisis. The prices resumed again in mid 2008 and according to the latest study they are expected to increase 0.8% per year in the future (King, 2012).
4.2 House Price Volatility
The prices of houses in the UK have been crashed two times in the last two decades; first between 1990 and 1992 and then between 2007 and 2009. The house prices resumed after the recovery from recession in 1992 and continue to increase next 15 years. During this period, the prices increased well exceeding the general rate of inflation producing a substantial wealth effect. However, the house prices started to decelerate again in mid 2000s and began to fall in 2007 and continued to decrease throughout 2008. The prices resumed again after 2008 (see figure 1.4).
4.3 House Price Bubbles
The property investment is considered as a secure deal for all the stakeholders including investors, property developers, homeowners, and asset managers. This is more true when there are no alternative opportunities for investment especially during the financial crisis
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when share prices, profits and interest rates are low. The house price bubbles and consequent price crashes in the UK mainly occurred due to a general housing shortage (Forrest and Yip, 2011). The figure 1.18 demonstrates quarterly fluctuations in the UK housing market in the last six years.
Figure 1.18 – Quarterly changes in the UK housing market
Source: Nationwide (2012)
The above diagram clearly states that how house prices in the UK during 2008 crashed due to the burst of bubbles of real estate when sellers were cutting house prices to meet the expectations of buyers.
4.4 Regional Variations
The prices of houses vary significantly all across the United Kingdom where the average prices are higher in London and South East and lower in North. Figure 1.19 illustrates a comparison of UK house prices in London, North, and the UK from 2006 to 2011.
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Figure 1.19 – Comparison of UK house prices
Source: Nationwide (2012)
The regional differences in the above diagram can be described in terms of demand and supply conditions. A number of factors account for higher average prices in London. These factors include: limited housing stock, high employment rate, high incomes, and migrations. On the other hand, more house stock, low employment rate, easier planning, and lower incomes are the factors that influence on the demand and supply of houses in other regions of the UK as evident in figure 1.19.
5. Conclusion
A number of factors can examine changes in housing demand where income effect, level of population, and future house price expectations in short run are most influencing factors. The demand curve with an increase in demand due to these factors will shift right (upward) and similarly, a decrease in housing demand will move the demand curve to left (downward). On the other hand, factors like labour cost and changes in number of suppliers may affect supply of houses. The supply curve with an increase in supply due to influencing factors will shift right and similarly, a decrease in housing supply will move the supply curve to left. The government can adopt supply-side policies (e.g. subsidies, relax regulations, tax concessions) to control the aggregate supply of houses which will shift the supply curve to right (downward). Similarly, in order to control demand of houses, the government can adopt
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demand-side policies (e.g. changing deposit requirements, interest rates, and mortgages). A successful demand-side policy of government will shift demand curve to the right (upward). It was found by analysing the six year trends in the UK housing prices that since 1992 the house prices have increased well exceeding the general rate of inflation producing a substantial wealth effect till 2007. However, the house prices started to decelerate again in mid 2000s and began to fall in 2007 and continued to decrease throughout 2008 due to financial crisis (see figures 1.17 and 1.18). It was also found that regional differences in the UK and the entire world account for high or low prices and consequently can affect the demand and supply of houses.
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