Individuals' quality of life is strongly depended on housing. A pleasant and convenient place to live makes people feel healthier and happier. The economy is also affected by changes of housing market. A dynamic housing market partly causes a strong economic growth. Therefore, housing market not only in the UK but also in all other countries is always received a great concern for everyone, from residents to the Government.
In fact, the relationship between house prices and economic activities are not simple. The impacts of demand and supply on prices of housing are complex. Moreover, due to the unique structure of housing market in the UK, market will never provide enough number of houses compared to the demand, according to the 'Understanding supply constraints in the housing market' report by FTI Consulting for housing charity Shelter.
The aim of this report, firstly, is to examine and explain the factors that determine the demand and supply of houses then determine house prices in a free market, mainly concerned on UK housing market from 2006 to 2012. Secondly, it analyses how and to what extent Government policies could affect the price of houses.
I. The Factors That Determine House Prices in a Free Market
1. Demand Side Factors
1.1. Economic Growth, Income and Unemployment
Increasing income and stable job enable spending more money to buy a house. This means that the higher the income and the lower the unemployment rate, the greater is the demand for a house. As a result, house prices are also raised. For example, UK's GDP growth rate in November, 2006, according to Office for National Statistics ONS, reached at 0.9% and continued to rise till the end of year 2007. As well as, the unemployment rates always stood in low level, never over 5.6% during this period (ONS). Consequently, the Land Registry's quarterly report, out on Wednesday, 8 November 2006, shows that the average house price topped £200,000, and then remained in this level to the end of 2007 (Nationwide). "A strong economy and still accommodative financing conditions are helping support strong housing demand and above average activity in the market" and "conditions will remain firm into 2007," said the senior economist at the Royal Institution of Chartered Surveyors, David Stubbs.
By a contrast, economic recession causes significant reducing the buying houses demand. When the recession started, the unemployment rate has sharply raised from 5.2% (May, 2008) to 8.0% (July, 2009). Therefore, house price showed the fastest fall since 1991; the average price was £173,583 in May, 2008 (Nationwide), and then continued to fell to £159,900 in December, 2008 (Halifax). The unemployment rate has remained in high level (never lower than 7.9%) till 2012 (ONS); GDP has also growth negatively by -0.4% during 2012; therefore, house price, the Nationwide reported, fell by 1.4% in September, 2012. Robert Gardner, the society's chief economist said, "The weaker price trend observed in recent quarters is unsurprising, given the disappointing performance of the wider economy".
1.2. Mortgage Lending and Interest Rates
In UK, the majority of people are funded by a mortgage loan for house purchase. Conditions of mortgage loan and interest rates, as complement products, strongly affect the demand for buying house.
In the first half of 2012, the Bank of England offered various attractive mortgage products (for example, a sharp cut in the cost of long-term, fixed-rate mortgages for people with at least a 40% deposit) and held interest rates at 0.5%, a record low rate, to support housing demand, overall UK's house sales were 11% higher than last year, but in fact, house prices, according to Nationwide, still fell by 1.5%.
On the other hand, in 2008, the credit crunch leaded to the shortage in mortgage products, deterring people to buy houses. As a result, house price fell by a record 16.2% in December, 2008 (Halifax report) due to the sharp decrease in housing demand.
1.3. Demographic factors
In the 2006-2012 period, UK population has increased by 2,622 thousands (ONS) and number of households has also risen from 25,750 to 27,330 thousands (Department for Social Development in Northern Ireland.). There are some main reasons such as a decline in family size and marriage rate, a growth in divorce rate and net immigration from Eastern Europe and life expectancy, etc. Those have made housing demand in UK increase; however, average house price, according to Land Registry, slightly fell to £163,376 in August, 2012 because of other factors.
1.4. Renting House
Due to the recession, housing market has been altered; year 2009-2011 showed that fewer people than ever were buying their houses. 34% number of households in England 2010-2011 rented their houses (English Housing Survey of Department for Communities and Local Government DCLG). Renting house plays a substitute product; more rental demand causes less buying house demand.
The rental market was incredibly strong that pushed cost of renting was higher; in theory, it makes some people back into buying. In fact, number of buyers has fallen noticeably over the last four years; although, now buying a house is over £130 cheaper a month than renting (Halifax).
2. Supply Side Factors
In the short run, supply affects prices less than demand because building a new house takes a long time and obtaining planning permission is difficult; therefore, supply for housing become fixed. However, if housing supply is inelastic, an increasing in demand will cause a huge increasing in house price.
Long run supply
2.1. Cost of Building
Building costs include materials and labour costs that have a significant on supply. A shortage of materials and labour push up the cost of materials and the wage rate, and then cause an increase in building costs. It makes the supply curve shift to the left.
During the 2010-2012 period, material cost, for example, have gone up due to an increase in prices when the economy has rebounded after the recession, as well as labour costs have risen (never under 100 index points from January, 2010 in UK according to ONS). As a result, housing supply has decreased and been unable to keep up with demand in recent years. There were only over 100,000 new houses were built in UK in 2010 (ONS). It caused the average price of a house increased by 8.6% or £13,000 from the start of 2009 to the same period of 2010 (Nationwide).
2.2. Number of Suppliers and New Houses
Many suppliers have gone out of business during the recession, said Don Magruder, vice president of Ro-Mac Lumber & Supply based in Leesburg. Builders find better profit from other types of investment. Despite increasing demand, number of new houses in UK sharply fell from over 200,000 to more than 100,000 in the 2007-2009 period (ONS). Builders did not want to build houses because they concerned that the impacts of credit crunch started in 2007 made their houses cannot be sold.
In this year, construction output is expected to drop by 6.3%, reported Construction Products Association. In general, number of new houses in UK is always low that makes the shortage of housing; it is the key factor explain why house prices in UK are always more expensive than other country. "Britain's housing shortage has pushed up house prices to the point where an entire generation is struggling to afford a home of their own. With house building at record lows, all political parties need to tackle this issue head on and set out a long-term strategy that not only boosts supply now but ensures future generations have the homes they need" said Campbell Robb, FTI Consulting for housing charity Shelter's chief executive.
II. The Effects of Government Policies to House Prices
According to Department for Communities and Local Government DCLG, the government department responsible for developing government housing policy in England, housing policies of UK Government aim increase the number as well as quality of houses, including affordable houses, to buy and rent through access to mortgage finance and by reinvigorating Right to Buy, improving the flexibility of social housing, and solve homelessness issue. Therefore, house prices are influenced by a range of government policies.
1. Taxes
Taxes are the most obvious and simplest policy that affects house prices. Various taxes make the cost of selling and buying a house become more expensive. However, the Government uses these taxes to encourage increase institutional investment in housing market and rising house value.
Besides that, the Government encourages people to own their houses more than renting a house through the policy that owner occupier maybe pay 18% less than tenants for the same property after tax.
2. Banks
The Government controls the house prices by controlling banks to keep a reasonable interest rate in all the time. When the housing market has been gloomy due to impacts of the recession, the Government launched some consumer stimulus packages by allowing banks provide many attractive mortgage products as well as reduce interest rates to encourage raising housing demand.
3. Affordable housing
The Government plays a vital role in the quantity and quality of affordable houses provided. If public subsidy for social housing increase and the difficulties on land availability are solved, more affordable houses will be delivered. Registered Social Landlords (RSLs) can also give private house builders lower land costs and easier building permissions to require them to produce affordable houses.
Conclusion
The report analysed the theoretical foundations compared to the fact about the relationship between demand and supply and the price mechanism. In fact, various factors, such as income, unemployment rate, mortgage loan, interest rate, demographics, renting demand, materials and labour cost and number of suppliers, strongly interact together to create price of houses in the free market.
In last section, this report assessed the impacts of Government policies on house prices as well as housing market. By using different instruments such as taxes, mortgage finance, affordable housing, the Government plays an irreplaceable and vital role in keeping the equilibrium point between demand and supply and price stability in housing market.
