The behaviour of the UK housing market
There has been a clear pattern in house price over the last few decades. A steady rise throughout the eighties followed by price contractions into the nineties This type of behaviour is frequently seen in property markets and is called a ‘boom & bust ’.
The simple explanation is that demand increases quickly for a myriad of reasons – many unforeseeable. The market cannot react quickly enough with sufficient supply and this causes prices to rise to allocate what is available.
Fear, panic and speculation usually join the equation and this induces people to enter into the market driving prices even higher. The ‘bust’ eventually follows as other equally unforeseen factors now enter the market quelling demand just as supply is catching up. Prices continue to fall as unwanted supply continues to be pushed into a weak market because of lagging supply and speculative purchases forced back the market.
Expanding on the above description we can now focus in on the main factors which were affecting the UK housing market during this period:
• Large scale deregulation of the financial industry allowed banks to compete with the normal mortgage providers i.e. building societies. This led to the removal of certain restrictions causing an increase in available credit.
• A general improvement in the economy throughout the eighties and a reduction in personal taxation created strong incomes growth. This increased peoples abilities to finance mortgages.
• There was a significant growth in the key age groups that purchased property.
• UK borrowers usually take mortgages at short-term rates. This can increase the volatility of demand in times of large swings in rates.
• The Thatcherite political philosophy, which actively encouraged home ownership, also affected demand Equally the same philosophy actively discouraged councils form building public housing. This reduced one element of supply.
• The time taken to build houses and the limited availability of land in certain parts of the UK is another factor.
• A critical factor in the housing market was a psychological one Greed and fear can distort peoples perceptions increasing the amplitude of any rise or fall.
Using these factors to analyses the demand supply framework, we can now see how much of the behaviour of the market can be explained by economic theory.
Let us assume that in the early 1980s the housing market was in equilibrium i.e. the quantity of housing demanded equaled the quantity supplied and their was neither a surplus or shortage in the market. The demand curve accurately represented the quantity that consumers were willing to purchase at various prices; and the supply curve the amount willing to be supplied at various different price levels.
However, within a short time the factors we have outlined above began to impact on both the demand and supply components
Demand
In the years after the election of the Thatcher government in 1979 a combination of the above factors increased demand for housing substantially. Interest rates began to fall, financial deregulation meant that loans were easier to obtain, the political climate encouraged home ownership and there was general increase in the demographic group that wished to purchase houses. This led to a shift in the demand curve up and to right i.e. there was a general increase in the overall demand for houses at all prices rather than just a movement along the demand curve.
Supply
In theory suppliers should have responded by producing extra supply in order to meet the ability to pay more – a movement along the supply curve However, the two mains sources of supply had fundamental problems. The private suppliers who built and renovated property could not react fast enough as there are obvious physical limitations on building and acquiring land. This lag meant that in the short-term the supply of houses was almost fixed. This drove up prices as the quantity could not change.
Also, for political reasons, the government wanted to eliminate councils from the equation. This put more pressure on the private suppliers to replace their output as well.
The supply side eventually reacted and more and more resources were devoted to building houses. With a shift now in both the supply curve and the demand curve the quantity being supplied increased dramatically. This can be seen in the by the fact that the number of private dwellings being “produced” peaked in 1988 with 175,000 units Yet the rise in prices during this period was equally impressive as psychological factors obviously took hold and people bought for speculative reasons – this is obviously not based on any economic rationale but can be understood and reflected within a demand/supply framework The extra demand was still consuming the extra supply.
In the early 90s interest rates rose and in 1992, because of the Sterling Crisis, jumped to levels unimagined by many new house owners. The sudden and dramatic increase in mortgage hit an already weakened housing market and led to a drop in demand for housing. It also impacted peoples ability to repay mortgages. Potential buyers became nervous and pulled back from purchasing. As prices fell people waited for further price falls. There was also an excess of supply coming back onto the market from speculative sources, foreclosures and housing that was already in the building pipeline. This resulted in another shift in the demand curve and supply curve which reduced the equilibrium point – the price. This caused the falls in the prices we see after 1989 as the market returned to a less volatile equilibrium.
In summation we can say that the behaviour in the UK housing market is in most part explained by demand and supply analysis.
Tags: borrowers, home ownership, house price, housing market, incomes, mortgage providers, public housing
