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Housing Market Economics: Revision Guide 2006

1. Introduction................................................................................................................. 3

2. Overview of the UK Housing Market............................................................................ 4 The nature of housing ....................................................................................................................................................................... 4 The Pattern of Housing Tenure.......................................................................................................................................................... 5 Explaining the Growth of Home Ownership in the UK........................................................................................................................ 7 Home ownership and renting – comparing the costs and benefits .................................................................................................... 8 The Private Costs of Running a Home............................................................................................................................................... 9

3. Microeconomics - Market Demand and Supply......................................................... 11 Housing Demand ............................................................................................................................................................................ 12

4. Elasticity of Demand for Housing .............................................................................. 15 Price Elasticity of Demand .............................................................................................................................................................. 15 Income Elasticity of Demand for Housing ....................................................................................................................................... 15

5. Macroeconomics: The Aggregate Demand for Housing ............................................ 17 Mortgage Interest Rates.................................................................................................................................................................. 21

6. Supply-side factors in the UK Housing Market.......................................................... 23 Factors Affecting New Housing Supply ........................................................................................................................................... 25

7. Rented Housing and the Buy-To-Let Boom ............................................................... 27

8. Market Failure in Housing.......................................................................................... 30

9. Government Intervention in Housing......................................................................... 41 Options for Government Intervention in the Housing Sector ........................................................................................................... 42 Intervention through the Tax and Benefits System .......................................................................................................................... 42 Stamp Duty..................................................................................................................................................................................... 42

10. Interest Rates and the Housing Market ..................................................................... 44

11. The Regional Housing Market ................................................................................... 45 Explaining Regional Differences in House Prices............................................................................................................................. 46

12. Macroeconomics: Housing and the Economy ........................................................... 49 Recent Trends in the UK Housing Market........................................................................................................................................ 49 House Prices and National Income.................................................................................................................................................. 52 The Housing Market and the Savings Ratio..................................................................................................................................... 54 Housing and Related Industries ...................................................................................................................................................... 54 Housing and Aggregate Demand..................................................................................................................................................... 54 House Prices and Inflation .............................................................................................................................................................. 57 Housing and the Balance of Payments ............................................................................................................................................ 59 Housing and Unemployment........................................................................................................................................................... 59 Difficulties in Forecasting House Price Movements ......................................................................................................................... 60

13. Current Government Housing Policy ......................................................................... 63

14. Housing Glossary ...................................................................................................... 65

15. Useful Internet Resources on Housing...................................................................... 70

© tutor2u 2006 www.tutor2u.net


1. Introduction Housing - the most important price in the economy! In the UK, houses are the most important asset for most individuals by far – and the price of property is probably the most important price in the whole economy.

Source: Roger Bootle, Deloitte and Touche Economic Review, 1st Quarter 2004

The British have long enjoyed and occasionally endured an obsession with property. Our television schedules are filled with a bewildering variety of make-over programmes and self-appointed experts advising us on how to add value to our properties. Housing market economists appear on our screens attempting to make sense of the latest gyrations in property prices. Experts seek to make sense of the mortgage maze and analyse the pitfalls of the rising level of consumer borrowing. Other analysts point to the dangers of our fixation with bricks and mortar and they press for reform the British housing sector. Leaders of charities raise the question of homelessness, an endemic problem of poor quality housing and the persistent regional divide in housing values. Politicians warn about a looming housing shortage across the country.

It is virtually impossible to read right through a daily newspaper without some mention or feature linked to the changing fortunes of the housing market. The housing market contains over twenty four million properties and the total value of the housing stock exceeds three billion pounds.

A Room with a View! Because housing is important to millions of people in their daily lives, it is illuminating to have the opportunity to study the market and housing as a whole in more detail.

The main aims of this 2006 edition of the Housing Market Study Companion are to provide for you an overview of housing and provide opportunities for further reading and independent research.

We will consider the microeconomics of housing including the demand and supply factors influencing prices and the important issue of market failure and government housing policy.

We will also identify some of the inter-relationships between the housing market and the macroeconomy - for example how changes in house prices can feed through to key macroeconomic indicators such as GDP growth, unemployment and inflation.

Key terms used in this Study Companion can be found in the glossary at the back and I have also provided some links to useful internet resources.



2. Overview of the UK Housing Market The market for housing in Britain comprises the owner-occupied sector (privately-owned properties), private rented accommodation, housing made available by non-profit-making housing associations (known as registered social landlords) and local authority housing (council tenants living in council owned and maintained properties).

The nature of housing Housing differs from many other goods and services in that it fulfils a number of uses over time.

• Housing as a Consumption Good

Housing is a consumer durable that provides a flow of services to the occupier over time. A high percentage of people stay in the same property for many years and they may renovate or improve their properties in their own chosen style in a bid to “add value” to the property should it be placed on the open market.

• Housing as an Asset

Housing is important as an asset. A period of rising house prices lead to an increase in wealth and this can have a large effect on consumer demand since there are many complementary industries linked to the housing market whose fortunes depend on the number of transactions in the industry. We will come back to this idea when we consider some of the macroeconomic consequences of the recent UK housing boom.

Chart 1: Household estimates and projections for Great Britain

Chart 1 is adapted from data published by the British government on population projections up to 2021. The total number of households is forecast to rise over the next decade and beyond. Partly this is due to changes in the age structure of the population as our population grows older together with forecasts that we will import extra labour from EU and other non-EU countries. Another reason for a rising number of households is that the average size of households will continue to decline. People are living longer and many older people wish to retain their independence during retirement by staying in their own properties. There is also a trend towards people marrying later and the effects of rising divorce and separation rates.


Housing Market Economics: Revision Guide 2006 Can sufficient new and renovated houses be made available to meet the projected boom in

household numbers? Or is Britain now facing a housing crisis because of a growing shortage of properties? We consider this issue when we look at housing market failure in a later chapter.

The Pattern of Housing Tenure Housing tenure refers to the distribution of ownership among different types of property.

1. Owner-occupied housing - owner-occupiers either own their property out-right if people have paid off their mortgage loan. Or they are in the process of buying their property and have some remaining mortgage debt left to repay

2. Privately rented housing – i.e. properties made available by the rented sector. This includes properties made available through the expansion of the ‘buy-to-let’ sector

3. Public rented housing – this is council / local authority housing – also known as social housing made available at a subsidised rate to tenants

4. Quasi rented housing sector – this includes different types of housing made available by non-profit making housing associations – acting as registered social landlords

Table 1: Housing Tenure in the UK

Year Owner Occupied

Rent privately or with a job or

business

Rented from Registered Social

Landlords

Rented from Local Authorities

All Dwellings

1981 12,442

2,378 473 6,305 21,595

1995 16,239

2,462 989 4,651 24,341

2004 18,316 2,663 2,001 2,983 25,953% change 00-04

+12.8 +8.2 +102.3 -35.9 +6.6

Source: Office of the Deputy Prime Minister, Housing Statistics

In 1914, only one home in ten was privately owned and the majority of properties were rented out by landlords. The post-war years saw a huge expansion of council house building and by 1970, over 30% of the housing stock was in local authority control. This has now declined to a level less than one half of the 1970 figure. The private rented sector also declined during the 1960s and 1970s before stabilising at around 10% of the total housing stock by the end of the twentieth century.

Seventy per cent of the housing stock in the UK is now owner-occupied. This is one of the highest rates of private home-ownership in the European Union. According to data from the Halifax, owner occupation is highest in the South East (76%) and the South West (75%). In contrast, home-ownership rates are lowest in Greater London (59%) and Scotland (64%). However, Scotland has seen the fastest rate of increase in home-ownership in the past ten years, a twelve percentage point rise – three times the average UK growth



The decline in local authority housing

In the last twenty five years, there has been a large reduction in the stock of council houses built and maintained by local authorities

The growth of housing associations

Housing Associations are providers of low-cost housing for people in the UK who cannot afford to buy their own properties

The major long-term changes in the pattern of housing tenure can be summarised as follows:

1. A rise in the proportion of the population that are owner-occupiers

2. A falling share of the population in private rented properties despite buy-to-let

3. A decline in the share of housing supply met by local authorities

4. An increase in the housing stock made available through housing associations

Chart 2: The Pattern of UK Housing Tenure



Chart 3: Housing Tenure in the European Union

The UK has one of the highest rates of home-ownership within the European Union although below that of Spain and Ireland. Home-ownership is lower in Germany (Europe’s largest economy) where less than one home in three is under private ownership.

In May 2004 ten countries joined an enlarged European Union. Most of them are former Eastern Bloc countries that have undergone a transition from centrally-planned systems to market economies. It is wrong to assume that home-ownership is automatically lower in countries that are emerging from state-planned systems of resource allocation. Indeed many of these countries have brought in a programme of privatisation of housing and other assets. In the Czech Republic for example, home ownership is higher than in the United Kingdom.

Explaining the Growth of Home Ownership in the UK Why has home ownership become so popular in the United Kingdom?

1. Rising living standards – As incomes rises, so demand for housing increases because people can afford to enter the market. The demand for housing has positive income elasticity although this varies according to the type of property.

2. Increased supply of mortgage finance – the market for mortgage loans in Britain has become fiercely competitive leading to an expansion of the supply of mortgages. Home-buyers can choose fixed-interest rate mortgages which offer a fixed rate of interest over a number of years, and which make it easier to plan mortgage repayments when assessing family/personal finances.

3. Lower mortgage interest rates – mortgage rates charged to home-buyers have fallen to historically low levels. Even when house prices are rising, lower interest rates have the effect of reducing the costs of servicing (paying) the debt on a mortgage and this encourages more potential home-buyers into the market.

4. Subsidies and tax breaks for mortgage-payers – over many years the government has offered subsidies for people seeking to buy a home. Since 1979 over 1.6 million council houses have moved from the local authority sector into owner-occupied status. However, most of these housing subsidies have now been phased out.

5. The decline in the size of the private rented sector – in many areas of Britain there remains a shortage of rented properties at an affordable price and this has made renting a property appear a poor substitute to buying one.

6. The decline in the supply of social (council) housing



7. The desire to accumulate wealth – the culture of owner-occupation has many roots, but one of them undoubtedly is an expectation that income from owning property will provide people with a means to enjoy a better retirement. According to a report in the Financial Times published in May 2004, up to a third of the population said they are saving in property to provide retirement income - and 15 per cent said they planned to use income from properties other than their own home to finance their old age. This is a risky strategy to adopt!

Home ownership and renting – comparing the costs and benefits What are the main advantages from owning rather than renting a home?

• The prospect of earning a capital gain from rising property prices.

• The security from owning an asset from which further borrowing can be secured e.g. in the form of a housing equity loan.

• A desire to build up wealth and pass it onto succeeding generations within the family.

• The utility and satisfaction (private benefit) from modernising / improving a property and then living in the property over a number of years.

Renting a house or flat does not involve the same financial commitment and, although living in a rented property provides a flow of services for tenants over time, there is no opportunity for making a capital gain, merely regular entries of payments into the rent book!.

However, renting a house or flat may give people more flexibility and freedom to move when family, work or other factors demand it.

Many people do not become homeowners. There are two main reasons for this:

• Personal Preferences: Many young people opt to rent because they don’t want to commit themselves to a mortgage when career and family plans are unsure.

• Housing Affordability: Many households cannot afford to take on a mortgage. The problem of affordability is most acute in regions and localities where house price inflation has been strongest – for example London and the South East.

Are there enough rented properties in the public sector?

There has been a sharp decline in the building of new properties by local authorities in recent years. Councils still spend millions of pounds each year renovating properties (such as the example in Plymouth shown on the right).

Pressure groups claim that more needs to be done by local councils to increase the supply of properties available for people on lower than average incomes.

Housing renovation schemes improve the quality of the local authority housing stock

Thousands of people own more than one home. Rising wealth and a desire to avoid lengthy and time-consuming commuting to work are two of the factors likely to boost demand in the years ahead. The average time taken to commute each way to and from work has risen from 22 minutes in 1986 to 26 minutes in 2002. This involves an opportunity cost for those affected, and it is interesting that people are prepared to use some of their wealth to buy second homes in urban areas closer to central business districts. Another feature of the housing market is


Housing Market Economics: Revision Guide 2006 the preference for buying overseas holiday homes – it is estimated that more than 750,000

overseas homes are now owned by UK households.

The Private Costs of Running a Home According to research published by Halifax Bank of Scotland, the cost of owning and running the typical UK household was £5,948 in 2004. Mortgage interest payments account for around a third of the annual costs of owning and running a household and the Local Authority Council Tax made up 15% of the total cost. For the average family, housing expenses take up 17% of income.

There are differences of over £3,000 per year in housing expenditure across the United Kingdom. London housing costs are the highest (£7,691 per year) 77% above annual housing costs in the North East which is the cheapest region at £4,358 per year. Relative to household income, the South West has the highest housing costs, 19% of gross disposable income; whereas costs are lowest in the East Midlands at 16% of gross disposable income.

Chart 4: Annual Costs of Running a Home (in 2004)

The table below breaks down the average cost of running a home for UK households in 2002.

Table 2: The Costs of Running a Home in 2002 Average Cost £Maintenance and repair of dwelling 451Water supply and miscellaneous services relating to the dwelling 263Electricity, gas and other fuels 670Household appliances 249Tools and equipment for house and garden 166Goods and services for routine household maintenance 274Telephone account 328Toilet paper, toiletries and soap 150Household Insurances 300Housing: mortgage interest payments, water, council tax etc on second dwelling 2,751

of which Mortgage interest payments 1,820 Mortgage protection insurance premiums 94Council tax, domestic rates 775


Housing Market Economics: Revision Guide 2006 Move home or stay put?

Well over a million homes are bought and sold each year, but for most people a home is somewhere to live in for many years at a stretch. Indeed thousands of homes are inherited and remain within the family for generations. When might a homeowner choose to remain in their current house and not be an active participant in the housing market? We can identify plenty of social and economics reasons

Social Factors Economic Factors

• Settled family life, people often have a desire to build roots (social ties) in a local area

• Uncertainty over future path of house prices and future movements of interest rates– buying a more expensive property is a financial risk

• Home might be close to good schools, excellent leisure facilities and transport infrastructure

• The costs of moving home – including estate agents fees, removal expenses etc which can run into several thousand pounds.

• House may already be large enough to meet changing needs and wants of the home-owner

• General macroeconomic uncertainty – including the fear that people’s incomes may not keep pace with mortgage repayments. Or that unemployment may rise in an economic slowdown / recession

• Plenty of scope for housing development / improvement of the existing property

Housing Snapshot

There were 20.8 million households in 2001 – this is expected to rise to 24.5 million by 2021

Of 21.6 million dwellings in the UK in 2004, 71% were owner-occupied, 11% privately rented; 11% belong to local authorities and 8% are managed by registered social landlords

Nearly 40% of the UK housing stock was built before 1948

300,000 households in England have a second home in England

Since 1979, 2.9 million homes have been sold by local authorities and housing associations



3. Microeconomics - Market Demand and Supply The housing market in the UK is segmented. It is worth remembering that virtually every individual property has unique characteristics in the marketplace which affects potential demand and value.

The interaction between market demand and supply

The determination of price levels in local housing markets are great examples of microeconomics in action!

Each day there are literally hundreds and thousands of separate interactions between buyers and sellers with prices being offered and agreed before a final transaction is made.

The price that is established with each housing transaction in the market depends on

• The price that the seller is willing to agree for their property with the buyer

and

• The actual price that the buyer is willing and able to pay

Offers and reservation prices Home-buyers place offers for a property that the seller can either accept or reject. The seller will often have a reservation price for a property – that is a minimum price that they are prepared to accept from a potential buyer.

These days, a growing number of properties are bought and sold at auction. Auctions account for 5% of all property transactions in the UK and they are becoming more popular with both buyers and sellers. The auction process is often quicker, cheaper and more open than other ways of buying a property.

A Sellers Market When market demand for properties in a locality, area or region is high and when there is a shortage of good quality properties (i.e. supply is scarce) then the balance of power in the market shifts towards the seller. There is nearly always excess demand in the market for good quality properties because they tend to be in short supply. As a result, the seller can wait for offers on their property to reach (or exceed) their minimum selling price. Indeed early potential buyers may come straight in with an offer in excess of the asking price in order to avoid the possibility of losing the property that they want.

A Buyers Market When demand for housing is weak during a downturn or perhaps when much of the available housing has become unaffordable, and when there is a glut of properties available on the market (excess supply), the balance of power switches to potential buyers. They have the luxury of a much wider choice of housing available and they should be able to negotiate a price that is lower than the published price. Sellers may require a quick sale and this puts extra bargaining power into the hands of buyers. During the last housing market recession in the early 1990s, at property auctions across the country it was possible to pick up some high quality housing at very low prices. Thousands of homes were up for sale by building societies who had repossessed properties from home-owners unable to keep up with their mortgage commitments.



Bids and Offers The housing market operates using an offer system – the potential buyer must agree with the seller on a price.

In recent years there has been a housing boom in the United Kingdom. In most areas of the country, housing demand has out-stripped the available supply. This gives the balance of power in the market to the seller.

Housing Demand The demand for housing represents the quantity of properties that homebuyers are willing and able to buy at a given price in a given time period.

Some new property developments are sold in blocks to buyers – for example a new block of flats might become available on the market and purchasers are asked to make an offer for them at a price close to the list price. However for the majority of properties, the price is determined by a negotiation process between buyer and seller.

The market price depends on many factors. Some of these are thought to add extra value to a property when it is eventually put on the market The desirability and affluence of the local neighbourhood is inevitably a subjective judgement on behalf of the potential buyer. Local factors affecting demand include:

• Unemployment rates and employment opportunities.

• Local crime statistics and the reputation of an area.

• The accessibility of good local shopping and transport networks.

• The quality of local schools and hospitals and other civic amenities such as parks, leisure centres, libraries and other sites of public interest.

A local state school with an excellent GCSE and A level exam record can add several thousand pounds to average house prices in an area. According to research published in the Economic Journal in October 2004, wealthier parents in the UK are willing to spend up to a 30% premium on houses in the catchment areas of very good schools.

Semi-detached v Detached properties A study by economists at the Nationwide Building Society found that if a semi-detached property was sold, and a detached property the same size, with all the same features, in the same area was bought, it could cost more than 10% more.

Number of bedrooms A rise in the number of bedrooms can add value to a property - but the “value added” is limited by the total floor space available. Extensions to a property (i.e. from loft conversions and the construction of conservatories) tend have a greater impact on the market value than creating more bedrooms from the same floor space.

Convenience of a second bathroom Prices tend to be higher for properties with more bathrooms. For two identical properties in the same street, an extra bathroom could add as much as 10% to the price. However, the more


Housing Market Economics: Revision Guide 2006 bedrooms a property has, the greater the value that is contributed by a second bathroom. For

example, in a two-bedroom house a second bathroom would be less desirable than one in a five-bedroom house.

Home improvements When improving a property, two avenues that are often considered are adding, or enlarging a garage, and adding central heating. Adding a double garage, rather than a single one, more than doubles the contribution it makes to the value of a property.

The land available for a double garage is often at a premium - there is a trend towards two or three car family units. And, many households make use of the extra garage space to add extra utilities such as extra freezer units. Again this will vary between different regions. For example, because of the shortage of space and the price of land a garage will add more to a property in London and the South East than one in Scotland.

Homeowners often exaggerate the effect that improvements can have on a property’s market value! Equally, the failure to do some basic DIY before putting a property on the market can have a negative effect on the price that a would-be buyer is prepared to offer for a property.

House prices and home improvement – adding value? When house prices are rising, many homeowners choose to remain in their properties and spend money on housing developments. These are designed to increase the market value of the property as well as giving extra utility to occupants. Home improvements avoid the costs of moving house such as estate agents feeds; liability to pay stamp duty and removal costs.

Loft conversions have become popular in recent years partly because of the growing number of people who work from home.

New and second hand homes Despite the fashionable trend towards period properties, buyers are still willing to pay a premium for the benefit of living in a new home. One reason is that new properties have warranties that cover some of the repair and maintenance costs associated with newly constructed properties, and they tend also to incorporate modern building technology.

However, in rural locations good quality period properties generate an extra premium over newer houses.

Specific local factors can often have an effect on house prices. For example the types of businesses located near residential areas, the impact of new road and by-pass developments and other projects that require planning permission and fluctuations in the strength of the local and regional economy.



DIY – does not guarantee success! There is always an opportunity cost involved in ‘do-it-yourself’.

o The time cost involved in home improvement projects

o The opportunity cost of projects – sacrificing other consumption (e.g. an overseas holiday or a new car)

o Extra costs to the homeowner arising from a bodged DIY job!

o The externalities created by noisy DIY work and the waste that is generated. Botched DIY projects may also be missed by potential homebuyers



4. Elasticity of Demand for Housing

Price Elasticity of Demand Price elasticity of demand (Ped) measures the responsiveness of demand for a product to a change in its own price. When housing is regarded as a necessity and when there are few close substitutes available, we expect demand to be inelastic. This may well force up the eventual market price when a transaction is agreed.

The price elasticity of demand for a property depends on the availability of close substitutes – for example the supply of rented housing. If you have set your heart on a particular property, or are convinced that you need to live in a specific area, perhaps to live within a school catchment area or because you want to be close to friends and family, then you will be far less sensitive to the market price and demand will become price inelastic.

Price

Quantity

D1

Supply

P1

Price

Quantity

D2

Supply

P2

Q2 Q1

An inelastic demand for housing An elastic demand for housing

Income Elasticity of Demand for Housing Evidence suggests that the income elasticity of demand for housing in the UK is positive. The demand for housing grows when real incomes are rising.

Income elasticity of demand varies across different types of property – but the data suggests that the demand for housing in Britain is sensitive to the economic cycle and that changes in the growth of real GDP and unemployment can have a large effect on demand from year to year.

Housing and the Derived Demand for other products A derived demand exists when the demand for one product affects demand for related (complementary) products. The housing market provides good examples of this. For example when there is a rise in demand for new homes, this creates a fresh demand for the inputs that are used in the design, construction and retailing of homes in other sectors of the economy. A new home represents a tangible product that can be enjoyed by home-owners. But to create this, there are associated demands in the factor markets for essential inputs and labour. The


Housing Market Economics: Revision Guide 2006 flow chart below tries to show the inter-relationships between product markets, factor markets

and capital markets in the economy.

Product Market

(E.g. housing)

Labour Market

Capital Market

Individuals Businesses Buy labour

services Sell labour services

Savings Borrow to fund

investment

Buy Products Sell Products



5. Macroeconomics: The Aggregate Demand for Housing

Chart 5: UK House Prices 1986 - 2004

In this section we consider the main macroeconomic factors affecting demand for property.

The Growth of Real Incomes and Earnings Privately owned housing is a normal good and as our living standards rise, so the demand for housing expands, including demand for more expensive properties as people move “up market”. The income elasticity of demand is higher for the most expensive properties (i.e. luxury housing) although consumers may actually become less sensitive to price.

Interest Rates

Since most homes are purchased with a mortgage, changes in interest rates affect demand for housing. Interest rates also affect the relative rate of return on different forms of financial investment, for example the return from saving in a bank account rather than using spare money to purchase properties subsequently used for letting to other tenants.

Consumer confidence Consumer confidence is vital! If expectations for the future performance of the economy deteriorate and people become less optimistic about their own financial circumstances, they may be tempted to delay entry into the market for property. Rising unemployment reduces


Expectations of future price

movements in the market

Changes in unemployment

and interest rates

Confidence & expectations for personal

finances

Trends in alternative

investments (inc shares)

Housing Market Economics: Revision Guide 2006 demand for all types of housing because confidence is low.

Economic Growth When the economy is enjoying sustained growth and rising prosperity, improved confidence raises the number of homebuyers. The British economy is currently enjoying the longest phase of economic growth for over forty years.

Unemployment Financing a home purchase involves making a long-term commitment through a mortgage lender. In areas when unemployment is persistently above the national average, incomes are likely to be lower.

These macroeconomic factors, incomes, employment and confidence are critical in determining the direction of house prices. When these three factors are rising the conditions are normally in place for sharp upward movements in prices. In recent years the economy has enjoyed steady growth, falling unemployment, low interest rates and stable consumer price inflation. In other words, the macroeconomic fundamentals have been very good for the housing market and have supported a period of very strong housing demand.

Table 3: Macroeconomic Factors Affecting Housing Demand

Real GDP Real HouseholdDisposable

Consumer

Growth Income Spending

Inflation

Unemployment

% change % change % change % change Million1980-84 9.6 0.9 1.3 1.5 2.31985-89 5.7 3.8 4.3 5.3 2.61990-94 4.6 1.3 2.5 1.2 2.41995-99 2.8 3 2.5 3.5 1.72000-04 2.5 2.7 3.4 3.2 1

Source: HBOS UK Economic Fact Book, May 2005

However other economic variables also come into play. We will now consider two of them – housing affordability and mortgage interest rates:


Housing Market Economics: Revision Guide 2006 Housing Affordability

Chart 6: UK Housing Affordability 1988 - 2004

Housing affordability can be expressed in several ways. One approach is to calculate the ratio of house prices to average incomes. Because most homes are purchased using a mortgage, if prices are low relative to incomes, this encourages people to move up the housing ladder into larger and more expensive properties. This then helps to open up the supply of lower-priced housing on the market and provides incentives for younger first-time buyers to find their ideal starter-property. Notice here the important inter-relationships between different parts of the housing market.

The sharp acceleration in house prices in the late 1990s and early years of the new decade has taken the affordability measure close to five times average incomes – the highest figure since the housing boom of the late 1980s. Rising prices have “priced many people out of the market”

Decline and fall of “Trading Up”

Soaring house prices are making it difficult for people to trade up in the housing market. The extra disposable income and the existing housing equity needed to make the jump from smaller flats to family homes and family homes to grand houses is increasingly beyond most middle-class families.

Source: Halifax Bank of Scotland www.hbos.co.uk

There are significant regional variations in the figures and wide differences between local areas – but despite this, most housing experts believe that housing in the UK remains reasonably affordable by historical standards. The main reason is that mortgage interest rates are lower than at any time in the last twenty years.

A second approach in measuring housing affordability is to calculate the percentage of disposable income taken up by monthly mortgage repayments. Again when prices and interest rates are low, potential homebuyers will be attracted into the market in the expectation that they can keep up with their mortgage commitments.


http://www.hbos.co.uk/


Table 4: Measures of Housing Affordability

Ratio of House Prices / Incomes Mortgage Interest Payments as % of Income

1999 3.5 16.4 2000 3.5 18.2 2001 3.7 13.8 2002 4.5 14.4 2003 4.9 14.1 2004 5.4 19.3 20 year average 3.9

Source: HBOS, UK Factbook, May 2005

As we can from the table above, housing affordability has worsened if we focus solely on the ratio of average house prices to people’s incomes. But in contrast, the burden of meeting interest payments on mortgages has actually declined during the recent housing boom and is way down on the huge levels seen in the late 1980s and early 1990s when the British housing market last went into recession.

High prices are squeezing first-time buyers out of the housing market

Affordability is the name of the game in the housing market and the latest research from economists at the Halifax demonstrates just how difficult it has become for your typical first time buyer to raise sufficient funds to break into the property game. According to the Halifax, a new entrant to the housing market will have to save at least fifteen per cent of their earnings for at least five years before being able to afford a deposit on a starter property. Little wonder that the average age of first time buyers (FTB’s) continues to edge high year by year.

Since the start of the decade, the amount that FTB’s have to put down as a deposit for a property has grown to nearly £24,000, equivalent to over three quarters of the average earnings of people fresh to property buying. The number of first-timers has shrunk to its lowest level since 1980 (just 320,000 in 2005) a ten per cent decline on the 2004 figure and well down on the figure of 530,000 in 2002.

And high prices have the effect of severely limiting the range of properties that FTB’s can actually afford. The Halifax estimates that nearly ninety per cent of semi-detached homes are unaffordable at present compared to 41 per cent less than five years ago.

Chart 7: Mortgage Interest Payments



Mortgage Interest Rates Chart 8: The Leading Mortgage Lenders in the UK

What is a mortgage?

A mortgage is a loan to finance the purchase of a commercial or residential property. Mortgages are generally linked to the income of the borrower and the property is used as security for the loan.

Variable and fixed rate mortgages The mortgage choices available to home-buyers are a variable rate, a fixed rate loan or a discount rate, which offers a discount on the variable rate. Many fixed rate loans and virtually all discounted offers have a sting in the tail in that people are required to remain with the chosen mortgage lender¹s variable rate for some years after the initial deal expires.

• Fixed rate mortgages: fix the monthly interest repayment over a set period of time, regardless of what happens to interest rates. After the end of the fixed rate period, the mortgage cost reverts to the lender's standard variable rate.

• Discount rate mortgages: peg the interest rate to a fixed amount below the variable rate. This offers some protection from the threat of rising interest rates.

Mortgage rates normally follow the base interest rates set by the Bank of England although they don’t have to. Much depends on how successful the mortgage lenders are in attracting fresh savings that they can use to lend out to new borrowers. The intensity of competition in the market for mortgages also dictates whether lenders immediately follow through a Bank of England rate change with alterations in their own lending terms and conditions.



Mortgages – a financial commitment o A mortgage is a secured loan o If you do not keep up with repayments, your

home is at risk o It is compulsory for homeowners to take out

insurance so that they can continue to make repayments if they lose their job

o The Halifax is Britain’s biggest mortgage lender

o Most loans are at variable rates of interest o Interest repayments on the mortgage affect a

household’s “effective” disposable income

Limits to mortgage loans Homebuyers are normally limited to borrowing three times their first income plus half of the second income, or two-and-a-half time’s joint income. Most lenders are prepared to lend 95% of the property's estimated market value but most charge less interest to people who are able to put up a bigger deposit on their property. Anyone who takes out a mortgage worth more than 75% of the house’s market value must also take out insurance to protect the lender against the borrower not paying the mortgage.

Typically first-time buyers in the market take out mortgages that are a higher percentage of the asking price for the property. This is because they have a lower level of accumulated savings.

Table 5: Trends in Mortgage Interest Rates

Annual average Average Mortgage Rate Real Mortgage Rate Base Interest Rate

per cent per cent per cent 1980-84 13.1 4.6 11.4 1985-89 12.6 7.1 11.8 1990-94 10.1 5.9 8.7 1995-99 7.1 4.3 6.3 2000-04 5.3 2.8 4.5

One feature of the UK housing market in the last decade has been greatly increased competition between mortgage lenders including competition from other countries inside the European Union and the opening up of online mortgage finance via the internet. Thousands of existing homeowners have taken advantage of the chance to re-mortgage their properties with a new finance supplier and reduced their monthly repayments at the same time.

Expectations of future price movements and housing demand Expectations of changing prices can have a considerable bearing on the demand for all types of property. Consider this basic question. Should housing to be regarded as a consumer durable that provides a flow of services to the owner over a long period? Or should we think of a house purchase, as one of major investments that we expect will provide us with substantial capital gains? The answer is probably a mix of the two!

Rising prices in the late 1990s and the early years of the new decade has made housing a desirable form of investment.



6. Supply-side factors in the UK Housing Market Supply-side factors are important in setting house price levels at a local and national level. There is a consensus among experts that there is a shortage of good quality housing in the UK which affects the affordability of the market for people on different incomes. Improving the supply of housing without damaging the general environment is one of the most important policy issues that needs to be addressed both now and in the future.

The Need for More Housing Supply Increases in UK house prices are due in part to supply shortages in the market according to the House Builders' Federation (HBF) which revealed that new home building is failing to keep pace with demand. A spokesman for the HBF said: "The country needs 200,000 new homes annually to keep pace with the growth in households. With only 160,000 being built, we have a serious problem."

Adapted from the House Builders’ Federation web site, February 2002

Price Elasticity of Supply of New Housing One feature of the UK housing industry is that the supply of new housing is price inelastic in the short run. This implies that house prices in the short term are determined almost exclusively by demand factors such as income, unemployment and interest rates.

Why is housing supply so inelastic? Several reasons have been put forward for the low price elasticity of supply of housing:

1. Construction companies cannot suddenly plan and then build thousands of new homes in areas when there is an increase in demand. One reason is the existence of planning regulations and other constraints on new housing developments – where local authorities may restrict the building of new property in accordance with their local housing plans. These restrictions includes legislation to protect the green belt.

2. Large increases in house prices do not seem to lead to significant increases in the amount of land made available for housing developments.

3. Supply is also restricted by the limited availability of skilled labour such as bricklayers and electricians and other factor inputs needed in the construction process. These factors, together with time delays in construction projects mean that the supply of newly built properties is limited.

Low elasticity of supply and higher prices

When the price elasticity of supply of new homes is low, then the quantity of housing available for purchase is not responsive to short term changes in price.

So for example a 15 per cent rise in price may lead to only a 3% increase in new housing supply in the first year. Elasticity of supply in this case is +0.2 (a low figure). This low elasticity suggests that rising demand can quickly feed through into higher prices in


Housing Market Economics: Revision Guide 2006 the market.

Price

Quantity

Price

Quantity

Price

Quantity

Price

Quantity

Inelastic Supply Curve

Perfectly elastic housing supply An elastic supply curve for housing

Perfectly inelastic housing supply

D2 D1

P1

D2 D1

SS

P1

P2

Q1 Q2 Q1 Q2

Q1 Q1 Q2

D1

D2 D1 D2

P1

P2

The Supply of Older Housing

The supply of older properties plays a key role in affecting the balance of demand and supply in the housing market. The available supply depends on the number of people putting their homes on the market when they move from an area or from people choosing to upgrade to a more expensive house with a particular area.



Price

Quantity

D2

SRS

P1

Q2

Price

D1

Q1

P2

An Outward Shift in Housing Demand –

Long Run Market Supply is more elastic

An Outward Shift in Housing Demand –

Short Run Market Supply is inelastic

Quantity

SRS

P1

Q2

D1

Q1

P2

D2

LRS

Q3

Often the level of housing supply impacts on property valuations in a highly localised way. Particular areas of a town or city can become hugely popular but if supply is limited, the “pent-up demand” for properties carrying desirable postcodes can send housing values soaring. Conversely when there is a large rise in the market supply of housing we expect to see lower prices for a given level of market demand.

When demand for housing increases perhaps because of an inflow of population into the area, or a rise in incomes following a fall in unemployment, there is upward pressure on market prices.

As supply becomes more elastic over time (shown in the right hand diagram in the figure above) assuming the conditions of demand remain unchanged, we expect to see downward pressure on prices and a further increase in the equilibrium quantity of houses bought and sold.

Factors Affecting New Housing Supply These can be summarised as follows:

• Costs of production for construction companies

o Employment costs (including wages, overtime payments and employer national insurance contributions etc)

o Costs of purchasing land for housing development

o Costs of purchasing building components and raw materials

o Costs associated with achieving the required planning consent from local authorities

• The number of construction companies in the market and their business objectives

• The extent to which the construction industry is able to achieve economies of scale in house building and reduce their constructions costs by implementing innovation in building projects



• Government taxation and subsidy of new housing developments (e.g. grant aid and other forms of public funding for housing developers building properties for key workers / public sector employees and financial support for other forms of social housing)

Price

Quantity

S1

Q1

Price

Quantity

D1

S1

P1

Q1 Q3

P3

D2

Q2

P1

An Outward Shift in Housing Supply An Inward Shift in Housing Supply

S2

P2

A rise in wage costs, land prices and raw material costs would all have the effect of increasing construction costs and cause an inward shift in market supply at each price level

Improvements in building technology, higher labour productivity, the entry of new firms into the industry and lower raw material prices would all lead to an outward shift in the market supply curve

S3

Rising labour costs push up construction costs One of the features of the housing market in 2005 was evidence of a rise in the costs of building new homes. According to building industry sources, the cost of erecting a new home has grown by over forty per cent over the last five years.

Labour costs have risen sharply. This reflects the shortage of skilled or semi-skilled construction workers. Many building firms are relying on migrant workers to overcome labour shortages.

There are skills shortages in the UK construction industry



7. Rented Housing and the Buy-To-Let Boom Currently less than one third of properties in the UK are available for rent from private landlords or from local authorities or housing associations. The size of the rented sector in Britain is below other European countries. But there are signs that the private “buy-to-let” market has partly reversed the long run trend towards greater owner-occupation.

Renting a property

Renting is an alternative to buying. In 2005 the average weekly rent in privately rented property was £113 (3% higher than in 2004). For people living in rented properties made available by registered social landlords (e.g. housing associations) the average weekly rent was £58 and £53 for council tenants living in local authority housing. 65 per cent of people living in council properties are not in the labour force, many are retired. In March 2005, 7 per cent of council rents were in arrears (not paid) which amounted to £438 million of unpaid rents. This figure was higher in London with rent arrears rising to 10 per cent of the total.

The Expansion of Buy-To-Let Schemes

Private letting has been a big growth area

“Buy-to-let” occurs where people purchase properties and then let them out to tenants. This has the effect of increasing the supply of rented properties. There are now more than two and a half million households living in a property rented from a private landlord.

Most buy-to-let property buyers regard it as a financial investment which will generate a flow of rental income from their tenants. Others are in the market in the hope of making capital gains when they sell one or more of the properties in their portfolio, For many landlords, it is their major source of income.

According to research from the Council for Mortgage Lenders, the two biggest factors that might cause buy to let investors to reduce the size of their property portfolios were rents being insufficient to cover the mortgage and secondly, rising interest rates. Many buy to let investors remortgage their existing homes to free up funds to buy and then let out new properties.



Chart 9: The Expansion of Buy-To-Let Mortgages in the UK

Switching to Renting

The increasing cost of houses has meant the number of people renting property has risen over the last 10 years. More than two million households now live in private rental accommodation. The typical rented property is occupied by single adults in their 30s with a high income.

Source: Adapted from news reports, July 2004

What Explains the Growth in Buy-to-Let? The demand for rented properties has increased for a number of economic and social factors:

o Social factors: Social change has played an important role - for example increased job mobility; greater student numbers; graduating students burdened with loans; and the increase of single-person households. Some commentators attribute the recovery in renting down to the appeal of flat and house-sharing like the young professionals in Friends, the successful US television sitcom!

o Financial incentives: Private investors like owning rental homes because they see good returns - from both rental income and capital growth. Over the past decade residential property has returned a higher return that stock market.

o Specialised mortgages: The buy-to-let market has been stimulated by the rise of estate agents dedicated to letting - and lenders keen to provide specialist mortgages. There are now more than 40 banks and building societies that offer buy-to-let money. Big players are Nationwide, Paragon, Bank of Scotland and Britannic Money, among others. Typically, landlords can borrow up to 85 per cent of the value of a home at interest rates of less than 2 per cent over the base interest rate.

Optimists believe that demand for rental property should grow over the long term. Some analysts expect almost 4m new households to be created in the next 20 years - and more than a quarter of these are expected to rent. Obviously the demand for rental properties tends to be greatest among lower income families, students and footloose workers who may have a job in a particular area for only a short length of time. But there are others choosing to rent for lengthy


Housing Market Economics: Revision Guide 2006 periods of time because they want to avoid the ‘boom and bust’ cyclical nature of the private

owner-occupied market.

Meanwhile the supply of new homes being built is limited - helping to keep rent levels high. Other commentators worry that too many amateurs are making too much easy money in buy-to-let property. They are concerned about pressure on rents and the effects of over-supply, especially in London. Inevitably, rising interest rates would choke off property inflation and damage the economics of buy-to-let. Often landlords underestimate the costs of management and repairs and re-lettings.

Average rents in the rental sector like any market depend on the balance between demand and supply. For example when demand from new tenants is greater than available supply, then rents will increase reflecting a relative scarcity of properties available to let.



8. Market Failure in Housing Markets and the allocation of resources

In a free market economic system, scarce resources are allocated through the price mechanism where the preferences and spending decisions of consumers and the supply decisions of businesses come together to determine equilibrium prices.

The free market works through price signals. When demand is high, the potential profit from supplying to a market rises, leading to an expansion in supply (output) to meet rising demand from consumers. Day to day, the free market mechanism is a tremendously powerful device for determining how resources are allocated among competing ends.

Market failure is best described as the failure of free-markets to operate efficiently and equitably leading to a misallocation of resources. When market failure occurs, there is allocative inefficiency i.e. it is possible to make someone better off without making someone else worse off.

Market failure represents a loss of economic welfare because the market is failing to meet people’s changing needs and wants.

In this section of the Study Companion we consider some of the possible causes of market failure in housing and the consequences of these market failures for millions of households.

Many housing market specialists believe that the housing sector in Britain is riddled with imperfections that can seriously damage economic efficiency and equity. Some of these imperfections are summarised below and then developed further in the following section.

• Lack of choice: The poor supply of substitutes to home-ownership which has the effect of limiting consumer choice and flexibility when people search for housing that meets their own specific needs and wants.

• Building delays: Time delays in the building of new houses linked to the complexity of the local authority planning process and national government housing policy – this is contributing to a long-term housing shortage.

• Costs of buying and selling: The high level of transactions costs involved in buying and selling properties – it often takes many weeks for a single housing transaction to take place.

• Asymmetric and imperfect information between buyers and sellers.

• Not making best use of our existing housing stock: The problem of under-utilised housing and homelessness in many towns and cities.

• Disincentives: The problem of labour market disincentives created by people becoming dependent on housing welfare benefits and other housing subsidies.

• Externalities: The externalities involved in home ownership (owning a home can create positive and negative externalities). And also the externalities created through an increase in new housing construction.

• Immobility of labour - in particular the geographical immobility of labour that results from wide regional variations in house prices.

• Lack of affordability in the market – this makes housing unaffordable for many groups and can lead to an inequitable allocation of resources in the economy.


Housing Market Economics: Revision Guide 2006 We now consider some of these housing market failures in more detail

(1) The Problem of Homelessness Measuring the scale of homelessness in the UK is difficult. The official figures from the government for the number of homeless people in priority need for England was 120,000 in 2005 (down from ten years earlier) but the true scale of homelessness is probably much higher than this. The official figures do not include the hidden homeless living in overcrowded conditions. The Shelter web site seeks to represent the needs of the many thousands of people in the UK who live in poor quality housing and those who are homeless.

(2) Unaffordable Housing

The newspapers are full of stories highlighting increases in housing wealth and the boom being enjoyed by millions of home-owners. Does this in fact create an illusion of wealth? Are we all really that much better off as a result of the sharp rise in average house prices in recent years? Or has the recent boom created a growing problem of equity in the housing market which affects people across the social divide?

Trapped in a cycle of poor housing by low affordability

The housing charity Shelter has warned of an affordability crisis in the homes market throughout Britain as mortgage payments rise towards an unsustainably high proportion of average household incomes. Shelter has compiled an affordability index showing that it is becoming increasingly difficult for a household on the average regional income to meet the average mortgage payment for a first-time buyer.

According to Shelter, "An unaffordable housing market puts pressure on the limited supply of social housing and means more people are trapped in emergency housing. So, for the record number of families who are trapped in a cycle of bad housing, the prospect of a decent place to live is fading further into the distance year by year."

Source: Shelter, October 2004, www.shelter.co.uk

According to Shelter and other housing organisations and pressure groups campaigning for changes to Government housing policy, affordable housing is now one of Britain’s most pressing issues. In many areas the shortage of affordable housing has now reached crisis point. Even those on moderate incomes are unable to access housing that they can afford.

This has created many problems including difficulties in attracting key workers to the public services such as education and health because of a combination of low pay and unaffordable house prices and housing costs.

Unaffordable housing means that people are missing out on what is viewed by many as an essential social need – since each £1 of income that people have in the market place is an economic vote – when housing becomes so expensive, effectively thousands of households become disenfranchised from the housing market – it is failing to meet their individual needs.


http://www.shelter.co.uk/


House price boom a sign of market failure not success

Large capital gains on houses are bound to create the perception that the housing market is a source of wealth creation, and there is no doubt that for millions of individuals it has been just that. But for society as a whole the fact that house prices have risen so far is a mark not of success but of failure. The losses are felt by all those millions of people who cannot afford to buy a home or who are constrained by the level of house prices to live in cramped or inadequate accommodation

Adapted from Economic Perspective, by Roger Bootle, Telegraph February 2004

(3) Poor Quality Housing The homelessness figures understate an even bigger problem - millions of people live in housing in poor condition.

The poor quality of much of the housing stock has an effect on the standard of living and quality of life of millions of people. There is evidence that poor housing contributes to a decline in life expectancy and increased incidence of illness. This imposes extra costs on the National Health Service and local authority provided Social Services. To these external costs we might add the impact of poor housing conditions on the educational attainment level of hundreds of thousands of school children.

In short - unfit housing contributes to social exclusion and higher crime and vandalism which generates external costs that all of us must bear. Improving the housing stock is a vital component of the government’s strategy for reducing relative poverty.

Council housing awaiting redevelopment in Walker, Newcastle

In many inner-city areas there are thousands of homes with little or no market value. They are in localities with poor reputations for high crime and vandalism.

Regeneration of these areas is costly but the long term benefits may be important.

Decent homes must meet statutory minimum standards in terms of repair, modern facilities and services and provision of a minimum degree of thermal comfort. In 2003, 31.3% of homes (over 6.7 million) were said to be of a non-decent standard.

(4) Empty Housing Housing is a scarce resource, yet hundreds of thousands of homes are empty at a time when demand is exceeding supply in many parts of the country. Across Great Britain there are around 860,000 empty homes. This is clearly an inefficient use of the available housing stock. This paradox is partly explained by the fact that demand for certain types of property in some areas is low – making it unprofitable for people to rent these properties out or attempt to sell them on the open market

Areas with a high number of empty homes tend to suffer from urban deprivation, higher than average unemployment and lower than average house prices. Urban blight is a structural social and economic problem that needs to be addressed if the issue of empty homes is to be effectively attacked in the years ahead.



Chart 10: Empty Homes

(5) Shortages of good quality and affordable rented properties

Rent

£s

Quantity of Rented Property

Demand

Supply

P max

Q1

Pe

Maximum Price (Rent) Ceiling

Q2

Free Market Equilibrium

Excess Demand

The UK housing sector is short of quality and affordable rented properties which creates problems for people for whom home ownership is not a realistic option but who need to move into new areas to find work. The decline of rented housing was partly the result of rent controls introduced into the market in the 1960s and 1970s – the basic economics of a maximum rent are shown in the figure below. Setting maximum rent levels had the effect of creating a contraction in quantity supplied which eventually lead to a chronic problem of excess demand.


Housing Market Economics: Revision Guide 2006 (6) Housing and Welfare Benefit Dependency

The government pays out huge sums each year to people in housing benefit. Dependency on benefit (which is means tested i.e. linked to people’s financial circumstances) can create disincentives for people to actively look for work which leads to a higher level of frictional and structural unemployment. Persistent poverty remains a major barrier to obtaining good quality housing in Britain. The most economically and socially disadvantaged people in society tend to live in the worst housing.

An Insurmountable Wealth Gap

Children born into families with little or no housing wealth (such as those in areas of low value property or renting) now face an insurmountable housing wealth gap. Poorer families are today more likely to be trapped in low value areas and miss out on the better services, jobs and resulting life-chances that a move to a more prosperous area could bring. Families with housing wealth are also more able to provide vital financial support and security to their children than poorer families.

Source: Adapted from the Shelter campaign, October 2004

(7) Shortages in the Supply of Housing

The chronic shortage of housing in many areas and regions is usually taken as a sign of housing market failure – the symptoms are growing waiting lists for social housing, increasing homelessness and millions of people unable to afford a decent property of their own because of high levels of house price inflation

In the summer of 2003, the Barker Review into the problems of housing supply found that the supply-side of the housing market acted as a constraint to the efficiency of the housing sector. The Barker Review concluded that historically, housing supply in the UK has been unresponsive to changes in price - three times less responsive than in the US and four times less responsive than Germany. The Review found that low levels of house building constrain economic growth, damage the flexibility and performance of the UK economy and reduce living standards for everyone. Persistent regional price differentials also reduce the geographical mobility of labour leading to higher unemployment.

The Barker Review also criticised inefficiencies within the UK house building industry. It characterised the industry as being labour intensive and suffering from low rates of innovation. House builders' aversion to risk meant that they were reluctant to develop on derelict land, and use new building techniques such as prefabricated homes.

Another complaint was that the leading home-builders deliberately restricted new housing supply in order to keep prices and profits high.



Chart 11: New House building

Barker Review criticises the UK house building industry

It is clear that the UK housing market is not working as well as it should. In particular there is a problem of weak supply, with major implications for the UK’s economic well-being and house price volatility. In order to best maximise profits many house builders control production rates and “trickle-out” no more than 100-200 houses per annum from a large development. This may not be desirable from society’s point of view.

Source: Adapted from Interim Housing Review, www.barkerreview.org.uk

What do we mean by housing shortages? Housing shortages are a symptom of excess demand in the housing sector. In other words, the housing market is experiencing disequilibrium. There are different aspects of the current housing shortage, each of which may require some form of government intervention

1. Shortages of affordable properties for sale – particularly in areas when housing demand has been strong leading to a rise in prices – this has created shortages of affordable properties for first time buyers, families on low incomes. Housing supply has proved to be price inelastic in response to rising prices.

2. A shortage of affordable and good quality rented property – again a problem for families on low incomes and for those who need to move to find work. Shortages of rented properties effectively force more people to go into the owner-occupied sector.

3. A long term housing shortage – demand for housing is likely to rise in the longer term due to a mix of economic, social and demographic factors – can the British economy supply sufficient homes to meet this demand? If not, there may be a housing crisis.

The Shortage of Housing and Consumer Welfare

One aspect of the debate about housing shortages is the effect that this has on the economic welfare of consumers and producers. We can make use of supply and demand analysis to look at some of the possible consequences. Consider the diagram below which shows the effects of two housing supply curves S1 and S2. Each supply curve represents a given stock of housing available at a given cost. So S2 is used to illustrate the effects of housing supply being lower than predicted.

The effect of a restricted supply of housing is to force average prices higher than they would otherwise be (assuming a given level of housing demand). Average price levels are P2 rather


http://www.barkerreview.org.uk/

Housing Market Economics: Revision Guide 2006 than P1. How is consumer welfare affected? One measure of welfare is consumer surplus –

defined as the difference between the price that consumers are willing to pay and the price they actually pay. Housing shortages cause prices to be higher and output to be lower. The result is a loss of consumer surplus and a rise in producer surplus going to home-builders.

Price

Quantity

Housing Demand

S2

P2

Q2

P1

Q1

S1 Consumer surplus when prices are at P2

Loss of consumer surplus due to prices rising from P1 to P2

(8) Inefficiency in Housing Transactions and Imperfect Information Over a million properties are bought and sold each year in the UK. But the system of home buying and selling in England and Wales is regarded as one of the slowest in Europe, it causes misery and frustration for many home buyers and sellers, and it leads to many housing transactions falling through even after an offer has been made. It can take around eight weeks to get from offer acceptance to the final exchange of contracts and over a quarter of offers fail after acceptance. The market is clearly not working well in this respect.

Another of the major problems in the housing market is the imperfect information among the buyers and sellers involved in a housing transaction. The would-be buyer of a property rarely has full information on the actual state and condition of the house or flat. The seller may indeed with-hold important information and the estate agency is clearly at risk of over-selling properties and in order to gain commission sales. Many home-owners admit to attempting to cover-over DIY disasters and engaging in short-term DIY projects to cover over cracks in walls and hide damp rather than taking steps to have them repaired!

(9) Housing and the Geographical Immobility of Labour It is widely recognised that the UK housing system impedes the geographical mobility of labour and thereby leads to a reduction in economic efficiency. Steep increases in house prices have led to a sharp rise in the average age at which people enter the housing market and reduced their ability to move to new areas in search of work.

• Large regional differences in house prices

• The shortage of affordable rented properties

• The time delays and high costs involved in buying and selling properties



The Property Trap As house prices rise public sector workers are finding themselves priced out of the market, Thousands of people are expected to leave London over the next decade, driven out by soaring property prices that are making the capital an unaffordable place to live for many people who work there every day. And the exodus is not confined to London. All across the south-east, where house-price inflation is seen as an indicator of a thriving economy, employers are struggling to recruit and retain staff. The most obvious victims are key workers in education, transport, health and the emergency services.

Source: Adapted from newspaper reports in June 2003

(10) Externalities: Is Housing a Merit Good? The issue of whether or not housing can be regarded as a merit good has implications for the type of government intervention in the housing sector that can be justified.

Private sector housing is clearly much closer to a private good because consumption by one person is rival to that of another and exclusion from most of the benefits of owning a specific property is possible (i.e. through the protection of private property rights). The benefits go to the owner or occupier rather than to society as a whole. Moreover, the private housing sector is complex (flats, semi-detached and detached housing, houses of every conceivable size and type and the exercise of individual choice is important to obtain suitable mix of housing attributes and therefore maximise a consumer’s utility.

But other housing might also be regarded as a merit good i.e. a product where the social valuation differs from that of the individual householder. For example a rational individual with a given level of income may choose to consume relatively little housing but society decides certain housing standards must be met and that there is a case for government intervention to ensure that people have access to some affordable properties. Council (social) housing probably falls into this category. The argument is that households on low incomes may be unable to afford a property in the free market and that the state has a duty to provide social housing at a subsidised rate below the free-market price for a particular type of property.

The state encourages consumption of housing through direct subsidy (e.g. housing benefits and subsidised council rents) to bring spending on housing closer to what is perceived to be a social optimum and also on grounds of equity and social need.

The effects of a Subsidy on Rent Levels



Price

Quantity

Demand

S1

P1

Q1

P2

Q2

Supply + Subsidy

P3

Subsidy per unit

A government subsidy encourages an increase in supply at each price level because the subsidy provides a reduction in a firm’s costs of production. The extent of the subsidy per unit is shown by the vertical distance between the two supply curves.

Housing as a merit good – diagram to show the positive externalities

Costs

Benefits

Quantity of Housing

Private Demand

Supply

Demand + External Benefits

Qp Qs

External Benefit

A

B

The Conservative Government in office from 1979 -1997 regarded private home ownership as a merit good in its own right. They sought to increase the demand for private sector properties through the Right to Buy discount scheme for council tenants and by offering mortgage interest


Housing Market Economics: Revision Guide 2006 tax relief to home-buyers. These two schemes provided subsidies for purchasing a home and

had, over a number of years, a big effect on the pattern of housing tenure in the UK with the result that Britain now has one of the highest rates of home-ownership among European Union nations.

Some housing experts regard this strategy as flawed – indeed they argue that financial support for people to buy their own homes is an example of government failure since it has led to a scale of owner-occupation that may be unsustainable in the long run.

(11) The externalities associated with new house building It is now widely recognised that Britain will need to supply hundreds of thousands of new homes over the next twenty years to meet the challenge of changes in population and household size. The Government has announced plans for major housing developments in a selection of areas in the south-east of England. But land for new housing developments must be found throughout the UK. And this poses important questions for the Government because of the environmental costs of new house-building. It has been estimated that over 40,000 additional houses a year are required simply to accommodate population growth and changing patterns of household formation in England alone.

The environmental costs of building new homes include:

• The destruction of some natural habitats, greenfield areas and other open spaces given over to housing developments

• Noise, air and other forms of environmental pollution created by the construction industry and waste and other pollution created by the population moving into a new development

• Increased traffic congestion in areas of new house construction

• Increased pressure on public services and infrastructure arising from an increase in population density in certain areas – for example an increase in policing costs and education and health services

• The impact on property prices of existing homeowners in areas and localities where new house building developments are planned. This effect can be important when the quality of new housing developments is poor – often the result of developments being rushed through in order to reduce a short term housing shortage problem

Set against this are the social consequences of the economy not providing sufficient new properties in both the private and public sector to meet our increasing needs and wants. Without an increase in total housing supply, the problems of housing affordability will get substantially worse. And this will have consequences for younger people and families on low incomes who are already struggling to find decent, affordable housing.



Pressure on scarce land space Oxford is a city with major housing needs. The population has been growing and there is great pressure on land available for commercial and residential property development.

The picture below shows the new Kassam soccer stadium together with a new multiplex leisure facility. What impact would these construction projects have on the local housing market?

Are there negative and positive externalities involved?



9. Government Intervention in Housing By intervening in housing, governments aim to tackle the failure of markets to deliver an efficient and equitable allocation of resources.

Intervention can occur through several channels:

• Taxation – affecting the incentives of consumers and businesses.

• Regulation – for example health and safety legislation and housing planning controls.

• Government subsidies – for example in the form of the provision of social or affordable housing for lower income households.

Although there may be sound reasons for government intervention, the effects of such policies at local, regional and national level cannot be predicted with complete accuracy. And remember too the “law of unintended consequences” (every government policy has at least one unintended effect) – meaning that intervention might actually deepen existing market failures – this is known as government failure and should be borne in mind when considering policies and their stated objectives.

Some free-market economists argue that housing is a industry that is not best suited to intervention – and that people’s needs and wants are best met by allowing greater rein for free-market forces.

Consider some of the following questions:

1. Should the government intervene directly to reduce regional house price variations?

2. Should the government actively seek to encourage the growth of the buy-to-let market and consider other ways of expanding the rented sector of the economy?

3. To what extent and how should the government intervene to ensure that sufficient new homes are built over the next ten years to meet the rising demand for homes?

4. Should the government use fiscal policy measures to control the aggregate demand for housing and therefore limit the growth of house price inflation?

It is important to realise that policies often have less of an effect than is commonly supposed. To what extent for example should the government intervene to guarantee housing for the homeless? Do changes in taxation really have much of an effect on the national market?

In your evaluation of housing policy try to scratch beneath the surface of the question. Consider for example:

• Why is the intervention being proposed?

• Will it work?

• On what assumptions is the policy being based?

• What are the alternatives to a particular policy?

• Are there any negative consequences arising from a particular policy being introduced?

Exam advice: The highest marks on the AS paper on the housing market are for those students who genuinely try to evaluate a particular issue or policy debate.


Housing Market Economics: Revision Guide 2006 Options for Government Intervention in the Housing Sector

Government Legislation and the Housing Industry Some of the more important recent legislative proposals are summarised below:

1980 Housing Act: This gave tenants the “right to buy” their council property at discounted prices. Since the right to buy was introduced in 1980, more than 1.6m homes have been sold. In some parts of London, nearly 30% of former council homes bought under this scheme are now in the hands of private landlords.

2001 Home Buy Scheme The Homebuy scheme enables council tenants as well as others in priority need on local authority waiting lists, to purchase a home on the open market with the help of an interest-free equity loan equal to 25% of the purchase price. The remaining 75% is funded by the applicant through a conventional mortgage and savings. The loan to cover 25% of the purchase price of a home does not involve the purchaser in making monthly payments. It is paid back when the property is sold instead. The amount paid back is 25% of the value of the property at the time it is sold. In view of the fact that house prices tend to be increasing, the amount repayable will generally be greater than the value of the original loan.

One of the aims of Homebuy is to release existing social lettings which can then be re-let to people in housing need. Homebuy is therefore targeted on areas where there is a shortage of social housing.

Intervention through the Tax and Benefits System Housing benefit is paid to low-income households – most of which is paid to people living in rented properties. Over 3 million households are now in receipt of housing benefit. The benefit is means-tested and covers all or part of the rent that households have to pay. The government does not discriminate between private and social rented housing. They leave the benefit recipient to choose which type of rented accommodation they prefer.

The disadvantage of housing benefit is that it contributes to the Poverty Trap – i.e. for low income households in work, earning extra income means that some housing benefit is taken away and this reduces the net rate of pay from working extra hours in a job.

Stamp Duty Stamp duty is a government tax levied on certain legal transactions including the purchase of property. In other words, if you buy a home for more than £60,000, stamp duty is payable.

Table 6: Stamp Duty 1999 2000 2005

Property valued at up to £60,000 0% 0% 0% Property valued at £60,000 - £250,000 1% 1% 1% Property valued at £250,000 - £500,000 2% 2.5% 3% Property valued at £500,000+ 3% 3.5% 4%

Changes in Stamp Duty have also been used by the Chancellor Gordon Brown in an attempt to boost demand for housing in brown-field sites. In the autumn of 2002, Brown scrapped stamp duty on home sales under £150,000 in economically-deprived areas, in an attempt to help blighted inner city areas - and also to give first-time buyers a foot on the ladder in London.

Government subsidies for housing developments Recently the government has introduced subsidies for construction companies looking to develop brownfield sites into new housing developments. This is intended to increase the supply of good quality housing in urban areas and limit the pressure on green-belt land for new housing schemes


Housing Market Economics: Revision Guide 2006 Government subsidies for home improvements

Some subsidies are available for households investing in home improvements designed to reduce energy consumption (e.g. loft insulation)

Government Intervention to reduce the shortage of housing The elasticity of housing supply in the UK is low – one of the lowest in Europe – current government policy is focused on improving the elasticity of supply so that house building is more responsive to changes in market demand

o A loosening of planning restrictions: Relaxation of planning constraints for new housing developments – including relaxation of the greenbelt restrictions. There is no shortage of land in the UK, merely a shortage of land on which it is possible to build new homes.

o Building homes on brownfield sites: Financial incentives for construction companies to build new homes on brownfield sites (e.g. previously developed land) e.g. reclassification of land used for light industry. The funding may meet some of the costs of decontaminating land and reclamation of land space.

o Encouraging self-build schemes: Financial incentives for people wishing to self-build homes – they work out cheaper in the long run and they give people the satisfaction of building a home to their own specification and design.

o Build more social housing: Allowing each local authority (council) greater freedom to borrow money to fund the construction and supply of social housing may help to reverse the collapse in the building of council properties over the last ten to twenty years. Increased funding for the 1,400 housing associations responsible for building and maintaining nearly 3 million homes in the UK is also an option.

o Increased innovation and productivity in housebuilding industry: Encouraging more innovation in the building industry – for example innovations that make it possible to build new homes attractively at higher densities (i.e. more properties per square acre).

o Reducing the number of empty homes – There are several options for this including compulsory purchase orders if owners of properties allow their properties to remain empty and unused for 6 months or more – these properties could then be made available to people on housing waiting lists at sub-market rents.

o Tax breaks for investors willing to make rented properties available at affordable rents.

Demand-side policies: Measures to control housing demand These policies might seek to

o Encourage a slowdown in the growth of demand for housing in the most congested regions – for example by moving some of the major government departments into regions where house prices are lower and land is available more cheaply.

o Regional policy incentives to encourage inward investment into economically depressed regions to promote regional growth, urban regeneration, increase the level of employment and help to curb internal migration within the UK towards London and the South-east.

o Increased government spending on housing renewal in areas of high unemployment so that there is an increased demand for those homes that are available by councils.

o Increase the costs of owning a second home – e.g. by charging higher council tax on second properties. This would be designed to reduce shortages of affordable housing for people living in rural areas where many homes are bought up by weekend users.

o Increased stamp duty on the most expensive houses – reduced stamp duty where there is an excess supply of available housing.



10. Interest Rates and the Housing Market Monetary policy decisions affect the housing market. Control of interest rates is in the hands of the Bank of England. Their job is to set interest rates at a level that will meet the inflation target consumer price inflation of 2.0%.

It is important to remember that the main mortgage lenders set their own mortgage rates in a competitive market. Changes in official interest rates often do feed through to movements in mortgage rates but there is no direct (official) relationship between them.

Chart 12: Interest Rates set by the Bank of England

Percentage, since May 1997 base rates have been set by the Bank of EnglandBase Rate of Interest for the UK

Source: EcoWin

97 98 99 00 01 02 03 04 05 06

Per

cent

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

The levels of base interest rates for the UK since 1997 are shown in the chart above. The Bank of England was given independence in setting interest rates from May 1997 onwards. Interest rates have their own cycle – and there have been three rate cycles in that time.

Generally interest rates have been on a downward trend in recent years. They reached a low of 3.5% during the summer of 2003 before starting to rise again during 2004. The Bank of England decided to cut interest rates by 0.25% in August 2005 to their current level of 4.5% (as of March 2006) – but essentially interest rates have moved only gradually in a very narrow band stretching from 4.0% to 4.75% over the last two years. This stability of interest rates has been an important reason behind a gradual slowdown in the housing boom but avoidance of a full-blown recession in the housing market.

Most economists expect UK official interest rates to move lower at some stage during 2006. The economy has experienced a growth slowdown and unemployment is rising. The Monetary Policy Committee may decide to inject a little extra spending power into the economy by cutting interest rates towards 4%.



11. The Regional Housing Market For many years there has been a large regional divide in house prices which has led to divergences in housing wealth and barriers to the geographical mobility of labour. Economic theory can help to explain some of these regional variations and this is covered in the next section of the Study Companion.

Over the last three or four years there appears to have been a turn around in regional house price inflation

Chart 13: Regional House Prices

Average house prices £s, seasonally adjusted, source: Halifax house price dataA Selection of Regional House Price Averages

Source: EcoWin

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q398 99 00 01 02 03 04 05

GB

P

50000

75000

100000

125000

150000

175000

200000

225000

250000

275000

Greater London

South West

Wales

North of England

South East

The North South Housing Divide Despite the changes apparent during the last two to three years, the regional house price divide will remain with us for many years to come. For example prices in Inner London are almost four times higher than those in County Durham. It is worth remembering however that there are often wide differences in prices within counties and regions as well as between them. As we have said before, the housing market in the UK is highly segmented and highly localised with specific factors affecting local prices which are independent of the picture for a county or region as a whole. There are pockets of high house prices in regions where the average price for the region falls well below the national average.


Housing Market Economics: Revision Guide 2006 Explaining Regional Differences in House Prices

Table 7: Highest and lowest prices by district in the UK in 2005

£s

£s

Kensington and Chelsea 715,023 Rhondda, Cynon, Taff 88,023Westminster 507,899 Sedgefield 84,393Camden 413,579 Easington 83,449Elmbridge 410,644 Barrow-in-Furness 77,345South Bucks 408,011 Pendle 73,924Richmond upon Thames 384,820 Hyndburn 72,189Hammersmith and Fulham 383,515 Blaenau Gwent 69,436Chiltern 381,533 Merthyr Tydfil 68,787Wandsworth 336,833 Kingston upon Hull 66,348Islington 320,530 Burnley 55,707

Source: Office of the Deputy Prime Minister

Any analysis of the regional house price divide must focus on both the demand and supply side of regional housing markets.

Differences in rates of economic growth Growth of output and incomes has been strongest in southern regions in recent years fuelling higher levels of employment and rising real incomes. Manufacturing industry has been in recession and industrial output has a relatively larger share of regional GDP in northern areas compared to the south and south east where services dominate the economy to the extent that nearly 80% of GDP comes from the tertiary sector.

Unemployment rates and employment levels There are differences in unemployment and employment rates across the main regions of the UK. In the South-East the region is close to full-employment and the percentage of the population of working age in paid work is also much higher in the south than in northern regions. This boosts the incomes of households and increases the demand for housing on each step of the housing ladder

Population drift (between and within regions) Population drift occurs when there are movements in population from place to place. People tend to move towards where the better work opportunities and higher earnings are to be found. Greater London for example has seen a sharp rise in prices because of the increased popularity of properties closer to the City. In the last decade, the population of the City of London has expanded by over 50%. And there has also been a ripple effect at work - the cost of housing in many areas of London has become prohibitive so that less desirable localities which may not have been considered previously now attract buyers because of the relative value / purchasing power they offer to potential homebuyers.

In contrast, the areas of the UK that have experienced the largest declines in total population size over the last ten years have all seen house price growth slower than the UK average.

Differences in household Incomes Average per capita incomes vary between regions. In the North East, Wales and Northern Ireland gross household disposable income per capita is less than 90% of the UK average. In contrast in London, the South East and the East Midlands, per capita disposable incomes are well above the UK mean. These disparities in take home income affect the demand-side of regional housing markets.


Housing Market Economics: Revision Guide 2006 Land prices and development costs

The relative scarcity of land in some regions forces up the cost of land purchase for housing developers and this is reflected in the market prices charged for new properties. Land is scarce, and land for residential development is often tightly regulated by local authorities.

Wages in the construction sector Wage levels in the construction industry vary from region to region and these cost differences will impact on price levels. The prices of other inputs used in housing construction can also differ throughout the country.

Differences in House Prices between Edinburgh and Glasgow The average property in Edinburgh now costs 58 per cent more than in Glasgow. The average home in Scotland’s capital is now valued at £134,468, compared with just £84,572 in Glasgow. In Edinburgh, prices have been fuelled by the factors of a booming city economy and a shortage in the supply of housing. Edinburgh’s economy is growing rapidly, which is increasing demand for housing. The attraction of living within the city centre and the closest suburbs is also high because of the difficulty of commuting into the city, which again drives demand. But experts sounded a cautionary note that the growing disparity in property values could lead to longer-term problems for Scotland, including skill shortages and homelessness. Socially there could be problems of people struggling with the affordability of housing and, at the bottom end that is more likely to lead to homelessness as housing rents increase.

The persistent divide in regional house prices is a cause of geographical immobility of labour and frequent media reports on key worker shortages in public services such as education, health and transport cite the lack of affordable housing in London and the South East as a major constraint in delivering the government's targets for improving public services.

Government intervention to affect regional house prices The situation is simply described, there is a fundamental excess demand for housing in a handful of regions (including the South-east, East Anglia and many parts of London and the South West) whereas in less prosperous regions, the main problem is a long-term excess supply of housing.

To what extent should the government intervene in the housing market to achieve a greater degree of regional balance? Will government intervention make much of a difference?

Some economists argue that there are self-equilibrating forces that will reduce the regional divide over time. Their argument is that in areas where house prices have risen to high levels, affordability has declined and so too has demand from first time buyers. As demand for housing falls, price levels will decline - many areas within London are already seeing house price deflation and this can be expected to spread to other regions where affordability is now extremely poor.

In regions where house prices are well below the national average, affordability is good and some rebound in prices is likely partly because there is plenty of scope for price increases, and secondly because of the ripple effect of people selling up in high price regions and seeking to move to areas where prices are lower - the demand for second homes in low-priced regions is increasing.

Other housing economists argue that the regional divide is a structural feature of our housing market and that direct government intervention at local and national level is required to make any significant difference. Examples of such intervention include the following:

(1) Increasing the supply of housing in expensive areas: The argument the solution is to limit the supply of new house building in expensive regions has lost ground in recent years. Excess demand for housing can be partially reduced by relaxing planning controls on new house building in regions where properties


Housing Market Economics: Revision Guide 2006 are in short supply. Clearly this threatens greenbelt land and can cause further environmental

problems in areas where housing density is already high. But options for the government include releasing new land for development (some of which might be covered by existing greenbelt protection) and offering incentives for construction companies to build affordable housing on brownfield sites for example by cutting stamp duty on such properties or reducing / abolishing VAT.

(2) House building programmes in economically depressed regions. Can new homebuilding help to rejuvenate the regional housing markets of areas where prices are significantly below the national average? Surely the problem is already one of excess supply? This argument ignores the demand-side effects of new construction projects in these regions. Increasing the quality of the housing stock in these areas will make regions more attractive for inward investment and inward movements of population. House building creates jobs in many industries and this can have a sizeable positive multiplier effect on incomes and spending.

(3) Active regional policies Regional policy has a role to play in encouraging new investment into less favoured regions by both domestic and international businesses. Tax breaks for new factories and employment creation together with increased spending on education and training in specific areas can act as a spur to greater investment.

In the long run, reducing the regional divide can only seriously be addressed by

(a) Increasing employment opportunities and average incomes in areas where regional house prices are low

(b) Boosting growth in depressed regions and achieving a better balance in growth between regions (for example avoiding excess demand in the South east whilst at the same time there is sizeable excess capacity in regions with high unemployment)

(c) Taking steps to increase the supply of affordable housing across the country – because housing shortages are not simply the preserve of Britain’s most prosperous regions

(d) Increasing the supply of good quality and affordable rented housing to reduce the pressure on people to buy properties

Brownfield Site Housing

In regions and areas where house prices are high and demand outstrips supply, is there a case for government incentives to boost the construction of new homes on brownfield (former industrial) sites?

Or is increasing supply in congested regions not the best long-term strategy?



12. Macroeconomics: Housing and the Economy In this section of the Study Companion, we consider how fluctuations in house prices can affect the components of aggregate demand and also how changes in the housing market feeds through the circular flow of income and spending to influence the rate of growth of real GDP, cost and price inflation and the UK balance of trade in goods and services.

Chart 14: Index of House Prices

average prices per month, £s, source: Halifax plcAverage house prices in the UK

Source: EcoWin

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

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P

25000

50000

75000

100000

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150000

175000

Since the mid 1990s we have seen a sustained rise in the value of housing with acceleration in house price inflation over the period 2000-2004 followed by a slowdown in 2005. In real terms there have been large increases in the market value of properties. This has provided a substantial increase in householder wealth and has supported the growth of consumer spending which itself is the biggest single component of aggregate demand.

Recent Trends in the UK Housing Market In the early 1990s the British housing market experienced a recession leading to a slump in price levels. High interest rates, rising unemployment and a collapse in consumer confidence led to a sharp fall in demand for all types of housing and caused prices to plummet in most areas. The recession was deepest in southern regions where many thousands of homeowners had borrowed heavily to joint the housing market. Prices fell in each year from 1991-1993 leaving over a million and a half people living in dwellings whose market value was less than the mortgage debt on the property – this is known as negative equity.

The UK housing market remained in the doldrums for several years and with it the expectation that house prices could move only in one direction (upwards) was extinguished for good. Home-


Housing Market Economics: Revision Guide 2006 owners, who have started to believe that house prices can only rise, would do well to think

back to the last recession! Mortgage repossessions soared as homeowners found it difficult to service their mortgage interest payments. These repossessions added to the supply of houses on the market, further depressing price levels.

Prices remained static for most of the first half of the 1990s. It was only following a sustained pick-up in the economy from 1996 onwards that the housing sector enjoyed a significant return of housing demand.

Chart 15: Nationwide and Halifax House Price Inflation

Annual percentage change in UK house prices, data is seasonally adjustedUK House Price Inflation

Nationwide House Price Index [ar 12 months] Halifax House Price Index [ar 12 months]Source: EcoWin

Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep00 01 02 03 04 05 06

Perc

ent

0

5

10

15

20

25

30

Nationwide House Price Index

Halifax House Price Index

Since the start of the decade the UK housing market has shown a high level of cyclical volatility. The annual rate of change of prices has remained positive but the rate of inflation has varied from nearly 0% at the start of 2001 to a peak of just under 30% in the autumn of 2002. Generally house prices have been rising at a fast rate although the market slowed down considerably during 2005 before showing signs of recovery in the final months of last year.

Table 8: Focus on the UK housing market Mortgage loan

approvals Private sector housing starts

Nationwide house prices

Halifax house prices

Housing transactions

000s 000s % change % change

000s

2000 1,114 130.7 13.0 9.8 1,431 2001 1,256 136.1 10.5 8.5 1,456 2002 1,404 136.9 19.8 17.4 1,587 2003 1,362 147.4 19.6 22.4 1,344 2004 1,208 162.2 17.4 18.6 1,785 2005 1,207 120.7 - - -



The most recent housing boom What have been the main factors driving house prices higher on the demand side?

Table 9: Macroeconomic indicators and the housing market

Unemployment (LFS Measure)

Real Disposable Income

Real GDP Mortgage Interest Rate

000s % of income % change %2000 1638.0 4.8 4.0 6.82001 1431.0 4.2 2.2 6.02002 1533.0 1.7 2.0 5.02003 1476.0 2.8 2.5 4.72004 1426.0 2.1 3.2 5.02005 1.7

The strength of demand and prices in the housing market is the result of a number of factors.

1. Falling unemployment – unemployment in the UK has been on a downward trend for some years and the reductions from 2000-2004 helped to boost the number of people able to finance a mortgage.

2. A period when real disposable income has increased – the economy has been growing and real incomes have increased as a result.

3. Historically low mortgage interest rates and apparently a greater willingness among the main mortgage lenders to loan out an increasing ratio of people’s incomes when funding a home purchase.

4. A high level of speculative demand – built on the expectations that property prices will continue rising – this includes a strong speculative demand from overseas.

5. The effects of the boom in the buy-to-let market. What have been the main factors driving house prices higher on the supply-side?

1. Scarcity: Continued shortages of good quality existing properties on the market

2. Low level of new housebuilding – housing supply has proved to be remarkably slow to respond to the demand for properties – i.e. there is a low price elasticity of supply for housing. Table 8 provides some data on the number of new private sector housing starts. In 2005, the number of new starts was just 120,000, the lowest rate for some years.

3. Rising wage costs in the construction industry – not least because of shortages of skilled labour especially in regions of very low unemployment

4. Rising land prices – which clearly affects the costs of developing land for new residential construction projects



House Prices and National Income Housing in Britain takes up a significant share of national output and spending. The output of the construction sector accounts for about 7% of gross domestic product and recent estimates suggest that nearly 15% of aggregate demand is linked directly to the housing industry. Fluctuations in the growth in the housing sector have important effects on the business cycle and can influence other key variables such as unemployment, inflation and the balance of payments. We now consider some of the most important transmission mechanisms between the housing market and the broader economy

Chart 16: Index of Construction Sector Production

Index of output, Constant Prices, Seasonally AdjustedValue Added in the UK Construction Industry

Source: EcoWin

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

2002

=100

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House prices form the main part of personal wealth. Household wealth is the sum of financial assets (such as cash in the bank, direct equity holdings, life assurance and pension funds) and non-financial assets less outstanding debt (e.g. mortgage debt). When prices are rising, this leads to a rise in consumer confidence and a willingness to spend on “big-ticket” goods and services.

Who wants to be a millionaire?

The number of millionaires in the UK has nearly doubled since 2001. The Centre for Economics and Business Research said soaring house prices had led to a surge in the number of people with assets worth more than £1m in the past decade. The CEBR defines household wealth as the total value of people's property, investments and other assets, minus any borrowings they have such as a mortgage. Unsurprisingly, given the impact of property prices on household wealth, the highest concentration of people with assets worth seven figures is in London. The group estimates that 175,000 or 41% of the country's millionaires live in the capital, where they account for 5.5% of all households.

Source: Centre for Economics and Business Research www.cebr.co.uk


http://www.cebr.co.uk/

Housing Market Economics: Revision Guide 2006 Mortgage Equity Withdrawal

Many mortgage lenders allow homeowners to borrow some of the capital gain (or equity) that has built up from their ownership of property.

Housing equity = the current market value of a property minus the value of the mortgage debt

Example

You purchased a property in 1998 for £80,000 using a mortgage of £73,000. By the end of 2000, the market value of the property has grown to £100,000. You still owe £73,000 on your mortgage. But you now have (£100,000 - £73,000) £27,000 worth of equity in your property.

The mortgage lender may allow you to borrow some of this money by taking out a housing equity loan. Say that you decide to borrow £5,000 to finance some home improvements or to pay for an overseas holiday or a family wedding. This loan is added to your existing mortgage (you now owe £78,000). This borrowing is known as mortgage equity withdrawal and it can add considerably to total consumer demand in the economy.

Chart 17: Mortgage Equity Withdrawal

Mortgage Equity Withdrawal in Recent Years The housing market is a key mechanism through which monetary policy operates in the UK. An important aspect is consumers’ willingness to draw on their housing equity for consumption purposes. This is known as mortgage equity withdrawal (MEW) and is measured as the difference between changes in mortgage lending and in housing investment.

Borrowing secured on rising house prices has been a major factor driving household spending higher! The majority of households use MEW funds for spending on big-ticket items, such as kitchens, bathrooms, and household appliances. Many of these are imported from overseas so there is a strong link between mortgage equity withdrawal and the trade deficit in goods between the UK and the rest of the world. About one quarter of equity withdrawal is used to fund home improvements and a third is used to finance the purchase of a second property.

However, not all this borrowing is used for consumption. For example, a proportion will be “last-time movers” as elderly people sell properties to move into nursing-related accommodation or finance a move to the warmer climate of Spain and Portugal. The release of equity in these circumstances is unlikely to boost aggregate consumption.


Housing Market Economics: Revision Guide 2006 The level of housing equity borrowing reached a peak in 2003 but has since slowed down – a

reflection of the general slowdown in the housing market but also a reflection of an awareness of homeowners of the risks of borrowing too much against the market value of their properties.

The Housing Market and the Savings Ratio Rising house prices can contribute to an increase in consumer confidence and borrowing secured on the value of property. The result is an increase in consumer spending independent of the level of disposable income. Borrowing to finance spending is counted as dis-saving and the surge in house prices in the late 1990s and the first five years new decade has contributed to a fall in the household savings ratio. The savings ratio measures the percentage of disposable income that is spent rather than saved. During the last recession, the savings ratio climbed to over 10% of income and remained high for several years. One reason for this was the depressed level of house prices and high level of housing debt. People were saving partly to repay borrowing during the previous boom. There was a sharp decline in the savings ratio from 1998 onwards as consumer confidence recovered and the latest boom in the UK housing market encouraged a sharp rise in secured lending.

Housing and Related Industries The volume of housing transactions measures the number of houses bought and sold each year. Think about the industries and businesses that stand to gain from an increase in the volume of houses bought and sold. These are industries that are complementary to the housing sector

• Estate agents and furniture removal companies

• Home furnishing retailers

• Solicitors and housing surveyors

• Local newspapers (carrying adverts for homes on the market)

• Builders, plumbers, electricians and others providing household services

• Carpet and kitchen manufacturers

When the housing market is strong we see a high demand for these complementary services. When the housing market is in a slowdown, demand for new furniture, kitchens, double-glazing tends to dip.

The Construction Industry Output, employment and profits for the building sector are closely linked to the growth of demand for new properties. When demand for new houses is rising, the building sector is looking to buy up land earmarked for development and build houses to meet this demand. An increase in the output of the construction industry adds directly to UK Gross Domestic Product. Over recent years both the residential and commercial construction industry has enjoyed boom conditions.

Housing and Aggregate Demand In the diagram below we use the linear SRAS curve as part of our analysis



General Price Level

Real National Income

AD1

SRAS1

P1

Y1

LRAS

Yfc

P2

Y2

AD2

SRAS2

P3

A housing boom may cause aggregate demand to shift out from AD1 to AD2 taking the economy beyond the level of potential GDP – this creates a positive output gap (i.e. excess demand) which puts upward pressure on costs, leading to a shift in SRAS and a rise in the general price level

The extent to which a boom in the housing market leads to rising growth depends on the elasticity of aggregate supply. When real national output is below potential (i.e. there is a negative output gap) then rising prices and an increase in housing market activity provides a cyclical boost to demand, output and incomes.

However if AD is growing faster than the normal rate the economy can sustain, then aggregate supply becomes inelastic. In this situation the trade off between economic growth and inflation worsens, more of a rise in aggregate demand feeds through to higher prices rather than an expansion of output. This is illustrated by a shift in the AD curve from AD1 to AD2 in the diagram above.



Real National Income

AD1

SRAS1

P1

LRAS

P2

P3

AD2

AD3

A housing boom causes an outward shift of AD causing an expansion of short run aggregate supply, a rise in real national output and an increase in the general price level. A deep housing recession would lead to a fall in AD from AD1 to AD3 (other factors remaining constant). AD1 – AD3 is an inward shift of AD causing a contraction of short run aggregate supply, a fall in real national output and a decrease in the general price level

Y1 Y2 Yfc Y3

General Price Level

The multiplier effects from investment in new housing

New Housing ProjectNew Housing Project Higher EmploymentHigher Employment

Rising IncomesRising Incomes

Higher ConsumptionHigher Consumption

Local EconomyLocal Economy

Housing DemandHousing Demand

Local House PricesLocal House Prices

We should remember the possible multiplier effects of a rise in demand in the housing industry. Consider a decision by a leading house-builder to construct 500 new houses in a local town. This investment in the local housing sector adds directly to the incomes of people working



House Prices and Inflation and indirectly cause a rise in inflation? The evidence of the

t of Housing on the Consumer Price Index ion measures. The main items

Higher house prices typically mean higher estate agents’ fees, and these also show up directly

mission mechanism of a rise in housing

for the house-builder together with the people working in other businesses further down the supply chain. Other businesses stand to gain from the housing transactions that will take place as these properties are bought on the open market. The incomes generated add to spending power in the local economy and if local house prices rise because of increased demand, there may be a general (positive) wealth effect for other people whose houses are not currently on the market.

Can rising house prices directlyhousing boom in the late 1980s is a definite yes! The sharp rise in house prices helped to fuel an unsustainable consumer boom that caused aggregate demand to grow too quickly. This led to a rise in demand-pull inflation together with a huge increase in the UK trade deficit with other countries.

The Direct EffecRising property values feed through directly into official inflatincluded under housing in the consumer price index are

• Rent levels and Mortgage interest payments

• Council tax and rates, water and other charges

• Repairs and other maintenance charges

• Do-it-yourself materials

• Household insurance and ground rents

in inflation figures. More generally, rising house prices boost household wealth and consumer spending and so might contribute to a rise in inflation.

The indirect effects on inflation relate back to the transdemand on aggregate demand and the output gap but also on costs and prices in the construction sector. For example a boom in house-building would put upward pressure on land prices, architect’s fees and higher wage costs in the construction industry. These would feed through into a rise in cost-push inflationary forces.



Chart 18: Housing and Consumer Price Inflation

Annual percentage change in the UK Consumer Price Index, the inflation target is 2%Consumer Price Inflation for the UK

Consumer Prices, All items [ar 12 months] House Prices, Halifax, UK, SA [ar 12 months]Source: EcoWin

98 99 00 01 02 03 04 05

Perc

ent

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

House price inflation

Inflation target = 2%

Chart 24 tracks monthly movement in house price inflation and consumer price inflation for the UK since 1998. The main feature of the data is the stability of inflation over recent years contrasted with the much higher rate of growth of house prices. The evidence is that the surge in UK house prices has not led to a pick up in inflation that would threaten the Bank of England’s ability to meet the government’s inflation target. Although rising housing wealth has been a key factor fuelling consumer demand, other factors have helped to keep general price inflation in check. These factors include:

• The strength of the sterling exchange rate against other currencies including the recent surge in the value of sterling against the US dollar

• Weakness in global commodity prices leading to reduced cost-push inflation

• Increased competition in many product markets partly as the result of the opening up of markets to new suppliers and regulatory control of the main utility industries such as electricity, gas and telecommunications

• The deflationary effects of globalisation and continued low inflation in the major economies of the world

The result is that the Bank of England has been able to keep interest rates at historically low levels despite the pressures from the housing market

The Bank of England does not have a specific target for house prices and nor can the decisions of the Monetary Policy Committee have any direct effect on the prices of different properties. Instead the Bank looks closely at what is happening to house prices as part of its overall assessment of economic conditions. It believes that too rapid a rise in property prices can lead to distortions in the economy - for example an excessive or risk surge in consumer borrowing.


Housing Market Economics: Revision Guide 2006 Equally a deep recession in the housing market could easily bring into focus the risks of a

deflationary downturn. So it seeks to set interest rates at a level where the rate of house price inflation is more moderate - a cooling down of the market rather than allowing it to tip into a slump.

Housing and the Balance of Payments Chart 19: Housing & the UK Balance of Trade in Goods

Annual percentage change in UK house prices and monthly trade balance in goodsUK House Price Inflation and the Balance of Trade in Goods

House Prices, Nationwide, United Kingdom, all properties, Index [ar 12 months] Trade Balance, Total trade in goods, GBPSource: EcoWin

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct00 01 02 03 04 05 06

GBP

(bill

ions

)

-6

-5

-4

-3

-2

-1

0

Monthly Balance of Trade in Goods (£ billion)

Perc

ent

0.05.0

10.015.020.025.030.0

Nationwide House Price Inflation (%)

During a housing boom, consumer confidence and rising wealth together with equity withdrawal leads to an increase in the growth of consumer demand. Because British consumers have a high marginal propensity to import because of a high income elasticity of demand for imports the result is a widening of the trade balance in goods because of a strong demand for overseas products. Strong evidence for this is shown in the chart above.

Housing and Unemployment Does the structure of the British housing market contribute to unemployment? Economist Professor Andrew Oswald has argued that it causes higher unemployment by impeding the mobility of labour. The basis of the Oswald argument is that our housing market makes it expensive to change location. One of the weaknesses of the British housing system according to Oswald is the limited availability of rented property available for people who need housing on a temporary basis when moving between jobs or fulfilling short-term contracts in different parts of the country. He believes that the rented housing sector is an important instrument for maintaining a high degree of geographical mobility. In a recent article on the issue, he wrote:

Oswald also believes that

• The UK housing system works to the particular disadvantage of younger workers many of whom are effectively priced out of the housing market altogether



• The housing system increases the demand for commuting leading to higher levels of road congestion which adds to costs and prices and damages business competitiveness

• The housing system discourages entrepreneurial behaviour – not least because of the costs and delays in achieving planning permission to set up businesses in new properties. And why should someone invest £150,000 creating a new business whose rate of return is highly uncertain, when that money will (until recently) have almost guaranteed a very high yield simply by being thrown into property?

Interest rates and homeowners Chart 20: House Price Inflation and Interest Rates

Annual percentage change in UK house prices, data is seasonally adjustedUK House Price Inflation and Interest Rates

United Kingdom, Policy Rates, Base Rate Nationwide House Price Index [ar 12 months]Source: EcoWin

Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep00 01 02 03 04 05 06

Per

cent

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0

Base interest rates (per cent)

Nationwide House Price Index

Rising interest rates should have the effect of reducing demand for many different types of housing. The Bank of England tends to move interest rates in a series of small changes – normally it changes them by 0.25% at a time. Such a change only has a small impact on mortgage servicing costs. For a £100,000 mortgage, monthly payments on a repayment mortgage will only rise by about £15. This will have little direct impact on the housing market. However, interest rate changes also affect the costs of borrowing through credit cards and bank overdrafts. With overall household debt already at high levels, any increase in rates can lead to difficulties in meeting each of the different forms of debt. In addition, there is the impact on consumer confidence as households anticipate a period of higher interest rates

Difficulties in Forecasting House Price Movements There are difficulties in making accurate forecasts of future movements in UK house prices

• The main problem lies in forecasting in which direction the macro-economy as a whole will go – in particular what is likely to happen to interest rates and unemployment.



Many of the key macroeconomic variables which impact on the housing market are volatile – good examples include consumer and business confidence

• The British economy is an open economy, meaning that a large and rising share of our national output is exported or subject to international competition from imports. Our financial markets are also open which makes the UK vulnerable to global economic shocks affecting the volume of trade in goods and services and the level of overseas capital investment. The housing market can be affected by unexpected fluctuations in our overseas trade performance (affecting both jobs and incomes) together with the speculative demand for properties from overseas investors.

• The national housing market is really something of a misnomer. Trends in average house prices are dependent on what is happening in thousands of local markets and in different regions. Economic variables impact differently on each region (for example a change in interest rates or the exchange rates has an asymmetric effect on demand, output and incomes in each of the main regions of the economy)

• There are inherent problems in forecasting the amount of speculative behaviour in the market both from domestic and international property buyers and sellers.

Forecasting the future for the housing market It is difficult to predict what will happen next to the UK housing market. There are big differences of opinion between economic analysts and other commentators on what will happen.

It is widely assumed that house prices are now over-valued – because of the excess demand, prices have soared beyond their long-run fundamental equilibrium level. Clearly, with house prices over-valued, there is a danger that a loss of confidence could trigger a market recession. But so long as UK interest rates stay low, as is generally expected, the probability of a full housing market crash is fairly low. The market slowed down in 2005 but did not go into a recession – this is known as a “soft landing”.

The optimistic scenario for the housing market is based on the following: 1. Prices: affordability is less of a problem now because of lower interest rates. The high

demand for housing is a natural reaction to an economy adjusting to permanently lower interest rates. But price increases will naturally level off – rising prices will cause a contraction of demand but no recession.

2. The economy – the general macroeconomic background for the UK remains benign – low unemployment, stable and sustainable economic growth and rising real incomes will keep confidence and expectations positive – a recovery is expected in the global economy – and this will help the UK housing market in 2006.

3. Investing for retirement: Many more people are now prepared to buy into the housing market as a means of investing for their retirement. This will give the housing market a higher level of demand in the years ahead.

4. More supply - an increase in housing supply will help to relieve housing shortages in the medium term making prices more affordable in the most expensive areas.

5. Interest rates - the Bank of England has the flexibility to cut interest rates in the event of a fall in house prices and the government could use some stimulatory fiscal policy measures to boost demand in the market (e.g. relaxation of stamp duty).

The pessimistic scenario for the housing market is based on the following: 1. Too much speculation: Housing has become too much of a financial asset rather than

a durable good – people have lost sight of what housing should provide for people and the speculators are making prices too volatile.



2. Squeezed out of the market - Housing affordability has worsened and the number of first-time buyers has shrunk – they are the life-blood of the market – if they disappear, demand will dry up.

3. Bye-bye to buy to let boom - The buy-to-let boom will eventually come to an end and many of these investors – not in the market for the long term – will seek to sell their properties to release the equity and move their wealth away from property into stocks, bonds etc – this will increase housing supply and cause a fall in prices.

4. Fears of higher inflation and higher interest rates - Interest rates will have to rise and they may rise more than the financial markets are expecting – the Bank of England will eventually have to choose between house prices and inflation – it cannot allow its policy dilemma to persist for much longer. The very high level of oil prices is a factor suggesting that inflation may return to the UK.

5. Unemployment and confidence: During 2005 the level of UK unemployment started to pick up partly because of a slower rate of growth of GDP. If the increase in unemployment gets any worse, then confidence will seep away from the housing market and prices may start to fall. Once prices are falling, people may try to sell their properties to avoid make a loss on their investments

Chart 21: Hometrack House Price Survey

£sUK House Prices, Hometrack, overall national average price

Source: EcoWin

Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep01 02 03 04 05 06

GBP

110000

120000

130000

140000

150000

160000

170000



13. Current Government Housing Policy What is housing policy? Housing policy is any government action, legislation or economic policies which have a direct or indirect effect on

1. The supply of housing

2. The level of and rate of growth of house prices

3. Tax policies affecting house purchase

4. Housing standards in both the owner-occupied and rental sector

5. Patterns of housing tenure

Government policy towards home-ownership now tends towards being neutral. The main focus of Labour’s housing policy at the moment is to increase the supply of affordable housing in key shortage areas and to take steps to reduce the looming “housing crisis” prompted by estimates that the UK will need an extra four million homes over the next twenty years.

Is There A Looming Housing Crisis in Britain? Over the last 30 years the number of households has increased by 30% while the level of house-building fell by 50%.

In 2004, even at the peak of the housing cycle, 150,000 new homes were provided. Yet the ageing and growing population means household growth is at 189,000 per year (about the same level as in the eighties).The Barker Review said that the market is not sufficiently responding to housing demand and that as a result house price increases are the highest in Europe.

We face growing housing demand with an increasing number of people living alone relative to previous decades and others marrying later in life. Single person households, according to the latest household projections, will account for 67% of household growth between the years 2001-2021.

By the year 2026 only three out of ten of today's ten year olds will be able to afford to buy a home when they have families of their own if we stick with current building rates.

Source: Office of the Deputy Prime Minister Statement of Housing Policy, December 2005

According to the National Housing Federation, increasing prosperity and high land costs are combining to throttle the supply of affordable housing. Housing is needed for people in acute housing need and with limited income, but also for key public sector and service industry workers, to maintain the social infrastructure.

Policy Measures to Counteract Housing Shortages A range of initiatives and targets have been introduced by the Government

• The Starter Homes Initiative – this is a £250 million scheme involving £10,000 equity loans designed to aid up to 10,000 key workers, particularly nurses, teachers and the police, to buy homes in urban and rural areas where high prices would otherwise prevent them from living in or near to the communities they serve

• The HomeBuy scheme which starts in 2006 will enable social tenants, key workers and other first time buyers to buy a share of a home and get a first step on the housing ladder.

• Targets for new social and private sector housing developments on brown field sites. Increasingly, new buildings are being constructed on land that has previously been



developed. The percentage of new housing developments taking place on brown field land rose from 55 per cent in 1989 to 61 per cent in 2004.

• Release of green-field sites for “sustainable” new housing developments – new growth areas are located in the "Milton Keynes quadrangle" of Bedford, Milton Keynes, Corby and Northampton; the London-Stansted/Cambridge M11 corridor; Ashford in Kent; and the "East Thames Gateway", including east London, north Kent and south Essex. It is inevitable that these proposed schemes have met with vociferous local opposition.

• Plans for new housing regeneration schemes in the North of England and other areas of below average economic prosperity

• Measures to reduce the scale of vacant dwellings – the current housing vacancy rate in the UK is just under 4 per cent

• Encouraging part-ownership and part-rental housing schemes which allow housing associations to take a stake in the private housing sector and lower-income households to take their first steps on the housing ladder

• Reductions in value added tax on new social housing developments.

• The government is trying to encourage home-builders to construct a wider range of housing, and not focus too much on large houses which have only one or two inhabitants. New houses are being built bigger. In 1971 15 per cent of new houses had only one bedroom and 7 per cent had more then four. In 2002-03 only 6 per cent had one bedroom and 34 per cent had more than four.

Rural housing shortage is now critical warns report Lack of land, "Nimbyism", and planning laws are causing rural social housing shortages and increased homelessness, housing associations are warning. The National Housing Federation (NHF) says that the situation is now critical. Rural house prices are rising but there has been a fall in the number of new affordable homes being built. And from 1999-2003 the proportion of homeless households in rural areas increased by 24%. The federation wants VAT to be reduced to 5% for refurbishment of empty rural houses and for surplus government land to be used for social housing. It is also recommending that more rural people be given key worker status and for the right to buy social housing to be restricted.

The NHF acute shortage of affordable housing is a threat to the prosperity and existence of rural communities and market towns.

Source: National Housing Federation, January 2006

The Barker Review – Weaknesses in the UK Housing Industry

Volatility and rising house price trend are costly to the economy and to households

Housing supply is unresponsive and inflexible

Land supply is constrained by planning issues

Inadequate supply of social housing as an alternative to home ownership


http://www.housingcorp.gov.uk/resources/hrc.htm


14. Housing Glossary

Asset A financial asset is a store of wealth and which can rise or fall in value.

Asymmetric information

Asymmetric information occurs when somebody knows more than somebody else. Such asymmetric information can make it difficult for the two people to do business together and is a common feature of the housing market where the buyer nearly always knows less about the property than the seller. This kind of information asymmetry result in inefficiencies and market failure

Bank of England The Bank of England is the UK’s central bank. Originally founded in 1694, it was recognized as the central banknote issuer in the UK in 1844. The bank plays a key role in the fight to keep inflation under control. The Treasury sets the inflation target (currently CPI inflation of 2.0%) and the Bank of England has operational responsibility for setting interest rates to achieve those aims. Interest rates are set by the Monetary Policy Committee which meets each month.

Barker Review The Barker Review was a review of housing supply published by Economist Kate Barker in March 2004. The report concluded that the long-term upward trend in real house prices in the UK had created problems of affordability. In addition, the volatility of the housing market has exacerbated problems of macroeconomic instability and has had an adverse effect on economic growth. To improve macroeconomic stability and deliver greater affordability for individuals a lower trend in house prices is desirable

Building Society A building society is a mutual organisation owned by its members - its savers and borrowers - and not by shareholders. Its traditional purpose was to lend money to individuals to purchase or re-mortgage their homes. In recent years many building societies have de-mutualised and opted to become public limited companies (plcs).

Buy to Let A rapidly expanding market in the UK housing sector where private sector agents purchase properties on the open market and then offer them for rent. The buy to let market has boosted housing demand in recent years and had a large effect on the supply side of the private rented sector

Capital gain When an asset rises in value leading to a profit for the asset’s holder

Consumer confidence

The state of consumer confidence or pessimism – a key factor influencing the demand for housing and also demand for consumption on goods and services

Consumer durables

A consumer durable provides a flow of services to its owner over a period of time without being used up – housing can be regarded as a durable good – it provides private benefits to the occupier. Other items include audio-visual equipment and furniture.

Consumer spending

Consumer spending on goods and services which now accounts for over 65% of aggregate demand in the British economy

Cross-Price Elasticity of Demand (CPeD)

The responsiveness of demand for good X following a change in the price of a related good Y. An application to the housing market would be the effect on the demand for owner-occupied property of a change in average rent levels (assuming that rented housing is a substitute for home-ownership).The CPeD for two substitutes is positive whereas the cross elasticity for complementary goods is negative. The most important relationships in housing are between close substitutes e.g. owning a house versus renting, but also between housing and all other expenditures



Economic cycle Regular fluctuations in the rate of growth of real national output, employment and incomes. There is some evidence that the volatility of the UK housing market over the last twenty years has amplified our cycle and perhaps made the UK economy less convergent than other economies within the European Union

Equity withdrawal Secured lending by homeowners who decide to borrow some of the equity from their property. Equity is the difference between the current market value of a property and the outstanding mortgage debt.

First Time Buyers (FTBs)

New entrants to the housing market. Typically FTBs must borrow a greater percentage of the asking price for a particular property. They are the group most exposed to a decrease in housing affordability.

Fixed Rate Mortgages

A mortgage where the rate of interest payable on the loan is fixed for a specific period of time – often between 3 and 5 years. A fixed rate mortgage takes away some of the uncertainty as to how much a homeowner will have to pay each month and they have become increasingly popular in the UK

Geographical Immobility of Labour

Barriers to the mobility of labour between different locations – several factors limit geographical mobility including family and social ties, the cost of moving home and regional differences in house prices

Government Failure

Government failure occurs when government intervention designed to correct for market imperfections actually leads to a deepening of existing market failures leading to a further loss of economic and social welfare and efficiency

Homelessness A term to cover people who do not have formal and secure shelter. Estimates as to the true scale of homelessness vary – Shelter are the acknowledged experts on the problem of homelessness in Britain

House Price Surveys

Organisations such as the Halifax Bank of Scotland (HBOS) together with building societies such as the Nationwide and Northern Rock produce monthly house price statistics. Other regular sources of information on the state of the housing market include the website Hometrack, Barclays Bank and the Royal Institution of Chartered Surveyors (RICS)

Householder Developments

Householder development is a term used to describe the process of making a planning application to develop your property. Common examples include applications for people converting lofts, adding extra floors and finding other ways of creating added space without buying a new home. The huge rise in house prices has made it very expensive for people to move home and make small movements up the housing ladder. This has encouraged a trend towards improving rather than moving home.

Housing Association

Housing associations are independent, not-for-profit landlords. They help to meet housing need by providing decent, affordable homes to people on low and moderate incomes

Housing Benefit A means-tested welfare benefit which provides financial assistance to low income households that covers some of the cost of their rented accommodation

Housing Chain A housing chain refers to the chain of buyers and sellers involved in each house move. First time buyers are chain-free as they don't have to sell anything.

Housing Supply Housing supply is usually defined either in terms of the numbers of units of housing available in local, regional and national markets or in terms of the value of the housing stock. In any given time period the supply of housing stock available is determined by the number of home demolitions, the rate or new home conversions and the level of new home completions



The housing stock adjusts slowly over time and this makes demand side factors more important in determining price levels. One reason is that new home building is normally a very small proportion of the total stock

Housing Tenure Housing tenure is the right or legal arrangement people have to occupy a house. There are four main groups of housing tenure in the UK. Owner-Occupation; private rented property, council rented property and housing made available through Registered Social Landlords

Income Constraint An income constraint represents a barrier to a person or family being able to afford a particular property. This is because most properties are bought using a mortgage and there are limits to how much mortgage lenders are prepared to loan out to homebuyers. This is linked to the idea of housing affordability.

Income Elasticity of Demand

The responsiveness of demand for a product to a change in consumer’s real incomes. Latest empirical evidence for the UK finds that the income elasticity of demand for housing is quite high suggesting that housing demand is sensitive to the macroeconomic cycle and changes in real incomes

Inflation Target The Government sets an inflation target for the independent Bank of England to reach. The current target is for consumer price inflation of 2%

Interest only Mortgage

An interest only mortgage is a housing loan in which you pay no more than the interest charged. In effect, you are merely servicing the debt, not reducing it. The amount you owe on the mortgage remains constant. If you have an interest only mortgage, the onus is on the homebuyer to arrange how to repay the capital at the end of the mortgage term. Most borrowers with these types of loan take out some kind of long-term savings plan such as an endowment policy.

Local Authority Housing

Housing provided directly by local councils – the vast majority of which is made available for rent from council tenants

Market Failure Imperfections in the workings of the free market which leads to a mis-allocation of resources and a loss of economic efficiency. There are many potential causes of market failure which might then provide a justification for some form of government intervention

Maximum Price A maximum price is a legally imposed price ceiling in a market. Buyers and sellers cannot legally agree a price that exceeds a maximum price. To have any effect on a market, a maximum price must be set below the normal free-market equilibrium price. The end result is often an excess of demand over supply.

Merit Goods Goods and services which are perceived to deliver external benefits and which might be under-consumed by the free market. Many economists regard the problem of under-consumption as resulting from information failures in the market – for example a failure of private agents (e.g. consumers) to value correctly the benefit they might receive from purchasing and consuming a product

Migration The movement of population from one area to another – migration can take place across localities, regions and countries

Monetary Policy The use of changes in short term interest rates to affect both the level and pattern of economic activity

Mortgage Interest Rate

The rate of interest on a mortgage at a fixed or variable rate



Negative Equity A situation where the market value of a property falls below the outstanding mortgage debt – in the last recession over 1.5 million households suffered from negative equity because of the collapse in market prices

Nominal Interest Rate

The money rate of interest on a loan. The real rate of interest adjusts the nominal rate using a measure of inflation

Normal Goods Goods that have a positive income elasticity of demand. Most goods are ‘normal’ goods – i.e. if income (Y) increases the demand for the good increases. Many are “superior” goods – i.e. if income increases by 1% demand increases by more than 1%. Some are inferior – as income increases, demand declines. Income elasticity of demand has a particular importance in the housing market

North-South Divide A term that attempts to capture large scale regional differences in house prices, incomes, unemployment and other economic indicators between predominantly northern regions in the UK and their southern counterparts. The term is often criticised as being too simplistic. There are often even bigger disparities in income and wealth levels within rather than between regions

Owner-occupiers Households that have purchased their own property. The majority will still have some outstanding mortgage debt to repay but others will have bought their own properties out-right

Planning Controls Regulations that allow local authorities to control new housing developments and changes to existing properties – often seen as a factor reducing the price elasticity of housing supply in local markets

Population Density Population density is defined as the total population divided by surface area – changes in density may reflect net movements of population which themselves impact on housing demand

Price Elasticity of Demand

Responsiveness of demand following a change in the good’s own price

Price Elasticity of Supply

Price elasticity of supply (Pes) measures the relationship between change in quantity supplied and a change in price. If supply is inelastic, firms find it hard to change production in a given time period

Price Premium The extra price that a homebuyer is willing and able to pay for a property because of special factors affecting demand. For example, there is growing evidence that the exam performance and reputation of local state schools in a local area can have a significant effect on the price that young families are willing to pay to buy a property.

Real Interest Rate The money rate of interest adjusted for price inflation

Real Mortgage Rate

The real mortgage rate is the money rate of interest on a mortgage adjusted for the effects of inflation. So for example if the rate of interest on a housing loan is 7% in money terms. And the rate of general price inflation is 3%, then the real rate of interest on the mortgage is + 4%.



Registered Social Landlords

RSLs is an umbrella term to describe organisations that provide housing on a “not for profit” basis – mainly for people on low incomes. These include Housing Associations, tenant groups, friendly societies, various housing trusts and also organisations such as the YMCA. RSLs operate in-between the public and private housing sectors. They account for about 5% of total housing provision, but this is likely to increase in future years. The Government is keen for RSLs to be at the forefront of the drive to provide good quality and affordable social housing in areas where there are major housing shortages and where sky-high prices have made housing unaffordable for households on modest incomes

Rent Controls Maximum prices introduced into the market for rented housing in the 1960s and 1970s which had the effect of reducing the supply of privately rented property available in the UK over the long term

Repossessions Properties taken back from the purchaser by the lender because the purchaser has fallen behind on repayments

Reservation Price The reservation price for a property is the minimum price that they are prepared to accept from a potential buyer.

Stamp Duty Stamp duty was first levied in the UK in 1694. Stamp duty is payable on documents which transfer ownership of an asset (e.g. on the sale of a house or disposal of shares). It is also payable on the grant of a lease.

Starter Property Typically a lower priced and smaller-sized property bought by first-time buyers who are taking their first steps on the housing market ladder

Tastes and Preferences

Changing tastes and preferences have an important effect on housing demand. Different household types demand different dwelling types, locations, levels of security of tenure. For example: compare young single people with the elderly.

Trading Up Trading up occurs when homebuyers attempt to move up the housing ladder to larger and often more expensive properties. For example, a young couple may sell their starter home (a two bedroom terraced property) and seek to buy a three bedroom semi-detached house. The ease with which trading up can occur depends on the differentials between house prices in different segments of the market. And also the amount of equity and financial savings that a household has. Typically, trading up involves taking out a larger mortgage loan.

Wealth Effect As people get wealthier, they consume more. This positive wealth effect has important consequences for monetary policy decisions since higher consumption can increase demand pull inflationary pressure in the economy. Falling house prices create a negative wealth effect and can increase the risk of a recession



15. Useful Internet Resources on Housing Association of Residential Lettings Agents www.arla.co.uk/index.htm

Barker Review into Housing Supply www.barkerreview.org.uk

BBCi Property http://www.bbc.co.uk/homes/property/

Building Societies Association http://www.bsa.org.uk/

Council for Mortgage Lenders www.cml.org.uk

Economist Magazine www.economist.com

Empty Homes Agency www.emptyhomes.com/

Federation of Master Builders www.fmb.org.uk/

Government Housing Policy www.odpm.gov.uk

Guardian Special on Housing Market http://money.guardian.co.uk/houseprices/0,1456,,00.html

Halifax Bank of Scotland (Economic Research) www.hbosplc.com/economy/home.asp

House Builders Federation www.hbf.co.uk

House Price Crash www.housepricecrash.co.uk/

Land Registry www.landreg.gov.uk see also property prices www.landreg.gov.uk/propertyprice/

National Association of Estate Agents www.naea.co.uk

National Housing Federation www.housing.org.uk/information/aboutus/index.asp

Right Move www.rightmove.co.uk/rm/s/rm

Shelter http://england.shelter.org.uk/home/index.cfm/setcountry/true/

Up My Street www.upmystreet.co.uk

Woolwich Building Society www.woolwich.co.uk/

Your Mortgage www.yourmortgage.co.uk/index.htm

Useful housing market articles on the Internet

• Background on Buy to Let http://www.arla.co.uk/btl/

• Campaign to Protect Rural England http://www.cpre.org.uk/campaigns/planning/is-there-a-housing-shortage.htm

• Finding an affordable home (BBC Business) http://news.bbc.co.uk/1/hi/business/3257313.stm

• Guide to the Mortgage Maze http://news.bbc.co.uk/1/hi/business/480121.stm

• How to add value to your home http://news.bbc.co.uk/1/hi/business/3239543.stm

• In-depth report on mortgages and housing http://news.bbc.co.uk/1/hi/in_depth/business/mortgages/default.stm

• Land Registry Property Prices http://www.landreg.gov.uk/propertyprice/interactive/

• The Times Property News http://property.timesonline.co.uk/


http://www.arla.co.uk/index.htm

http://www.barkerreview.org.uk/

http://www.bbc.co.uk/homes/property/

http://www.bsa.org.uk/

http://www.cml.org.uk/

http://www.economist.com/

http://www.emptyhomes.com/

http://www.fmb.org.uk/

http://www.odpm.gov.uk/

http://money.guardian.co.uk/houseprices/0,1456,,00.html

http://www.hbosplc.com/economy/home.asp

http://www.hbf.co.uk/

http://www.housepricecrash.co.uk/

http://www.landreg.gov.uk/

http://www.landreg.gov.uk/propertyprice/

http://www.naea.co.uk/

http://www.housing.org.uk/information/aboutus/index.asp

http://www.rightmove.co.uk/rm/s/rm

http://england.shelter.org.uk/home/index.cfm/setcountry/true/

http://www.upmystreet.co.uk/

http://www.woolwich.co.uk/

http://www.yourmortgage.co.uk/index.htm

http://www.arla.co.uk/btl/

http://www.cpre.org.uk/campaigns/planning/is-there-a-housing-shortage.htm

http://www.cpre.org.uk/campaigns/planning/is-there-a-housing-shortage.htm

http://news.bbc.co.uk/1/hi/business/3257313.stm



http://news.bbc.co.uk/1/hi/in_depth/business/mortgages/default.stm

http://www.landreg.gov.uk/propertyprice/interactive/

http://property.timesonline.co.uk/

housing market economics - freewebs.com market economics 2006.pdf · 1970, over 30% of the housing...

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