Houses are expensive and getting more so every day. Lots of people are renting because they are priced out of homeownership. But this trend towards renting affects home prices. And households buying their first (or a new) home affect the rental markets.
Why are these prices so unpredictable? How are housing prices set, anyway? And why are they set so high that nobody can afford them? To protect your home investment and be an informed renter or homeowner, you need to know:
- how the UK housing market got where it's at today
- how prices are determined, and which factors affect housing prices
- why we're seeing fluctuations in the housing market
- possible effects these fluctuations might have on you
Supply, Demand and the Market
For now, let's set aside the owner and renter labels. Let's all be consumers to look at how prices are set. Prices for everything, not just housing. You don't have to be an economics major or have studied economics to understand this; it's all very simple.
Conventional economics states that the law of supply and demand determines (housing) prices. Somebody has a house for sale, needs a house, agrees on a price, and everything balances out. Now, let's broaden the scope to imagine a market, crowded and noisy, with everyone there either wanting to buy or sell a house.
If there are more buyers than sellers, sellers can raise their prices until the buyers all lose interest. Conversely, if there are more sellers than buyers, the sellers will have to lower their costs because the buyers might get a better deal from another seller. In other words, if supply exceeds demand, prices go down; if the inverse is true, prices go up. That's the law of supply and demand.
Adam Smith, the Father of Modern Economics, proposed this imaginary marketplace. He attached many conditions to his market, among them that buyers and sellers would act in rational self-interest. He also insulated his market; his vision allowed for no external influence or interference, which there is. We'll talk about variables that influence the (housing) market in the next segment; let's talk about another economic concept.
Value-based pricing is a strategy sellers use to get buyers to pay as much as possible. Often, sellers of a particular good or service - property or a type of food- will decide among themselves what price range they'll set. For instance, all the landlords in a particular district will agree not to rent for less than a specified amount to eliminate market competition. Or all the breakfast cereal makers will negotiate their pricing amongst themselves and raise prices in tandem so that none is much cheaper than the other.
As Adam Smith laid out, people act in their 'rational self-interest'; it's rational for the seller to try to make as much money as they can. Theoretically, sellers' self-interest should balance against buyers' self-interest. Buyers want to hold on to as much money as possible. But if all the sellers agree to charge as much as possible, buyers don't have a lot of options.
And if it's for something they must have, like food or a place to live, they will have no choice but to pay whatever price is set. This strategy is also called 'charging what the market will bear'. It works for two reasons. First, people must have shelter and food; second, some buyers have more wealth than others.
Adam Smith avoided speculating on wealth distribution. In his 'free market', sellers were ethical, and everyone was presumably equal in status and wealth. But what happens when there are so many wealthy buyers that the less affluent are shut out? What happens when sellers set prices so only the rich can afford them?
None of this says that the law of supply and demand doesn't apply to today's (housing) markets. But the current needs cater to those who've enjoyed long economic growth. So much so that they can afford to continue growing their wealth by investing in scarce resources. Housing is a resource that everyone needs, but increasingly, fewer have access to.
What Causes Housing Market Fluctuations?
When sellers and buyers strike their deals, everyone is happy, and the market is in equilibrium. But then there are times when no buyers can make it to the market, so the sellers have nobody to sell to. Or maybe there's a typhoon, and all of their stock is ruined. What if there was a global pandemic and everyone wanted to hang onto their cash because they're uncertain about the future?
These are all variables that can cause (housing) markets to fluctuate. Flooding, fires and other disasters reduce the housing stock, making what's left dearer and more sought after. In the months after the 2008 financial meltdown, nobody was in the market for anything. Furthermore, many found that they suddenly owed more on their properties than it was worth.
That's when investors swooped in, buying lots of houses for pennies on the dollar. These mainly were investment firms and hedge fund groups looking to grow their portfolios. Adding a scarce resource such as property immeasurably boosted their bottom lines. Now, these firms rent those properties out at increasingly higher prices.
Whether anyone can afford those rents is immaterial. Merely owning the properties lets these investors grow their wealth. Their ownership keeps the property market stable and rising. Governments, keen on economic stability and growth, institute policies favourable to those initiatives. Those policies have shaped our current housing market.
Housing Market Fluctuations in the UK
We've experienced all those variables' effects over the past 20 years. They have caused fluctuations in our housing prices. But we can't lay all our current woes on the variables' effects. Now, it's time to add consumers - buyers and renters to the mix.
When property values hold steady, homeowners feel confident in their financial security; they believe their wealth will continue to grow. They might consider adding to their property or trading into a bigger, more excellent home. They might borrow against their equity to afford other investments. Each of these conditions has a different effect on the economy.
Let's say a household just had their property appraised, which returned a higher-than-expected value. The headlines keep saying how hot the property market is, so they want to jump in with all feet. They might even make a profit when they sell. So they join the large pool of buyers, all vying for a limited supply of houses.
In economic terms, demand is up, and supply is down; thus, housing prices rise. That's been the trend for the past eight years. But now, inflation - rising prices on everything, is causing uncertainty. Homeowners are again turning cagey; they want to hang on to their cash. Not surprisingly, recent reports show a corresponding dip in housing prices.
The Effects of Housing Market Fluctuations on Homeowners and Renters
Adam Smith posited markets and market actors' presumed rationality. He also declared that markets tend to self-correct. He wasn't wrong, save for the 'invisible hand' idea, even if such a hand makes for lovely imagery.
On the surface, it appears that housing prices and the cost of renting work independently. Let's say that house prices in a particular area have increased. Yet rents have remained relatively stable, perhaps because that area has a lot of subsidised housing. The difference between the two sets of prices is called the rent-to-price ratio.
This ratio may point to needed changes in the housing market. Homebuyers' willingness to spend, measured against renters' willingness to pay, can indicate that properties for sale in a particular area are overpriced. Comparing the two sets of figures can be a helpful indicator. Among other conditions, this ratio may signal a housing bubble.
These bubbles shouldn't be alarming. They happen all the time as markets correct themselves. Bubbles are preferred to crashes, times when markets can no longer balance themselves.
Rents help keep housing values in check. Rental rates do not 'spike' the way housing prices might. They do not vary widely across a region. So pegging home prices to rental rates makes a lot of sense. But this idea brings an unintended consequence.
As demand for rental property goes up, so do the prices. Having less of a supply of rentals also means the prices climb. And rentals typically feature in cities - close to jobs and shops. That makes them even more desirable.
This quality is one of the biggest challenges to building more affordable housing. During the Thatcher era, many council home dwellers gave the government up on their offer to buy homes. That reduced the amount of rental property on the market while increasing homeownership. We now need more affordable housing, both for rent and purchase.
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