Using supply and demand analysis identify the main factors in determining the price of private housing in the UK
Supply and demand analysis allow us to investigate and understand the operation of markets, or sometimes the failure of markets. Using supply and demand analysis, identify the main factors in determining the price of private housing in the UK. Support your analysis with the use of supply and demand graphs.
Task 1 (50 marks)
As of August 2019, the average UK house price was £235,000, an increase of 1.3% from the previous year 2018 and an increase of 28.5% from the average house price of £167, 716 in 2013. As figure 1 below shows, house prices in the UK have generally been on the rise since 2005, contracting sharply in 2009 before rising again. While there have been periods of stagnation, the general trend has been increased house prices in general, which has culminated in the highest ever average house prices in the UK at £234,853 as of August 2019 (ONS 2019).
Figure 1: Average UK House Prices 2006-2018
The rise and fall of house prices in the UK reflect supply and demand factors such as economic growth, consumer confidence, or planning restrictions that have impacted supply of new housing as will be looked at shortly.
1.1 Demand Side Factors That Affect House Prices In UK
1.1.1 Interest free mortgages
First launched in 2013, the ‘help-to-buy’ program, which is aimed at first time home buyers has been a major growth opportunity for the housing development industry (Kollowe 2019). According to the ‘help-to-buy’ program, first time home buyers are provided with interest-free loans by the UK government as a way to boost demand and affordability (Collinson 2017). Since its launch up to March 2019, 221,405 properties were sold through help to buy equity loan, with a £12.46 billion worth of equity loans (Ministry of Housing, Communities & Local Government 2019). During the period, first time home buyers bought properties 179,816 properties, making 81% of total home purchases. The figure below illustrates the total number of homes purchased under the scheme between 2014-2019.
Figure 2: Total number of homes purchased under the scheme between 2014-2019
Source: MHCLG 2019
As shown by the figure above, the number of houses bought under the scheme has been growing steadily. The number of properties purchased under the scheme in England totaled 52,404 in the year ending 31 March 2019, up by 9% compared to the year ending March 2018. Homes purchased in London totaled 6,115 in the same period, up by 30%. Interest free mortgages have grown house demand in the UK, boosting the private housing sector in UK.
Nevertheless, while the introduction of the program shifted the demand curve for private housing to the right, it was an imbalanced shift since analysts have since noted that more than half of Britain’s households which benefit from the Help-to-buy program have household incomes above £40,000 meaning it has not benefited middle to low income earners especially under 35 demographics who instead have resorted to renting as shown in figure below;
Figure 3: Change in tenure among low to middle income households aged under-35: UK 1997-98/2013-14
A lot of the explanation for the decline in the affordability in home ownership and subsequent rise in the private rented sector is primarily an issue of supply and limited availability of housing stocks as will be looked at later.
1.1.2 Population growth 2001-2019
The UK population has grown from 57.4million in 1991 to the current 66.4 million as of 2018. An important factor that can contribute to a rise in demand is growth in the number of consumers as a result of a growing population. Such demographic changes can be a result of new birth rates, increased life expectancy as well as an increase in net immigration (Krugman et al 2013).
Figure 4: Population growth increases demand
It is not just the growth in population that increases demand for housing but also other nuanced demographic changes. For instance, the increase in single-parent families and the growing number of single people living alone has increased demand for houses. Such demographics partly explain why three times as many 35-44-year olds rented privately in 2016-17 than 20 years ago, a 70% increase from 331,000 households in 1996-97 to 1.1 million in 2016-17 (MHCLG 2017).
1.1.3 Economic Growth / Real income 2001-2019
In 1977, the cost of home ownership was on average three times the median household income, but by 2013, home ownership cost was 10.5 times median household incomes, making home ownership three times as expensive as in 1977.
Figure 5: Ratio of UK house prices to household incomes, 1997-2013
Source: CSI 2016
Discounting the recent role of Brexit, it does seem to show that household incomes have failed to match house prices over the years, a decline in purchasing power.
More recently, Brexit has played a key role in the private housing market becoming stagnant especially in the South East and London. According to a PWC report (2019), GDP growth will be held back by slow household spending growth, and weak business investment as a result of Brexit uncertainty. In case of a hard Brexit, GDP could shrink further by as much as 8% and lead to an increase in both the unemployment rate and inflation (Statista 2018). Brexit uncertainties, inflation and low household real income have already put off buyers, reducing private housing demand.
1.1.4 Consumer confidence
Due to the uncertainty over Brexit, consumer confidence in the UK has been low. In fact, Woodhouse (2018) noted that consumer outlook for the general economic situation has declined. Consumer expectations for personal finances over the coming 12 months have also fallen by 3 points to 5, while the savings index dropped by 4 points. As Britons remain under pressure from weak wage growth and high inflation, consumer spending growth is very likely to remain on the low (Pattington 2018). Changes in consumer confidence are correspondent with changes in consumer spending, hence if consumers are less confident about the economic outlook, they will spend less on private housing, resulting in low demand.
1.1.5 Interest rates
Interest rates play a significant role when it comes to determining the cost of mortgage interest payments. Consequently, changes in the base interest rates will affect mortgage interest payments, which in turn will affect peoples’ ability to pay for private housing hence playing a key role in affordability. Since mortgage payments take up a big percentage of disposable income when it comes house purchases, changes in interest rate will consequently alter monthly mortgage payments, thus altering demand (MHCLG 2018). Higher interest rates will thus deter people from taking on mortgages thus reducing demand. However, in the UK, interest rates have been kept low and are likely to remain low due to Brexit uncertainty (BBC 2019; Chen 2019). In fact, the bank of England has not changed the interest rate since August 2018, staying at 0.75% as shown below.
Figure 6: UK interest rates 2009- 2019
Nevertheless, despite the low interest rates and lower cost of borrowing for houses, affordability issues have kept demand suppressed.
1.2 Supply Side Factors That Affect House Prices In UK
A key tenant of the UK housing sector is the extremely short supply of houses on the market compared to demand. Because house prices reflect demand and supply factors, one can pinpoint some of the supply side factors affecting house prices.
1.2.1 Number of private housing being built
According to current statistics, there is currently a backlog of 4.75 million households in need of housing across Great Britain (4 million in England). By housing need, data is referring to households that are currently facing affordability issues, homelessness, overcrowded living, and those living in unsuitable housing (Bramley 2018). As figure below shows, the serious shortage of private housing being built has created a backlog that isn’t being met new housebuilding, leading to expensive house prices for both owners and renters.
Figure 7: Backlog of housing need in Great Britain
With the latest government statistics showing New housing being built in the UK annually has fallen behind new housebuilding requirements as shown in the following figures. The UK is in need of 380,000 new builds annually but only 173,660 new build dwellings were completed in the year to June 2019, and while it was an increase of 8 per cent compared to the year to June 2018, demand still exceeds supply (MHCLG 2019b). Further, of these new builds, 75% or 131, 200 were private enterprise builds, which shows that private housing builds are not enough to meet national demand at the current rate.
The result has been demand growing faster than supply as demonstrated in figure below;
Figure 8: The result has been demand growing faster than supply
The consequences have been most felt by younger Britons. Those aged between 16 to 34 currently account for just 10 per cent of homeowners in the UK, having nearly halved since 1998 from 57 per cent in 1998 to just 25 per cent (Canocchi 2016). In comparison, over 45s make up three quarters of all homeowners. The result is that levels of private renting have more than doubled, from 22 per cent to 53 per cent as shown in figure below;
Figure 9: Change in tenure among low to middle income households aged under-35: UK 1997-98 2013-14
1.2.2 Planning restrictions
Part of the reason why elasticity of supply of new house builds is low is due to stringent planning restrictions especially on green belts. In fact, UK has a lot of land but much of it is off limits to new builds. If government allows new housing developments across land that’s currently restricted, it should increase the number of private housing suppliers, which should shift new build supply from left to right as shown in figure below and thus decrease the pressure on house prices hence stimulating demand;
Figure 13: Impact of planning restrictions on supply elasticity
Task 2 (40 marks)
Identify and explain the main government/ economic policies that can be used to stimulate the demand for private housing in the UK.
In economics, there are generally certain principle factors that can shift the demand curve for products or services. Some of them include changes in income, changes in tastes or preferences etc. Governments also have economic instruments or policies they can use to stimulate demand. In the case of private housing, the UK government can use the following policies.
Reduce interest rates
By reducing interest rates, the government will boost demand for private housing demand because the lower the interest rates are, the lower the cost of borrowing to pay for a house is, and the more consumers are able to afford to borrow to buy a house. Due to the low interest rates, most builders benefited from affordable mortgages which encouraged more Britons to buy houses (Kollowe 2019). Such incentives by the UK government have potential to grow demand for private housing in the country.
Stamp duty land tax is (SDLT) is a tax paid by buyers purchasing residential property in England and Northern Ireland that costs more than £125,000. It ranges between 2-12% of the purchase price of a property. It is also paid on any additional property bought costing more than £40,000 such as buy-to-let or a second home, which also attract a further 3% levy. At the moment, first time buyers pay zero rates up to a purchase value of £300,000 (GOV.UK).
However, UK government can stimulate demand for more private housing purchases by reversing stamp duty and the extra surcharges levied on properties on both the lower end of the market (under £500,000) as well as the top end of the market (above £1m).
Research by Vyomm, a London prime property portal, showed that a reversal of stamp duties could stimulate demand by enticing more buyers, especially second homeowners and property investors, back into prime and super prime markets which have seen a decline in demand as a result of the greater financial cost of buying and Brexit uncertainty (Shilling 2019). Introduction of stamp duty taxes in London saw a slowdown in transaction activity after a stamp duty was introduced in 2014. Boris Johnson has already vowed to eliminate stamp duty on properties under £500,000, a move that would significantly stimulate demand especially among those looking to get onto the property ladder.
Relax planning permissions e.g. allow building on green belts
According to the analysis, UK’s planning system is one of the major causes of the affordability crisis, especially in London and the South East one of the reasons that have resulted in low demand. In order to increase private house demand, the government should introduce planning reforms that will ensure availability of more housing land and maximize the potential in cities and towns for new homes. According to Wilson (2019), relaxing house building regulations such as making planning permission easier to obtain, would act as an incentive for private housing.
Several analysts believe that, most of the new buildings are most likely to be carried out by the private sector, a reason why UK government should put in effort to stimulate house-building by focusing on planning measures in order to make the system more open and accessible which will help tackle unnecessary delays. The UK government also introduced The New Home scheme which is aimed at encouraging local authorities to grant planning permissions for the building of new houses in return for additional revenue.
Tax incentives such as tax-free mortgages are very important in stimulating house demand. In order to increase home ownership in the UK especially among first time buyers, the government came up with supportive measures through saving products such as the Help to Buy ISA and Lifetime ISA, and also through equity loan schemes (Wilson 2019). This was aimed at increasing private housing demand. Since its launch, over 221,405 properties have been sold through help to buy equity loan, with a £12.46 billion worth of equity loans with first time buyers making 81% of all purchases, buying 179,816 properties ((Ministry of Housing, Communities & Local Government 2019).
Bramley, Glen (2018) “Housing supply requirements across Great Britain: for low-income households and homeless people” National Housing Federation [Online] at https://www.crisis.org.uk/media/239700/crisis_housing_supply_requirements_across_great_britain_2018.pdf
Chan Szu Ping (2019) “Bank of England forecasts low interest rates for longer” BBC News [Online] at https://www.bbc.com/news/business-49752883
Centre for Social Investigation (2016) “Are we facing a crisis in the affordability of private renting? [Online] at http://csi.nuff.ox.ac.uk/?p=412
Collinson Patrick (2017) “Help to buy has mostly helped house builders boost profits” The Guardian [Online] at https://www.theguardian.com/money/blog/2017/oct/21/help-to-buy-property-new-build-price-rise
GOV.UK (2019) “Stamp Duty Land Tax” [Online] at https://www.gov.uk/stamp-duty-land-tax/residential-property-rates
Hilber Christian (2015) “UK Housing and Planning Policies: the evidence from economic research” Election Economics, paper EA033.
Kollewe Julia (2019) “Barratt posts record £910m profit despite tough housing market” The Guardian [Online] at https://www.theguardian.com/business/2019/sep/04/barratt-posts-record-910m-profit-despite-tough-housing-market
Krugman, P., Wells, R., & Graddy, K. (2013) “Essentials of Economics” 3rd ed., Worth Publishers
MHCLG (2017) “English Housing Survey: Private rented sector, 2016-17” Ministry of Housing, Communities & Local Government [Online] at https://www.gov.uk/government/statistics/english-housing-survey-2016-to-2017-private-rented-sector
MHCLG (2018) “Analysis of the determinants of house price changes” Ministry of Housing, Communities & Local Government [Online] at https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/699846/OFF_SEN_Ad_Hoc_SFR_House_prices_v_PDF.pdf
MHCLG (2019b) “House building; new build dwellings, England: June Quarter
2019” [Online] at https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/835887/House_Building_Release_June_2019.pdf
ONS (2019) “Index of Private Housing Rental Prices, UK: September 2019” [Online] at https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/august2019
ONS (2019b) “UK House Price Index: January 2017” [Online] at https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/indexofprivatehousingrentalprices/september2019
Partington, R., (2018) “UK economy heading for worst year since crash, say economists” The Guardian [Online] at https://www.theguardian.com/business/2018/oct/14/uk-economy-heading-for-worst-year-since-financial-crash-economists-ey-item-club-no-deal-brexit
PWC (2019) “UK economic outlook” [Online] at https://www.pwc.co.uk/economic-services/ukeo/ukeo-july2019.pdf
Shilling, Conor (2019) “Boris Johnson's stamp duty plans could revive prime property market” Estate Agent Today [Online] at https://www.estateagenttoday.co.uk/breaking-news/2019/7/boris-johnsons-stamp-duty-plans-could-revive-prime-property-market?source=trending
Statista (2018) “Gross domestic product (GDP) year-on-year growth in the United Kingdom (UK) from 2000 to 2018” [Online] at https://www.statista.com/statistics/281734/gdp-growth-in-the-united-kingdom-uk/
Wilson Wendy (2019) “Stimulating housing supply - Government initiatives (England)” House of Commons Library; Briefing Paper, Number 06416.
Woodhouse, A., (2018). “UK consumer confidence drops as Brexit nears” Financial Times [Online] at https://www.ft.com/content/5cad83c6-c2b8-11e8-95b1-d36dfef1b89a
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