In the past 15 years, house prices in the UK have risen much faster than general inflation, and real incomes. The rise in house prices have confounded many industry experts, who have been predicting house price falls for several years.
Economic Reasons for House Price Rises include:
1. Long period of economic expansion.
Economic growth has been close to the long run trend rate of 2.5% for 15 years. This has increased incomes and confidence in the economy. However, it explains only part of the increase; this is because prices have risen much faster than incomes.
2. Low Real Interest Rates.
This is the nominal interest rate minus inflation. Since leaving the ERM in 1992 real interest rates have been very low. Interest rates fell as low as 3.5% in 2005. Since the bank of England was made independent people expect both lower inflation and consequently lower interest rates. Interest rates increase by only 0.25% at a time. This creates more stability for homeowners. Interest rates are much lower than pre 1992. This has been a significant factor in increasing demand for houses, especially in UK where most mortgages have variable interest rates.
3. Increasing number of households.
Demographic factors have increased the number of households (by a faster rate than the population). These include:
- Increase in divorce Rate.
- Marriage rates declining
- Aging population - more single old people.
- Immigration - has helped to boost population, especially in London.
4. Increase in Number of People buying second homes.
In London many houses are being bought by foreigners, for example, Russians and Arabs.
5. Increased availability of Mortgages.
The ratio of house prices to incomes has increased. Banks have sought to lend larger amounts than before. They have introduced new types of mortgages such as interest only, 50 year mortgages; banks have also relaxed lending criteria making it easier to borrow higher salary multiples.
6. Buy To Let Market.
This is the sector of the market where people buy a house and rent it out. The buy to let market has been buoyant because of rising rents. Buy to let buyers hope to get both income and capital gains. This sector of the market is more susceptible to speculation. This means people are buying houses in the hope of making capital gains.
7. Fundamental shortage of Supply.
The fundamental reason for rising house prices is the underlying shortage of supply. Demand has been increasing faster than supply. 1960s houses are being knocked down, and the number of new houses being built is at an all time low. There are many restrictions on building new houses. This is unlikely to be solved in the near future.