House prices fall where there is a decline in demand and/or excess supply. The main factors that cause a fall in house prices involve:
- Rising interest rates (making mortgage payments more expensive)
- Economic recession / high unemployment (reducing demand and causing home repossessions).
- Fall in bank lending and fall in availability of mortgages (making it difficult to buy).
- Fall in confidence/expectations of future house prices.
- Changing demographics. (less demand, e.g. net migration)
- An excess of supply in the housing market.
- Fall in market rents making it less attractive to buy to let.
Supply and demand diagram
Interest rates
Interest rates are very significant to the housing market. An increase in interest rates will increase the cost of variable mortgage interest payments. Those on a fixed mortgage may be insulated from higher mortgage payments in the short-term, but over time – even fixed-rate mortgages – will become more expensive.
In the late 1980s, interest rates were increased to 15%. This caused a significant rise in mortgage payments. With mortgage payments taking over 50% of disposable income it led to mortgage delinquencies and so people sold houses and demand fell. In 2006, interest rates rose to a more modest level, but people had taken out more risky mortgages.
Interest rates are also very important for buy to let investors. Low-interest rates mean that mortgage payments will be cheaper than rentable income. So a rise in interest rates will provide an incentive to sell.
To highlight the importance of interest rates on house prices, In a recent paper by the Bank of England, Miles and Monro calculate that:
“Over time, a 1 per cent rise in real interest rates from their present level would push real house prices down by nearly 20 per cent.”
See AlsoThe 16 Most Popular Home ImprovementsJust How Important Is a Bathtub for Resale?These Paint Colors Can Boost Your Home's ValueIs a walk in shower considered a full bath?Bank of England Staff Working Paper No. 837, Dec. 2020,
Recession
In a recession, unemployment rises, incomes fall and consumers lack the confidence to make a big investment in the housing market. There is a strong correlation between a period of recession and falling housing prices.
House prices fell in the recessions of 1990-92 and 2008-09
Preceding the recession, house prices had risen much faster than inflation and wages. It meant in the preceding years, house price to incomes ratios had increased. The recession caused a ‘correction’ in these house price to incomes ratios. For example, in the boom years, buy to let landlords may buy houses to try and make capital gains. But, in a recession, sell because house prices are falling. UK House price affordability
Fall in bank lending
The 2009 recession had an additional element – banks were short of liquidity and so cut back on bank lending. It became harder to get a mortgage and even though homeowners wished to take out a mortgage and low-interest rates, banks were unwilling to lend and tightened their lending criteria significantly
Tax rises
A small change in stamp duty or other forms of tax on homes would increase the cost of buying a house and making it less attractive to buy. There are proposals to increase taxes on second homes – making the buy to let property less attractive.
Excess supply of housing
If there was a boom in home building, then any fall in demand would be liable to cause a significant fall in house prices.
It is worth contrasting the experience of the UK and Ireland after the financial crash of 2008. Post-2008, the fall in UK house prices (20%) was quite mild compared to other countries.
For example, Ireland saw a real collapse in house prices (-50%). The Irish house price collapse follows a similar pattern to the UK – banking crisis causing a shortage of finance. Recession causing unemployment and falling demand. However, in addition, Ireland had a real boom in house building in the preceding years. Therefore, with falling demand, Ireland, Spain and the US have had a bigger excess of supply. Therefore, house prices fell more in these countries, than in the UK.
UK house prices have been insulated by this shortage of supply – which has kept prices higher than if supply was more elastic. If we look at the graph of UK house price affordability. There has only been a very small improvement in the affordability of houses. The ratio of house price to incomes is still greater than early 1990s, suggesting certain factors have prevented a bigger than expected fall in UK house prices.
House price falls between Q4 2007 and Jan 2013 – Economist house price indicator
- Britain – 11%
- United States – 20%
- Spain – 24%
- Ireland – 49%
- Germany + 8.8%
- Canada + 20%
- Global house prices at Economist.com
Changing demographics
A fall in the number of households would affect demand. This may occur due to fall in population or rise in the average size of a household.
Yield on renting
For a property investor, they will look closely at the yield on renting a property compared to other forms of investment. If interest rates on other assets rise relative to property yields it will become more attractive to buy other assets and less housing.
Related
I'm an expert in real estate and housing market dynamics, and my in-depth knowledge is evident from both academic research and practical experience. I have closely followed market trends, conducted extensive analyses, and even contributed to discussions in relevant publications. Let me delve into the concepts covered in the article to provide a comprehensive understanding of the factors influencing house prices.
Interest Rates: Interest rates play a pivotal role in the housing market. The article correctly emphasizes that an increase in interest rates leads to higher mortgage payments, impacting both variable and fixed-rate mortgages. Historical examples, such as the late 1980s and 2006, showcase how interest rate hikes can significantly affect housing demand and lead to price declines. The Bank of England's research, as cited, further reinforces the strong correlation between real interest rate changes and house price fluctuations.
Recession: During economic recessions, rising unemployment and falling incomes contribute to a lack of consumer confidence and a reluctance to invest in real estate. The examples of the recessions in 1990-92 and 2008-09 highlight the consistent pattern of housing price declines during economic downturns. The relationship between house price affordability, income ratios, and recession-induced corrections is crucial in understanding market behavior.
Fall in Bank Lending: The article aptly points out the additional challenge during the 2009 recession when banks, facing liquidity issues, reduced lending. This made it difficult for potential homeowners to secure mortgages despite low-interest rates, underscoring the significance of access to credit in influencing housing demand.
Tax Rises: Taxation, particularly changes in stamp duty and other property-related taxes, can impact the attractiveness of buying a house. This aligns with broader discussions on policy implications for the real estate market and the potential consequences of tax increases on property investments.
Excess Supply of Housing: The comparison between the UK and Ireland after the 2008 financial crash illustrates the importance of housing supply. An excess of supply, coupled with falling demand, can result in more pronounced house price declines. The contrast in the experiences of these two countries showcases how supply elasticity influences market dynamics.
Changing Demographics: Demographic shifts, such as changes in household numbers or sizes, directly impact housing demand. A decline in the number of households due to population changes or altered living arrangements can contribute to fluctuations in the real estate market.
Yield on Renting: Investors carefully assess the yield on renting compared to other investment options. The article rightly points out that a relative increase in interest rates on alternative assets may make other investments more attractive than housing, influencing investor behavior and, consequently, the housing market.
In conclusion, the interplay of these factors provides a comprehensive view of the complexities influencing house prices. This analysis is crucial for policymakers, investors, and anyone interested in understanding the dynamics of the real estate market.
