The Influencing Factors To The Current UK Housing Market - Assignment Example

? The influencing factors to the Current UK Housing Market Details: al Affiliation: Submission The influencing factors to the Current UK Housing Market There seems to be a general consensus among economists that house prices is one but an important variable in determining the direction that the national growth takes within a given economy at a given point in time. Like other goods and services in the market, the housing market is susceptible to the effects of demand and supply side factors, which may be quantitative and qualitative in nature. The national population size and its composition, urbanization, the level of economic prosperity, investor speculative activities, interventionist policies by the government, monetary policy systems, just to mention but a few, are among a host of dynamic influences that play significant roles in shaping housing markets both in developing and developed economies (Leamer, 2007). Given the fact that these factors affect housing markets in every country differently in terms of intensity and persistence, it is rather difficult to capture all of them in a macro modeling system applicable to all states (Meen, 2001). In fact, what holds in an industrialized nation’s context may or may not hold true for an emerging economy. As witnessed in the recent financial crisis whose causal determinant stemmed from speculations in the housing market, the intensity of speculative activities in this particular market differ across economies (Levin and Wright, 1997). The factors that influence the UK housing market are broadly categorized into two prospects; micro and macro-economic influences. Gross Domestic Product (GDP) as well as Gross National Product (GNP), the level of unemployment, rates of inflation, and rates of securing mortgages among other factors operating at the local level are classified as micro-economic influences. Those that influence activities in this particular market from the international level such as the global financial market and credit market liberalization are classified as the macro-economic factors. The UK housing market experienced a period of extra ordinary boom between 2003 and 2008. This happened at a time of rapid GDP growth momentum spurred by increased foreign investments funding and the effects of deregulation of the mortgage market. However, the period after 2008 has been of tough decision making for investors in the housing market. The era of good times ended with a bust following the global credit crunch and has been worsened by the recent occurrences of the euro debt crisis and the double deep recession that has persisted to date with devastating losses for investors across markets, both locally and internationally. Initiated by the U.S. subprime mortgage credit crush late in 2007, the intensity of crisis spread fast and wide to the extent that by early 2008, almost very sector in the UK had felt the pinch. Indeed, the drifts that started at the beginning of the first half of 2008 had reached both the residential and other business investment markets by the end of the second quarter (Shiller, 2008). The initial government stimulus package was being whitewashed under the watch of every investor. As the fallout from the crisis gathered drive, the strengths of the labor market weakened almost dramatically, leading to significant increases in unemployment levels in every sector. Businesses had to survive whatever the costs and so sacrifices had to be made and the UK housing market was no exception. By 2009, news from the Office of National Statistics was not a surprise given the global economic performance; United Kingdom was officially in recession, having shed off 1.5 percent of its robustness in the fourth quarter of the previous year. A further drop of 2.5 percent at the close of the year further weakened the economy, causing a string of nightmares to investors (Office of National Statistics, 2009). At this point in time, unemployment levels had hit a new level high; 1.92 million, further adding whores to the already overburdened economy. Reeling under the influence of plummeting oil prices, a loss of confidence in the capability of financial institutions with banks lending rates having contracted to dangerous levels, the housing market investors had to find safe havens for their good money. During the “feel good” period, it was the belief of every investor that the housing market in the west would ever blossom. In fact, the traditional economic models assumed that housing markets clear instantaneously with immediate price adjustments, so that demand equals the existing stock at any point in time. Indeed, a sense of well-being and satisfaction for housing investors derived from the rising housing market conditions almost validated with some sense of certainty that such explanation was perfectly in order (Oswald, 2009). Clayton (2003) points out that recent happening have enlightened investors; market for houses, just like other markets, are often inefficient and so do adjusts slowly to market driven conditions. Not known to many was the fact that the financial avenues play an important role in the now synchronized, globalized world. The new finance growth drivers such as asset backed securities have created a web of functioning with far reaching effects. Innovative ideas with improved liquidity have enabled the spreading of risks through local as well as international diversification. Following the 1988–90 and the most recent boom–bust periods, it is now a recognizable fact that the housing market is more than capable of deepening a recession or heightening a boom (MacLennan and Gibb, 1993, p. 1). The close links between housing market and the macroeconomic variables are now a reality to theorists as well as policy makers. There is, therefore a need for longer-term considered investment solutions to boom–bust issues, which comprises of equity and fairness in the housing market. Of necessity within the interconnection is the longstanding heightened interest in how the housing markets is intertwined with different economic variables. Macro and micro economic influences on the current UK housing market Although treated as a ‘standard’ econometric variable in the neoclassical model, the housing sector possesses certain unique characteristics making it more fragile than other goods markets. These attributes, notably; the nature of supply and the spatial fixity of houses, the time lags for market shortage signaling effects on the supply side to satisfy demand; the temporal flexibilities in the demand of this product; the complex behaviors underpinning consumer choices; the heterogeneous nature of housing; the plurality of housing both as an investment asset, for shelter as well as a marker of social positioning-all play important functions in regulating this particular market (Guthrie, 2010). Supply and demands shifts The above diagram illustrates the normal relationship of Supply and Demand in the housing market. A shift in the supply of houses (dark blue-light blue) triggers a fall in price from P0 to P1. A subsequent shift in demand, (dark red - light red) perhaps because of certain fundamental changes in lending standards has the effect of pushing prices further downwards from P1 to P2. Given the attributes associated with housing sector such as non-transportability of houses and the substitution effect of homes and rental housing, the competition between these two usually impacts directly on the housing market through a chain of reactions. As expected, house prices and their demand tends to portray an inverse relationship, with income and substitution effect playing a pivotal role in this explanation. An increase in the general price level, such as the one triggered by global credit crunch in 2008 has the effect of increasing house prices. With increased prices, economic growth was disrupted, real household incomes fell significantly forcing a downward trend in their demand. During this period, prolonged by the Euro debt crisis, higher prices have forced individuals to seek alternatives to owning houses, with rentals appearing more attractive, hence the shift in demand from dark red to light red in the above diagram. During the “feel good” period between 1995 and 2007 characterized by increasing GDP and GNP, significant increases in the ratio of house prices to incomes were recorded, therefore, shifting demand to the right on several occasions (Pattison, Diacon and Vine, 2010). In general, house prices were increasing at reasonable rates in comparison to the national growth. Therefore, there was enough incentive for Individuals to buy due to rising levels in their real incomes rendering rentals less attractive. However, when the recession caught up with the robust economy, companies had to shed off excess baggage. Job cuts meant increased levels of unemployment, effectively altering choices and shifting demand for buying houses to the left. That said, demand in the housing market susceptible speculative activities, so that a rise in houses prices can stimulate a rise in demand with buyers anticipations of speculative gains. Noteworthy for this analysis, changes in house pricing normally causes movement along the demand curve for houses. Non-price factors shift the demand as well supply curves from their original positions, either to the left or to the right, depending on factors of influence. There exist important spatial cleaves in the characteristics of houses serving to regulate information signals to both supply and demand sides. House price, like other goods and services in other markets, reflects its demand and supply. Equilibrium price, in this sense, is derived by the interaction of market demand and the level of supply. There has been a continuous rise in demand for housing in the UK over the last decade while supply has fairly remained stable. In comparison to other union members, UK house building has been the lowest in recent years, a factor that has contributed to rising average prices over the same period. Individuals do not simply seek housing for shelter but to satisfy a complex set of personal socio- economic as well as cultural requirements. The social and lifestyle trends, for instance, preference for late marriages, do influence demand patterns for houses, which in effect adds up to the total demand. Indeed, recent statistics reveal rising numbers of middle class single households, a fact that has sharply led to rising demand for flats and apartments (Pattison, Diacon, and Vine, 2010). “……Housing in a sense is the ultimate ‘basket of goods’, where neighborhood characteristics and the potential of access to broader services and opportunities inform an important component of the hedonic price. But the importance of the precise contents of the basket vary from person to person and place to place” (Orford, 2002). The foregoing statement underscores the importance of a deeper understanding of behavioral aspects of agents and demand groups that operate within the housing market (Marsh and Gibb, 2009).The housing market in the UK is, without a doubt, one of the most volatile within the union, let alone the whole world. Since 1970s, UK housing market has experienced four boom and bust cycles, the highest in the region (Marsh and Gibb, 2009). These cycles distort individual choices; force prices upwards through repossession of interest rates thus inhibit house building and buying by heightening wealth inequalities. The inherent cycles in this particular market segments are aspects political economies, and UK is no exception. The volatility in the UK housing market has a direct relationship on how individuals choose to live their lives and make broad ranging decisions over their lifetime events (OECD, 2004). The fact that the UK housing market is highly differentiated with regards to regional and local differences is one important predictor in determining how this market behaves. Indeed, the faith granted to the housing market to deliver has been hugely phenomenon in the recent past; a fact that explains the story behind the social inequalities with reference to national security, wealth status, income in old age, and more so the level of education –these differences matter a great deal. Apart from notions of spatial differentiation, the housing market volatility has been very sensitive to one-off occurrences predominantly at the macro level. The housing market, in much the same way as any other markets, responds to shocks as well as information flows. The sustained robustness in the UK housing market priors to the credit crunch has been seen as a result of long term trends in tenure change (political structures), regional economic performance (Euro zone), sustained household growth momentum and new housing supply policies. These are just but a few long-term cumulative tendencies of one-off policy changes that are viewed as more helpful due to their resistance to change. Major economic, social and political junctures define, to certain extents; features of volatility in the UK housing market. The 1979–80 housing boom and the subsequent slump coincided with the beginning of the Thatcher government. Indeed, the economic downturn was partly as a result of the introduction of monetarist policies to curb the effects of inflation. Again, the 1989–90 boom-slump scenarios were closely linked to housing mortgage-backed securities being overpriced as a result of government policies. So far, it is clear that performance of the housing market relates strongly with the broader macroeconomic trends with the eventual l effect of influencing sellers and buyers behaviors Of particular relevance to this discussion especially over the recent past have been the interest rates associated with property markets. Fuelled by a rise in demand of houses, the last boom–bust cycle occurred at a time of extraordinarily low interest rates. While interest rates and inflation do not vary spatially, these two variables do affect economic prospects in terms of householders’ equity, and their ability to access debt finances. In this sense, low interest rates do indeed precipitate uneven spatial outcomes, which do impact on market conditions. Changes in general interest rates charged on loans by lenders in the housing sector (such as building societies and banks) do influence the monthly repayments variable-rates on mortgages. Higher interest rates make mortgages less affordable, and so demand for houses will shift to the left as many will opt to rent rather than buy. According to MacLennan and Gibb (1993) analysis of the rising prices that preceded the 1990s downturn, a number of structural changes related to mortgage rates in addition to the rules and regulation in the mortgage market immensely contributed to the boom in the housing market. As the stories goes, the rules governing access to capital markets were relaxed ushering an era of increased competition among mortgage providers. As a result, investors switched from a queue rationing mortgage system to equilibrium rationing, which in effect led to a more fluid market for housing on the demand side. Increased freer capital lending practices led to significant increases in average loan-to-value (LTV) ratios as well as greater lending capacity to first-time buyers. Of curse, these benefits came at a cost of making the sector more fragile. The deregulation of the mortgage market in the 1980s continues to influence the housing market to date, and the most recent boom and bust was no exception (Stephens, 2007). In fact, higher average loan-to-value with longer repayment terms has somewhat been assimilated into the mortgage lending system akin of a culture. Historically, the housing market has been characterized by low levels of supply. The combined effects of high levels of household growth patterns and the consolidation of the social position of owner-occupation spurred by rising incomes have driven prices upwards almost three fold. As expected, these fundamental variables were uniformly spread across the UK. Nevertheless, certain factors such as demand-side growth pegged on household incomes were regionally differentiated. Whereas the 1980s and 1990s booms were closely linked to the ‘baby boom’ maturation cohort, current demographic trends have significant impacts on the housing sector. The impact of net immigration within the Euro zone, changes in social norms among other demographic influences vary across space. In particular, immigration has had tremendous effects in shaping the costs of owning homes in cities such as London in profound ways. Total demand for houses particularly in London has long been determined by the population number and other structural changes triggered by immigration trends. Other factors such as birth and death rates have also had their share in shaping demand and supply. Another characteristic of the population in this particular city has been the aging effect, which has been a factor in the periodic upward shift in the demand for houses (Glaeser, Gyourko and Saks, 2005). Elasticity is yet another factor that does influence the prospects in the housing market. Elasticity reflects the sensitivity of both buyers and sellers in the housing market to changes in price levels and aggregate income. Price/income elasticity of demand measures the level of adjustments in demand given a unit change in average prices/incomes. Demand for houses has always been inelastic due to the simple fact of existence of options a part from buying (Levin and Pryce, 2009 p. 716). For house buyers, housing has been perceived more or less as a necessity. As such, rising prices over the past 15 years has had a persuasive effect on people to spend a greater percentage of their earnings on housing. Backing this claim is the increasing generosity from mortgage lenders to finance bigger projects than before. Evidently, UK house prices have risen past 200 percentage mark, yet demand has kept pace over the same period; a suggestive indicator of an inelastic demand buying (Levin and Pryce, 2009 p. 719). As expected, the rising prices have hindered many low income earners from achieving their dreams, hence their demand has remained elastic. However, income elasticity of demand in the UK in general has been elastic. The rising incomes have led to bigger spending in housing, more particularly in the right locations such as cities. With reference to supply, its response in the short term has been very inelastic due to planning constraints hindering quick permission to erect such structures. In the long term, elasticity of supply of houses depends on the location of choice. It is just difficult to find building space in London, thus supply in this particular city is very inelastic (Saiz, 2008, p.213). However, an investor can easily find space in other parts of the country. It is apparent that the main threat to the UK economy, by extension to the UK housing market, is by and large the liquidity problem offered by UK financial institutions and banks. As UK inflation rate looks likely to settle at an average of 4 percent in the short term, costs of living are also fast outstripping increases in household incomes given the recent trends of massive job losses. As discussed above, growth in supply has been constrained, in part by planning systems widely recognized as highly complex. In fact, many academics argue that the current planning mechanics falls short of balancing local views to national needs. It is an open secret that a myriad of factors are at play accelerating demand while constraining supply causing a leaking mismatch towards the dramatic increase in UK house prices as witnessed over the last decade, exacerbated recently by the Euro crisis and the double deep recession. Addressing all these issues at ago seems like a hill to climb over night, as such the current demand trends will still continue to outstrip supply, thereby pressuring the UK housing market even more. According to the projected estimates, England expects an average of 240,000 new houses each year until 2026, which seems quite in order given the historical trends (Home Builders Federation, 2010). The economy is bouncing back slowly following the stimulus packages amid the crisis, thus stabilizing house prices. Though slow, correction feeding is expected through 2012. With a forecast of 5% decline in prices and some little growth until 2015, demand is expected to follow suit in picking up. References Clayton, J., 2003. Rational Expectations, Market Fundamentals and Housing Price Volatility. Real Estate Economics, 24(4), pp.441-470. Glaeser, E.L., Gyourko, J. and Saks, R.E., 2005. ‘Why Have Housing Prices Gone Up? American Economic Review, 95 (2), pp.329- 333. Guthrie, G., 2010. ‘House Prices, Construction Costs, and the Value of Waiting.’ Journal of Urban Economics, 68(1), pp.56-71. Home Builders Federation , 2010. 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Stephens, M., 2007. ‘Mortgage market deregulation and its consequences’, HousingStudies, 22(2), pp. 201–220. Read More