The Current UK Housing Market - Essay Example

? macro & micro economics Contents Introduction 3 Current UK housing market 3 Macro and Micro economic factors 5 Current economic situation and effects on housing market 8 Conclusion 9 Reference 10 Introduction The main participants in the real estate market are owner, renter, developer, renovator and facilitator. The demand side of the market comprises of the owner and the renter while the supply side comprises of the developer as well as the renovator. In order to analyze the demand and the supply factors a number of modifications need to be implemented in the microeconomic assumptions. The characteristics of the market include durability, heterogeneity, high costs of transaction, long time delays, an investment as well as a consumption good, and immobility. The housing market possesses the importance of second hand transactions. According to the largest lender of the country, 5% of the total transaction is for the purchase of new properties while the rest is for purchase of either old or modern property. Two reasons can be accounted to assess the importance of the housing market for the economy of UK. The first reason states that the purchasing of houses is one of the biggest single purchases for the household and the purchased commodity represents the biggest single item of the wealth of the consumer. The changes in the prices of the houses have the potential to affect the entire economy. Current UK housing market The real estate industry is suffering from another wobble as the lenders are raising the rates of mortgage. The potential buyers are feeling the heat of consumer squeeze. Analysts are of the opinion that it is going to be a tough year ahead and the prices of the houses are taking the declining curve. The market outlook reports that the average price of the new properties failed to take the rising curve in the months of April-May, 2012. The market is driven by the release of equity. According to the nationwide house price index for the month of April, the property values have declined by 0.2 percent. It also states that the house prices are going to fall further as the households are uncertain of any possible recovery in the economy. The lenders are putting double squeeze on the home owners. The experts of the industry concluded that this is the greatest threat for the industry and it has come at the time when the economy was showing the signs of recovery. The seasonally adjusted net balance of headline price recorded a slip of 19%. The newly agreed sales value turned to negative again. The price outlook of the three months declined in the month of April and net balance witnessed a drop from -3 to -17 (RICS, 2012, p. 1). Several economists have noted that the housing market has moved out from the impacts of business cycle for the major economies including that of UK (Jones, Colin and Watkins 2009 p.1). Some writers opined that the housing market of the country is correlated with that of the economy while some others opposed it. Some writers concluded that the market is dominated by the investors and that is why demand may be artificially high or low for a long time. The interest rates act as the key economic variable for the housing market and the level of the interest rate will have impact on the demand for housing as it has the potential to determine the cost of credit for the buyers. In order to boost the economy, the interest rates have been set at a lower level. The different stages of supply and demand controls the housing market and so the market for UK is same as the market as in any other part of the World. There are two potential risks that are associated with the housing market. The first is the interest rate and the second one is mortgage indebtedness. The borrowing costs are a significant factor that determines the rates of mortgage and the ability to pay back the loans. The repayments of the mortgages become expensive as the interest rates rise and the previous crashes occurred due to this reason. The offered mortgages vary from nominal fixed rate to variable rate or index linked. It must be taken into account whether the considered mortgages will be able to match the fall in the prices of the houses. The popular form of mortgages is fixed and discount mortgages. The popularity of the discount mortgages has declined rapidly over the last three years. The likely rise in the interest rates can be taken to be the reason. Macro and Micro economic factors Demographic considerations are the main determinants of the demand for housing. The other factors that tends to affect the demand of housing includes income of the population, the price of the housing, availability of credit and finance, the preferences of the consumers willing to buy houses, the preferences of the investors willing to invest in the industry and the price of the available substitutes as well as that of complements. The housing market of the country has responded in conventional fashion to the theories of supply and demand. If demand for the houses rises and the supply remains at the stable level, then the prices will shoot up while the price will decline if it is the other way round. The significant number of sales in the market drove the prices at the level from where the property bubble started. People were inclining in purchasing houses not out of necessity but because they thought of houses as the route through which they can acquire money. This kind of situations generally leads to crash as the price rises at such a level that could not be matched by demand. The extra demand placed by the investors inflates the price levels. As there is shortage of supply which could not match with the demand it can be noted that the supply is comparatively inelastic for the country as a whole. Certain areas within the country can also be determined where frequent fluctuation in the prices can be witnessed. The microeconomic factors seem to affect the market less than the macroeconomic ones. The key driver of extracting extra demand from the wealthy class has been the availability of buy to let mortgages. In order to generate income, the wealthy class entered the market and most of them were already the owner of properties. The current financial situation and the investment model of the long term played the role of the catalyst in driving the prices up. The confidence of the market is hit. People are scared that they might lose the houses due to the inability to pay and so the economy is certain that the prices may fall. The loss in the confidence level is the driving force in shaping the demand. The recent hikes of the rents can also give rise to excess demand although the probability of sustained rise in rents is low. Suppose the consumers were consuming ‘x’ quantity of the product when the income was ‘y’ amount. Now suppose due to some reason the income of the consumers rises to ‘y+1’ amount. As a result the demand for the product will rise to ‘x+2’ units. Thus a rise in income of the consumers will bring increased demand for the products if the product under consideration is a normal good. The price elasticity of demand measures the demand change due to a change in price of the product. The percentage adjustment in quantity demanded by percentage adjustment in price gives the coefficient of the elasticity of demand. Economists usually are not concerned about the sign of the price elasticity. It is the coefficient that is of concern since price and quantity demanded generally tends to move in opposite directions. If the value of the price elasticity of demand is zero, then it implies that the demand for the product is inelastic perfectly. This implies that there will not be any changes in demand conditions due to change in price. It will generate a vertical shaped demand curve. If the value of the price elasticity of demand is between zero and one, then the demand for the product will be inelastic. Investors will know that a demand change will be proportionally smaller than the change in price of the product. If the value of the price elasticity of demand is unity, it implies that the percentage change in demand conditions for a product will be exactly same as the percentage change in price of the same product. The demand is said to be unit elastic. If the value of the price elasticity of demand is greater than one, then the demand is said to be elastic. This means that a percentage change in price will bring more than proportionate change in the demand for the same product. The determinants of the price elasticity of demand is number of close substitutes available for the product, the transaction costs involved in switching between products, the necessity conditions of demanding a particular product, the percentage of income allocated by the consumer on that product and period of time allowed after the change in price. The value of the price elasticity for the chosen product will be between zero and one. (Riley, 2006). The income elasticity is one of the elasticity concepts that are in line with the demand for houses. The income elasticity is defined as the demand change due to change in income of the consumers taking all other conditions to remain constant. Positive income elasticity is said to exist for normal goods as the demand rises with the rise in income of the consumer. Since the products selected are normal goods in this case, the income elasticity will be positive. Current economic situation and effects on housing market The UK banks that are involved primarily in providing loans are concerned about the tax payers’ investment in the country. The aim behind the initiatives by the banks is to generate adequate money which will be fruitful for the balance sheet and will nullify the losses in the short term. The past four decades has witnessed sustained appreciation in the prices of the houses as well as sustained volatility. The positive as well as the negative shocks act as the drivers of the cycles. The shocks include income as well as employment, interest rate shocks and inflation and availability of credit. The recent downturn in the prices of the houses in the market is an indication of weaker employment opportunities as well as the income of the households along with the dearth in the funding process of mortgage. These indicators are only expected to improve gradually and the probability of further reduction in the prices is high. The rise in price of the houses is only going to be intensified with the imbalance between the growth of population and the supply of houses. The switch experienced in the past two decades is anticipated to persist over the next decade as the constraints will continue along with low inflation and the environment characterized by low rates of interest. Some analysts expect the ratio of house price to earnings to get back with the long term average of 4-5 in the next decade. But such a situation to take effect will require the price of the houses to further fall by around 20%. So such situation is not plausible as this would require the occurrence of a recession which will keep the rate of interest at the current scale for the coming periods (Oxford Economics Ltd, 2011). Conclusion Housing can be thought of as a consumption good which provides services to the purchases over course of time. It is a fixed asset and a major source of personal wealth. The economy and the markets for houses are slightly different in the current environment compared to the previous situations. It is necessary to take into account the policies of the government to deter the crashes in housing markets. Reference RICS, 2012., UK Housing Market Survey . [pdf]. Available at: http://www.rics.org/site/download_feed.aspx?fileID=11906&fileExtension=PDF. [Accessed:24th May, 2012]. Jones, Colin and Watkins, Craig (2009). Housing Markets and Planning Policy. [online]. Available at: http://books.google.co.in/books?id=d6ZpL13p_twC&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=false. [Accessed:24th May, 2012]. Riley, G. (2006). As Markets & Market Systems. [online]. Available at: http://tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand.html. [Accessed:24th May, 2012]. Oxford Economics Ltd, (2011). How much further have UK house prices to fall?. [online]. Available at: http://www.oef.com/OE_FA_Display_Frm.asp?Pg=UKSpec&Txt=UK%20Economics%20Services. [Accessed:24th May, 2012]. Read More