Housing Sector in Scotland - Term Paper Example

Economic Report on Housing Sector in Scotland Introduction The housing sector has traditionally been one of great significance and importance in the economic history and well-being of any nation. This is because as a country develops from an agricultural to an industrial and then a post-industrial economy, people move from the countryside to the cities in search of income and employment opportunities that fuel the country’s growth. In the process, they need a temporary or permanent place to live. As people find gainful employment, they may get married and settle down, or alternatively call their friends and neighbors to the new cities. The engines of economic growth thus provide an impetus for housing as people look for or develop suitable establishments that can be called a home or a place of residence. In turn, demand for housing units signifies that there are economic opportunities in a certain area. It must also be seen that the housing sector itself is a provider of gainful employment to a number of other industries such as masonry, steel, plumbing, water, power and other utilities, painting, upholstery and what not- the list seems endless. Once we have become aware of this, we can truly see the importance that demand and supply for housing units will have and does have on the economy of any nation, including Scotland. This paper is divided into three parts. Part A will present an analysis of the Scottish housing market for the first decade of the new millennium (2000-2010). It will look at the major factors affecting demand, supply and price of housing units. In the process of analysis, it will also seek to determine whether the housing sector in Scotland is volatile or not and what are the reasons for this. Part B will go on to review specifics regarding the reasons for the ups and downs in the housing sector. Part C will differentiate between factors that are indigenous to Scotland and factors that may affect the whole of the UK housing sector. It will then end with recommendations to be implemented that when done, will hopefully reduce the volatility of the housing market in the UK in general and in Scotland in particular. PART A Analysis of the Housing Market in Scotland (2000-2010) Available data shows that the average number of new housing units established per year in Scotland since the 1980s was 20,000 units; these have however peaked at 25,000 in 2007 and there has been a decline since then to around just 17,000 units in 2010. This decline was seen in the years 2009 and 2010. The average UK house price was £163,244 at the end of 2010, with London being the most expensive region in the UK overall, and Edinburgh leading the price rise in Scotland. In Scotland, the average price of a house was £137,491, indicating a decrease of 2 percent over 2009. Aberdeen City and Aberdeenshire were areas that had recorded a housing demand growth of 4 percent over the year ending December 2010. These areas have benefitted from strong and stable economic opportunities. Conversely Dundee, Angus, Lothian and Falkirk have been the lowest performing areas where demand fell by as much as 3 percent in the 12 months ending December 2010 (Scottish Housing Market Review, 2007 & 2010). Major Factors Affecting Demand, Supply and Price of Housing Units A look at the housing market in Scotland over the last decade (2000-2010) indicates that there have been some major factors affecting the demand and supply for housing units over the stated period. Generally it has been seen that demand for housing units has been spearheaded by the changing demographics in the cities, the economic climate and rates of interest and inflation. The opportunities for employment and living conditions impact upon the rate of migration of people to the major cities, and the number and types of housing units demanded are also dependant on the age and lifestyle requirements, marital status and gender of the new entrants. Ethnicity has also been taking on more importance as the migrants tend to call their own families to the cities or even close friends and neighbors who undoubtedly belong to the same ethnic population. The types of employment available for a particular group of people and their ages and rates of pay will also contribute to a housing decision- should they live together or apart and in how many households. On the supply side, the housing stock- meaning the number and types of units available in a particular quarter- does not change overnight. Supply of units will therefore be affected by booking of housing loans from banks, rate and number of expressions of interest in new housing schemes and so forth. It will typically take one or two quarters for changes in supply to reflect changes in demand (Scottish Government Analytical Services, 2010). The number of dwellings available for use at any time is also impacted by the housing inspections for suitability as they want to make sure that proper living and sanitary standards are available for prospective buyers or tenants. As far as the pricing factor for housing units is concerned, it is worthwhile to note that there is a primary market for new housing units and a secondary market for used or lived-in housing units. Depending upon the rate of migration or movement in response to employment opportunities in any given area or city of Scotland, prices in the used/second hand homes market can affect prices in the market for new houses and vice versa. For instance, if demand for new housing units is lesser than for used units, it indicates that prices for the used homes market are on the way up. Meanwhile, credit may be tight or there may be polices contributing to a lower rate of monetary expansion, which is an additional contributing factor to the contraction of demand for new housing units (www.nationwide.co.uk/hpi). The Story of the Last Decade UK House Price Affordability Index. Source: www.marketoracle.co.uk The UK housing market is very sentiment driven, and reflects the same sort of behavior as that of the stock market by moving between extremes of over valuation and under valuation against the UK 's GDP growth. By sentiment driven is meant that people tend to make decisions based on feelings and emotions rather than based on hard facts and realities. If people notice that demand for housing units has increased, they immediately assume that prices have fallen or loans are available at cheaper rates so it is a good time to buy. But realistically speaking, they must also consider their job situation and ability to repay the loan before going forward and booking a mortgage. Some of the peculiarities to be noted about the period 2000-2010 in the housing sector in Scotland are that this sector had been markedly affected by the varying costs of renting or buying a property. Consumer incomes and living standards also affected affordability of housing purchases. At the other end, recessionary trends in the world’s economic climate since 2008 have also affected Scottish housing prices; cost to build and the number and type of development projects in any given area led to gluts in some localities with sparse developments in others. This in turn led to increased demand for civic amenities, and there was evidence of overcrowding in some areas and under-occupancy in others. Is the Housing Sector in Scotland Volatile and What Are the Reasons for This? The demand for housing depends upon the income of the consumer, the price of a house relative to renting or sharing accommodation, the number of houses put up for sale in a particular period, let’s say a quarter- and the cost to build a house relative to purchasing a readymade one. Change in any of the above variables would affect the price for housing in a particular quarter. In normal cases, if the economy is doing well and incomes increase, demand for housing will increase as well. But because demand for housing is a long term decision, the consumer has to consider his permanent sources of income that can be used to fund a mortgage. Other problems in measuring the demand for housing accurately relate to slow adjustment of supply to demand- it takes some time and outlay and various permissions to build a house after all- and the fact that it may also take time to arrange for a bank loan after providing the needed collateral or sureties. Another complexity is the cost and duration to build a house of various descriptions- say a villa as compared to flats. Tenants usually have put the consideration to save and buy a house on the back burner for a number of years, till they progress in their careers and incomes increase for example. Those looking for a home would be driven by different expectations and considerations. Short Run Housing Scenario depicting unresponsiveness of Supply The supply of housing is fixed and therefore extremely inelastic in the short run. But it is also impacted by expected changes in housing policy, interest rates for mortgages etc. In case there is an increase in mortgage rates, demand for housing would be reduced and vice versa. However the expectations of gain in prices in future would fuel the supply of housing units. According to Le Grand, Propper and Smith (2008), if demand for a commodity rises then we can expect an initial rise in price. This stimulates producers down the line to produce greater quantities of a good. However, this meets only some of the additional demand in the market. The situation will lead to a reduction in price until a new equilibrium price is found. However, where there occurs an insufficient increase in production in response to increasing demand prices will rise to and remain at the immediate post change level. Where this dynamic is active we can describe supply as being inelastic. Where supply is elastic the bulk of change will take place in the quantity produced (Le Grand, Propper & Smith, 2008). The housing market is held to be an inelastic market (Scottish, 2005). O’Sullivan suggests that inelastic supply within the housing market flows from a number of variables including: an inefficient planning system; land banking by builders; inefficiency within the construction industry and risk aversion within the house building industry. Le Grand, Propper & Smith (2008) opine that whilst supply inelasticity is a key factor in why house prices rise rapidly speculative behavior on the part of consumers can also play a role. If house prices rise, as a consequence of increased demand within the market, then consumers are willing to pay even greater prices at that point in time. This is as a consequence of expectation of prices continuing to increase and of them being priced out of the market and in anticipation of asset gain. Likewise, a small reduction in demand can result in a relatively large reduction in price. Bramley, Munro and Pawson (2004), in discussing house price booms suggest that in order for a house price boom to take place then there needs to be an initial shock to the housing market such as a relaxation of the availability of credit or sudden demographic change such as inward migration. Le Grand, Propper & Smith (2008) suggest that it is the combination of inelastic supply of housing and speculative behavior on the part of consumers that leads to price volatility. This leads to affordability issues for borrowers as house price to earnings ratios become unmanageable and can lead to a situation where new buyers are unable to borrow anymore and there is a subsequent drop off in demand macroeconomic conditions can also put downward pressure on house prices (Bramley, Munro and Pawson, 2004). Le Grand, Propper & Smith (2008) suggest that the inelasticity of supply and market volatility has fundamental implications for equity of outcomes within the housing market. As when house prices rise it is those who are already home owners that gain at the expense of those seeking to own a property. As if there is insufficient supply to meet an increase in demand then existing owners will be in a monopoly position and will then gain monopoly profits. As a consequence the distribution of wealth will be affected that will have a greater impact on the poorest in society as they are the least likely to own property (www.ros.gov.uk). The housing bust of the early 1990's resulted in the UK heading for recession and a loss of confidence in the housing market that remained for over 5 years. UK Real House Prices v. GDP Growth. Source: www.marketoracle.co.uk Detrimental Effects of Volatility in Efficiency and Distributional Terms House price volatility leads to macro-economic instability as house price instability feeds through into the wider economy as a consequence of the linkage between changes in house prices and individual wealth and wider private consumption patterns (O’Sullivan et al, 2004). In the past the combination of low levels of investment, high levels of owner occupation, high house price volatility and regional divergences together have created a more challenging environment for the conduct of economic policy’ (O’Sullivan et al., 2004). PART B A Review of the Evidence in the Scottish Housing Market Analysis of the available data indicates that from 2002 till 2007 Scottish housing prices rose dramatically, ending up 31 percent above their historical trend in 2007 (Burgess, 2010). This price rise caused real problems in terms of affordability and presented a real barrier to home ownership. Amazingly despite the increase in prices, this increased demand for housing was met with very little additional supply. Other key economic events that drove an increase in demand were a reduction in the Bank of England base rate of lending and low levels of inflation. Inefficiencies within the Scottish housing market led the Scottish Government to set out targets for new house building of 35,000 units per year in order to ease the supply side pressures and also to ease affordability (Burgess, 2010). The situation in the Scottish housing market and concerns surrounding it prior to the credit crunch and subsequent fallout is captured in the Housing Supply Taskforce Report which stated: ‘The key concerns were the failure of supply to match demand, and the need to accelerate housing supply to increase the affordability, stability and fairness of the system to help deliver greater choice to the people of Scotland’ (Burgess, 2010). Variations in Performance and Reasons for This The economic theory underlying housing prices and the reasons for changes in them have already been highlighted in the preceding sections of this paper. The wider economy and the housing market saw a significant down turn following the significant trauma in global investment markets. The effects were that house prices alongside transactions levels fell significantly from 2007 (Centre for Housing Market Analysis, 2010). The availability of mortgage finance has been dramatically reduced. House building activity has been dramatically reduced. The level of mortgage repossessions has increased, peaking at 43,000 in 2009 (Centre for Housing Market Analysis, 2010). There are uncertainties as to the capacity of the house building and mortgage markets capacity to recover following the dislocations of the credit crunch. These uncertainties relate to wider global macroeconomic dynamics and the attitude of the regulatory authorities going forward (Pawson and Wilcox, 2010). PART C Analysis of Factors that Originate within Scotland It is wise to assume that the rates of housing growth, or lack thereof, should be connected to the general economic outlook, employment opportunities, rate of inflation, rate of taxation and other relevant factors pertaining to the housing industry. This is as true of Scotland as of anywhere else in the UK. In Scotland the highest housing prices have been noticed in Edinburgh, Aberdeen and Aberdeenshire while the lowest priced areas have been Falkirk, Angus, Lothian and Dundee. The changes in regional prices have also been connected to employment and interest rates, monetary policy and rate of inflation versus the cost of living. Factors Operating at the UK Level It was generally seen that all things considered, housing prices in London tended to be higher than elsewhere in the UK. This is because of the earnings and affordability factors compared to the rate of inflation. For example the Summer 2000 Review indicated that pay increases were 5 percent compared to an inflation rate of 2.5 percent. At the same time, the average mortgage payment rose from 19 percent of earnings in mid-1995 (or £200) to 25 percent of earnings by 2000. It has been seen that as affordability has decreased, consumer demand has followed suit. Most people were fearful about the rate of inflation, increase in taxation and other factors that increase the cost of living and take away their stability and purchasing power. The cost of lending by banks has also crept up during these years, adding to consumer despondency. Housing prices once again saw a relative peak in 2007 after which they have dropped to more comfortable levels. Housing prices had dropped in 10 out of 13 regions in the UK by December 2010. The northern regions of the UK generally saw weaker growth than the southern regions (www.nhbc.co.uk). Recommendations that Can Be Implemented to Increase Housing Market Stability in Scotland 1. The Government can play a greater role in controlling the prices of new housing units by setting regional targets for the maximum number of new units that can be set up in a quarter. The maximum lending by the banks for housing purposes can also be set, thereby ensuring that prices do not get out of hand. To achieve this end, proper monitoring must be done as well. 2. It is suggested that the Government should provide training in house construction as well as ensure that the normally used fixtures are available at reasonable rates so that the overall cost of construction could be minimized. 3. Credit must be made available to housing constructors as well as prospective homeowners at preferable rates by banks and other lending agencies. This must be reviewed each quarter and adjusted if need be for the next quarter so that housing loan targets are achieved (Council of Mortgage Lenders). 4. People found guilty of purchasing land for the construction of a house and then making a profit by selling the same property for a higher rate, rather than constructing a house upon it should be penalized in some manner. 5. The Government should do its best to stimulate the housing sector and increase transactions in both the market for new as well as used dwellings so that its beneficial effects on safety and security, shelter for the homeless and other related needs can be realized. Housing affects our community needs as well and this should be remembered and upheld when making new policy (Fresh Thinking, New Ideas 2010). Rationale and Cost Considerations The rationale for these recommendations is well founded. When people try to make the most out of a given situation, it creates opportunism. Competition is healthy and should be introduced in the housing sector. The Government should play a greater role as evaluator and mediator so that no one is cheated. It would take very little funding to create a Government sponsored institution or agency to monitor prices and make professional evaluations, but in the long run it would lead to level headedness and price stability in the much maligned housing sector in Scotland. Inflation Adjusted UK House Prices. Source: www.marketoracle.co.uk Conclusion We have studied the housing sector in the UK with specific reference to Scotland and delved into the factors that affect the stability or promote the variability of housing prices in Scotland. The macro-effects and factors indigenous to Scotland as well as those endemic to the whole of the UK have been studied and recommendations to the Housing Minister of Scotland proposed. Let’s hope that common sense and level headedness prevails when the next housing policy is announced so that the present deficiencies are removed and prices are stabilized to affordable levels. References Bramley, G., Munro, M. and Pawson, H. (2004). Key Issues in Housing. Palgrave Macmillan: Basingstoke. Chapters 2-4. Burgess, L. (2010). The Scottish Housing Market – Update June. SPICE Scottish Parliament: Edinburgh. Centre for Housing Market Analysis Scottish Government website: http://www.scotland.gov.uk/Topics/Built-Environment/Housing/supply-demand/chma> Centre for Housing Market Analysis (2010). Scottish Housing Market Review September. http://www.scotland.gov.uk/Topics/Built-Environment/Housing/supply-demand/chma Le Grand, J.; Propper, C. and Smith, S. (2008). Economics of Social Problems. Palgrave Macmillan. Ch 1 and 5. O’Sullivan, A.; Young, G.; Brittain, A.; Dowie, A.; Gibb, K.; Maclennan, D. and McLaren, J. (2004). Local Housing Systems Analysis: Good Practice Guide. Communities Scotland: Edinburgh. Pawson, H. & Wilcox, S. (2010). ‘UK Housing Review: 2010 Briefing Paper’. Coventry: CIH. Scottish Government Communities Analytical Services (2010). Analysis of the Scottish Housing Bubble? Accessed 17 Mar 2011. Scottish Government Communities Analytical Services (2010). Rationale for Housing Policy. Accessed 17 Mar 2011. Scottish Government (2007). Scottish Housing Market Review. Accessed 17 Mar 2011. Scottish Government (2010). Fresh Thinking New Ideas. Scottish Government: Edinburgh. Website of the Nationwide Building Society Accessed 17 Mar 2011. Website of the Registers of Scotland http://www.ros.gov.uk/>. Accessed 17 Mar 2011. Website of the Council of Mortgage Lenders Website of the NHBC.  Accessed 17 Mar 2011. Read More