The United Kingdoms Housing Market - Literature review Example

Business Economics Table of Contents Introduction 3 2.The United Kingdom’s Housing Market 3 3.Microeconomic and macroeconomic factors that affect the UK’s housing market 4 4.Property market challenges affecting supply and demand conditions 5 5.Performance of the UK’s housing market since the Crisis 6 6.Conclusion 7 Reference List 8 1. Introduction The 2007 global financial crisis had a great impact on Britain’s housing market. Housing prices suddenly increased to a great extent due to insufficient houses built which affected the demands of local people (Agnello and Schuknecht, 2011). Through this study, the researcher attempts to know about how did the Financial Crises affect British Economy and what are the other factors that are responsible for the fall of Britain’s housing Market. The main objective of this study is to analyse the major causes for the fall in UK’s housing market and whether this property market challenges are linked to supply and demand or there are other important factors that are responsible. 2. The United Kingdom’s Housing Market The UK’s Housing Market had a stock of around 27 million dwellings in 2009 and a relatively larger market share of around 70% owner occupied houses. Around 90% of the houses are occupied by single owner (Agnello and Schuknecht, 2011). If the proportion of owner occupied houses is considered with the proportion of houses that are rented, then it is found that around one third of the owner occupied houses are rented. When the home financing division is considered, researchers have found that around 46% of the citizens had their own houses whereas, around 54% where still paying mortgages (Buckleyand and Tsenkova, 2001). Most of the mortgages have variable interest rates and the interest rates can be fixed through remortgaging. This tightening of the UK’s mortgage market led to the financial crisis during the second half of 2007 (Buckleyand and Tsenkova, 2001). There are various factors which are responsible for the buyer’s choice of new houses that comprises mainly of the location of the houses, price, construction strategies and related government support schemes (White and Allmendinger, 2003). Often due to restriction imposed on the mortgage finance, it becomes difficult for those interested in purchasing new homes to avail loans. As a result, rising prices discourages the buyers from purchasing new homes. On the other hand falling prices leads to recession. The extra demand was outweighed not only by high production cost but also by huge land revenues. However, there was a constant supply of new houses through government and private agencies in order to meet the increasing demand for houses (White and Allmendinger, 2003). Further, the housing needs were also changing depending on household structures and lifestyles. One of the main reasons for the problems related to housing in the UK is that of planning. It is the government who is responsible for not investing sufficiently in the field of housing and the local builders are responsible for constructing houses at wrong places (Ortalo-Magne and Rady, 2006). 3. Microeconomic and macroeconomic factors that affect the UK’s housing market The financial crisis of 2007 is one of the main reasons for the collapse of the UK’s housing market. Along with the issue of affordability among the citizens of the UK, there was another major reason leading to the fall which dealt with the lack of supply of housing finance (Case and Quigley, 2008). Previously, the borrowers had the ability to finance up to 95% of their purchase price through mortgage debt (Crotty, 2009). Due to the financial crisis, many banks withdrew their offers of granting loans at a cheap interest rate as well as the required down-payments were increased to 25% from mere 10% (Crotty, 2009). This phenomenon was known as the ‘credit crunch’. Although the credit was made readily available, it was difficult for the housing market of the UK to regain its valuable position. The study says that the UK Financial Services Authority introduced some proposals in order to place greater formal restrictions on mortgage lending. Over the next 4 years, it was found that as a result of this restriction imposed on mortgage lending, the mortgages dropped by around 4 million (Leung, 2004). It is very important to consider that there are various types of mortgages with different interest rates. Researchers have pointed out that there was an inter-relationship between mortgage-interest rate and money market-interest rate (Iacoviello and Minetti, 2008). This increase in volatility reflects the importance of additional influences on the UK’s Housing Market. There were possible influences of the financial crisis. For example, it was seen that there was a substitution effect that led to the substitution of owner occupied houses to the rental houses. It was evident that the private sector rent increased at a much faster rate compared to inflation during this period. The owner occupiers started renovating their houses in order to offer these houses on rent. Another factor that can be held responsible for the fall in the UK’s housing market is that of the increased problem of unemployment. Due to high unemployment, people had less money in their hands and they could not afford new houses which led to fall in demand for houses. This further led to decline in housing prices (Iacoviello and Minetti, 2008). 4. Property market challenges affecting supply and demand conditions The study suggests that monetary policy is one of the factors that affect the demand for housing. In case of a rise in interest rate, the asset holders will prefer to hold bonds rather that purchase other assets like houses. This lowers the housing prices. There is a negative relation between the interest rate and demand for houses and this indirectly affects the purchasing power of the buyer. Thirdly, the amount that the buyer is willing to pay has a direct linkage with the interest that is to be paid for purchasing the house. This proves that current interest rates are important determinants of house prices (Rosenthal, 2006). However, the fall in housing demand gave a big jolt to the UK’s economy. In order to handle this situation, the Bank of England used a substantial policy stimulus by lowering the interest rate for home loans (Elbourne, 2008). 5. Performance of the UK’s housing market since the Crisis There were various factors that indicated that the UK’s economy would suffer a huge loss as a result of the financial crisis. The UK had a large banking sector whose role in the international financial system forced the country to realise that its economy was highly susceptible to be affected by financial shock. Another reason that led to the rise of housing prices in the UK was that of a new planning system which involved reduction of supply of houses. This restriction in supply of houses contributed to rise in demand for houses. Excess demand for houses led to further rise in national housing prices of the UK. However, it was found that although the prices rose, subsequently during the global financial crisis there was a 15% decline in housing prices after the crises (Hay, 2009). Mortgages in the UK are mostly Floating Rate Mortgages which are directly attached to Bank of England. As a result, monetary policy in the UK has a further impact on the household mortgage payment and hence the housing prices (Longstaff, 2010). Policies and procedures that are related to housing supply are the main reasons for the unresponsiveness of new housing supply to the market conditions. In the UK, variability in demand for houses is further dealt with interest rate sensitivity that gives rise to higher macroeconomic problems. However, the government of UK has made an attempt to increase the supply of land for building houses. UK therefore undertook a policy based on the forward planning in order to build sufficient number of houses. A significant study revealed that the British planning procedure involving urban extensions increased the housing prices to a greater extent making these unaffordable to the buyers (Longstaff, 2010). 6. Conclusion This study shows that the financial crisis has affected the relationship between mortgage interest rates and the housing prices in UK. The rents for houses were significantly rising as a result of the rise in demand for houses by prospective buyers. However, the restrictive policies applied by the UK government on the housing market led to lack of supply in sufficient houses. The study also reveals that the monetary policy has a significant impact on the housing prices which was examined by the Bank of England. Researchers suggested that housing prices should also be involved in the bank’s monetary policy framework because the housing market is important to determine the lending potentiality of the banks. One of the other factors responsible for the fall in the UK’s housing market is that of high unemployment because of which there is very low income in the hands of individuals. High interest rates on loans offered by banks for purchasing new houses discourages the low income groups from purchasing houses which further leads to fall in demand for houses. This study says that the relationship between mortgage interest rates and housing prices should not be overlooked as the mortgage interest rates has an impact on buyer’s affordability in purchasing houses. Reference List Agnello, L. and Schuknecht, L., 2011. Booms and busts in housing markets: determinants and implications. Journal of Housing Economics, 20(3), pp. 171-190. Buckleyand, R. M. and Tsenkova, S., 2001. Housing market systems in reforming socialist economies: Comparative indicators of performance and policy. European journal of Housing policy, 1(2), pp. 257-289. Case, K. E. and Quigley, J. M., 2008. How housing booms unwind: income effects, wealth effects, and feedbacks through financial markets. European Journal of Housing Policy, 8(2), pp. 161-180. Crotty, J., 2009. Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’. Cambridge Journal of Economics, 33(4), pp. 563-580. Elbourne, A., 2008. The UK housing market and the monetary policy transmission mechanism: An SVAR approach. Journal of Housing Economics, 17(1), pp. 65-87. Hay, C., 2009. Good inflation, bad inflation: The housing boom, economic growth and the disaggregation of inflationary preferences in the UK and Ireland. The British Journal of Politics & International Relations, 11(3), pp. 461-478. Iacoviello, M. and Minetti, R., 2008. The credit channel of monetary policy: Evidence from the housing market. Journal of Macroeconomics, 30(1), pp. 69-96. Leung, C., 2004. Macroeconomics and housing: a review of the literature. Journal of Housing Economics, 13(4), pp. 249-267. Longstaff, F. A., 2010. The subprime credit crisis and contagion in financial markets. Journal of Financial Economics, 97(3), pp. 436-450. Ortalo-Magne, F. and Rady, S., 2006. Housing market dynamics: On the contribution of income shocks and credit constraints. The Review of Economic Studies, 73(2), pp. 459-485. Rosenthal, L., 2006. Efficiency and Seasonality in the UK Housing Market, 1991–2001. Oxford Bulletin of Economics and Statistics, 68(3), pp. 289-317. White, M. and Allmendinger, P., 2003. Land-use planning and the housing market: A comparative review of the UK and the USA. Urban Studies, 40(5-6), pp. 953-972. Read More