MBA Programme-SAIM Assignment

8/8/2019 MBA Programme-SAIM Assignment

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MBA Programme-SAIM Assignment

UK HOUSING MARKET : THE ANALYSIS OF FACTORS AND GOVERNMENT POLICIES

THAT INFLUENCE AND DETERMINE THE PRICE OF HOUSES .



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Introduction

The United Kingdom , located off the northwest of coast continental Europe, is a state of over 59 million inhabitants. its housing market is one of the biggest in the whole world in

term of figures to such an extent that every imbalance between demand and supply generates tensions 1 throughout the entire UK economy and worries its gouvernment.

This permanet infatuation around this market can be explained by the fact that mostpeople don’t buy houses for accomodating only but also and especially as an investmentfor the future. Thus, every increase or decrease of house prices make feel them richer orpoorer.

However, given the immensity of this market, this paper will be specifically focus on theGreat London Urban Area which is a large city of nearly 9 million souls and over 3

million dwellings (made up in 4 main categories namely flats, houses, maisonnettes andbungalows). Moreover, there are also 4 principal tenures videlicet owner occupied, sharedoccupied, privately rented and socially rented. It is suitable to say that the london housing market is generally a second hand one as the number of newly built houses per year is lessthan 0.5 per cent of the overall stock of housing. It is also suitable to remember that wedefine the housing market as both the rental market and the buying and selling market.

Besides, this work will deeply try to examine some relevant factors influencing the pricesof housing in a free market. And the other hand, the incidence of government policies on

house prices will be thorougly analysed in the context of an undoubted failure in theLondon housing market ( Harris I. (2003) 2 ) and also economic recession (i.e. creditcrunch, unemployment and so on). To do that, there will be 2 different sections namely respectively Main Factors That Influence Housing Market and Government Policies

Towards Housing Market. Lastly, there will be a general conclusion with the aim of suming up the essential points.

1 Allusion to the Subprime mortgage crisis in the United States which started from mid 2006 and changedinto a global (financial and economic) crisis.2

In a recent reserch, Harris showed the imbalance between supply and demand on the free londonhousing market that he described in these terms “there are serious consequences of the unresponsivenessof supply to growth in demand…” ; (P.51).



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I Main Factors That Influence London Housing Market

In this section, which will be crossed by both theory and practice, is going to emphasize adeep examination on those factors that influenced the London housing market from 2006

to 2009 in a relavant way. It will also look a bit about the present reality and the futureexpectation on the market. To be comprehend properly, this section will be split into 2parts which will be respectively named Fundamentals of Demand and Fundamentals of Supply. Moreover, the analysis will put the emphasis on the buying and selling market of property rather than the rental one. Indeed, figures show clearly that the mojority of housing in the Great London Urban Area is owner occupied.

1.1 Fundamentals of Demand:

There are many factors that influence the decisions of house-buyers namely essentially house prices, people’s income, mortgage rates and economic situation. On the otherhand, demographic factor and the social change are also part of the most fundamentalfactors of change in the demand for housing.

1.1.1 London house prices:

From the beginning of 1995 to the first quarter of 2002 London house prices increased by 149 per cent whilst the UK average rose by 87 per cent only.

Figure 1.1: House Prices – London versus UK (% year on year change in quarterly average house prices)

According to Nationwide and Halifax data, 2002 saw the most significant rate of houseprice growth since 1989. From 2004 to the first quarter of 2007, the data from

Nationwide show that London house prices have increased moderately. Yet, in the middle





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Given the above table, property price to earnings ratios has steadily risen from 2001 to2006 and is expected to continue growing. The situation is even worse in Kensington andChelsea where house price (averaging £663,506) were 18 times to local income. Besides,the mortgage rates knew a strong panic during the crisis reducing interest rate 3 from 5 per

cent to 2 per cent in space of 2 months only. For the moment, according to the BritishBankers Association (BBA) data, the number of mortgages approved for property purchases has sharply decreased at 17,773 against 64,014 in July 2007, a drop of 72 percent. A recent data from the Bank of England Industry-wide has stressed the weakness of the UK housing market activity. Indeed, according to the same source, the number of mortgages approved to finance property purchase was 18 per cent lower in the firstquarter of 2010 than in the fourth quarter of 2009.

Figure 1.4.: a shift on demand curve from July 2007 to July 2009

Average Price of houses S

P P’ D

D’

0 Number of houses

17,773 64,014

This shift (on the left) in demand curve is indicative of a sharp fall of complete housesales. This situation results from two main reasons: firstly, house prices grew 16 times toearnings in London. Secondly, as a consequence of the significant increase of house priceto income ratios (first reason) and then the credit crunch, the number of mortgagesapproved for house purchases has dramatically decreased from the beginning of creditcrunch (2007) to now.

3 Mortgage rates are derived from interest rate



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1.1.3 Demographic Factor and Social Change:

The demographic factor is, without doubt, one of the fundamental drivers in the demandcurve for housing. For instance, the impact of population growth, immigration rate and

changing age profile is not negligible in the demand for housing. Moreover, social change(estimated by the divorce rate, the average age of household formation, etc.) is also animportant factor.

According to data from GLA (2003), the population of London remained constant in themid 1980s coming after a long period of decline. It has since been growing till now overtaking all predictions.

Table 1.1.: London households and Population 1971-2016, thousands

Years Household Numbers Population1971 2,705 -1981 2,635 6,8061991 2,841 6,8262001 3,056 7,188

2016 3,473 7,899Source: GLA (2003)

Today, the number of residents in the city of London is over 8 million people which arehigher than 7.899 millions, i.e. GLA (2003) population prediction for 2016. Moreover,unlike the fact that the net out-migration continues to decrease steadily in London andthe whole UK the natural population growth has overtaken 50,000 people last year.

Figure 1.5.: Net migration to and from the UK, 1991-2008 (Source: Office for National Statistics)



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On top of that, the London population is more and more dominated by the 20-39 agegroups . This change in the age profile must, “other things being equal”, result in a shift indemand curve for housing.

Figure 1.6.: Age profile-London and UK (by age group 2001)

And according to a recent data from Office of National Statistics, the divorce rate hasregistered a historical low rate in 2009 since a decade.

Theoretically, as there were both an increase of natural population growth and a relativedomination of youths in the population of London between 2007 and 2009 there should

have (unlike Figure1.4.) a shift on the right in demand curve to show an increase of demand for housing.

Figure 1.7.: Theoretical shift on the right in demand curve

Average Price of houses S

P ’ P D ’

D

0 Number of houses

Q Q ’





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Moreover, many researches proved a high correlation between house price growth andland price growth. When one goes up, the other goes up as well and vise versa. Yet, ashousing market is really represented by second hand properties, a change of constructioncosts and land price has an infinitesimal consequence on supply. In reality, supply of

housing in London has relatively stabilized while demand has been increasing since adecade till 2007.

Figure 1.9.: a quasi static evolution of Supply and a sharp increase of Demand

Average Price of houses S S’

P ’ P D ’

D

0 Number of houses

Q Q'

Some reasons of why the growth in supply of housing has been very low (quasi static) canbe the increase of land prices in London.

1.2.2 Availability of Land and Funding; Cost of Finance:

Available lands in London are very few therefore very expensive. Moreover, theavailability of funding and the cost of finance depend on “who you are”. In other words,

the bigger the company the easier is finding funds and the lower is the cost of Finance. With the economic crisis, it is, however, difficult even for most big experienced buildercompanies to work normally by supplying as they used to do before the credit crunch.

Thus, London new complete houses have steadily decreased and are probably expected todo so in the two next years.



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1.2.3 Future Price Expectation:

Unlike demand, supply should theoretically decrease when the future house prices areexpected to be higher than the present ones on the market and vice versa. This deferment

of supply is logic. Indeed, suppliers will make more profit if they sell once prices arehigher. However, as future London house prices are expecting to decrease. One shouldhave this:

Figure 1.10.: Shift on the left in supply curve

Average Price of houses S’ S

P ’

P D

0 Number of houses

Q ’ Q

“Holding other factors constant”, a deferment of supply that is to say a decrease in supply will directly increase the average price of houses.



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II Government Policies Towards Housing Market

In practice, no market is totally free. There are imperfections such as tax effects,asymmetry of information, capital market imperfections, and so on. On top of this, the

speculation on housing prices has been creating an enormous bubble since a decade which has amplified the problem of affordable houses in London. Thus, for all thosereasons, the intervention of government is justified. The latter, guarantor of publicinterest, makes sure of the market fairness through regulations such as the planning system, provisions for social housing towards less favour social strata, encouragement of affordable housing supply via free tax, and so on.

Today, with the economic crisis, the UK housing market is facing 3 main issues namely inelasticity of supply, lack of social housing and fall of house prices. According to the

Independent Journal 4, the recent UK coalition government of (David Cameron and Nick Clegg) is going to announce and carry out on 22 June some policies in order to tackle thefailure of housing market.

2.1 How Would The New Coalition Government Intend To Resolve TheInelasticity Problem of Supply?

Many economists have qualified the supply of UK housing market as inelastic. Indeed,according to data from the National Housing Federation, today, there are 4.5 million

people in demand for housing.

To create a balance between demand and supply, the recent government would, according to the Independent Journal, sharply increase capital gains tax from 18 per cent (presently)to 40 or 50 per cent in order to discourage anyone to own a second home or to speculatein prices.

This policy will not increase supply. However, it will calm (down) the tension betweensupply and demand by eliminating some speculative demand. Graphically, there will be a

shift on the left in demand curve (see Figure 1.4).

2.2 Which Measures Would Be Taken For Social Housing?

The economic crisis has risen the problem of social housing. A recent data from Officefor National Statistics works out the number of households on council waiting lists forsocial housing at over 1.8 millions.

4 Simon Read

”

What does the coalition mean for your home? From fragile prices to the social housing shortage, thenew Government has an overflowing in-tray of property problems. ” Independent Journal, Friday 21 st may 2010.



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Moreover, 50,000 beneficiaries of social housing are threatened with repossession. Thecoalition government (conservative-Liberal Democrat) should support these people toavoid that the economic crisis worsens more and more.

In addition, the excess of demand or the shortage of supply of social housing should betaken into account by increasing the UK provision of social housing. Thus, thissubmarket will reach the equilibrium between supply and demand.

2.3 How Would The Government Plan To Stop The Fall Of House Prices?

In the depths of the crisis of 2007, the former prime minister by the name of GordonBrown said that “the market is in urgent need of a fix.” To do so, the government haddecided, after consulting many experts, to refinance some banks and house buildercompanies to avoid their bankruptcy as it has happened in the United States of America

with Leman Brothers and AIG Company. These measures have certainly permitted tomaintain house prices by rationing mortgages.

According to some specialists, the policies of the new government will not be focused onthe maintain of house prices. Indeed, a recent prevision says that UK house prices will bedecreased by 3% at the end of this year comparing to figures of January 2010.

In the end, if the coalition government implements these new policies; the inelasticity of supply will sharply decrease; one can expect a balance between supply and demand onsocial housing market; in the long term, UK house prices will be prevented from a dropof prices.



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Conclusion

Housing market is highly complex. Therefore, the analysis of forces that influence itssupply and demand is both hard and complicated to such an extent that very few

economic researches have been done on the subject.

In the special case of London housing market, apart from house price problems, there is areal shortage of supply. This failure of the market, inelasticity of supply, cannot beexplained only by the sole endogenous factors (such as house prices, land prices and soon). On top of that, a major question remains asked namely why very few buildings havebeen completed in London over recent years whilst house prices have been increasing sorapidly.

Moreover, the recent crisis has clearly shown that house building is a business venture. Thus, suppliers are few and very cautious.

Given these issues which prevent the market from being fair and balanced betweensupply and demand, the government intervention is ever more than necessary. Indeed,housing market is, nowadays, used as the mirror of the state of London economy on thesame basis (with) earnings growth, unemployment, consumer confidence, etc.

This report has sought to examine some influencing and relevant factors of Londonhouse prices. It has also taken the impact of government policies into account. Yet, thismini research has faced a deep lack of data of factors related to supply. We strongly believe that future researches based on more data will go into in detail to comprehendmore the fundamentals of supply in the London housing market.



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References

Great London Authority (2001), “Empty Homes in London ”, October;

Great London Authority (2002), “ The Draft London Plan ”, February;

Great London Authority (2003), “Population and Household Forecasts based on theFirst Results from the 2001Census ”, SDS Technical Report 23, January;

Halifax (2002), “Key Workers Priced Out of the Housing Market in the South ”, July Research Release;

Halifax (2003), “Residential Land Prices Significantly Outstrip House Price Growth, ” February Research Release;

Harris, I. “Market failure and the London housing market ”, GLA Economics, May 2003

Maclennan, D. (1982), “Housing Economics: An Applied Approach, Longmans ”;

Maclennan, D . and Meen, G . (1993), “Housing Markets and National Economicperformance in OECD countries: lessons for the UK ”, Briefing Paper No. 3. JosephRowntree Foundation;

Nationwide (2002), “Quarter 3 2002 Housing Review, September ” 2002,

www.bbc.co.uk ; 31st May 2010;

www.independent.co.uk ; 2nd June 2010;

www.london.gov.co.uk ; 2nd June 2010;

www.marketoracle.co.uk ; 28th May 2010.

http://www.bbc.co.uk/


http://www.independent.co.uk/


http://www.london.gov.co.uk/


http://www.marketoracle.co.uk/






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MBA Programme-SAIM Assignment