What does drive house prices?

One of the features of economic life is that central bankers are obsessed with wealth effects. I have various examples of this from just the last week and I do not even need to leave the UK to get them! Let me start with something from the Bank Underground site and this bit does point out some interesting thoughts.

The value of the whole stock of housing is given by the price of the (tiny) fraction that changes hands in any given month (less than 0.5% in 2017). On one level, those prices are set by what the buyers and sellers active in the market are willing to offer and accept. But, more fundamentally, what those customers are willing to pay or accept for a house depends on expectations about the future path of prices and rents, not to mention the (perceived) value of their own or neighbouring houses.

The opening salvo is a point I often make in response to those who publish figures about the value of the UK housing stock as I note one in the Financial Times from the beginning of last year claiming it was £7.14 trillion. Where I am only partly in agreement is with the expectations of prices and rents. Many people buy and take no notice of the rental value. I am one example of that and have only ever taken more than a cursory interest when I have been considering working abroad.

So whilst I have sympathy with the argument there are issues which have been pointed out in the comments to the piece.

Houses should be viewed as a place to live vs an investment.

Also a more subtle one which will matter more in a bit pointing out that renting and owning are different in more than just the obvious ways.

The flaw in the argument that each house sold by a landlord either goes to a landlord or a former renter is that renters are more likely to share living space. To understand this you don’t get too many houses of multiple occupation in the owner-occupied sector, whilst “spare rooms” are rarer in the rental market.

Why does this matter?

Well there was a second article and look where the logic applied leads to and the emphasis is mine.

In yesterday’s post we argued that housing is an asset, whose value should be determined by the expected future value of rents, rather than a textbook demand and supply for physical dwellings.

So in the two days after the announcement that the RPI measure of inflation will be changed by removing house prices and mortgage interest-rates and replacing them with rents that are never paid we get this.What a coincidence of timing! What are the odds of that do you think? If the blog wishes to claim that it is independent of Bank thinking then it does not advance its case with either the timing of this. It is like living an episode of Yes Prime Minister.

On a personal level I cannot recall ever thinking much about rents when I purchased my flat. Those I know who do let properties always seem more concerned about price rises than the rents. But let us suspend reality for a moment as we note they say”should be” which is rather different to is.

Where does this take us?

We get a type of explanation of rising house prices over the past 20 years in the UK.

Lower interest-rates raise house prices by increasing the present value of future cash flows.

Really? As for example you can argue that people often buy the maximum they can afford so prices rise because the payment now is lower and then expect house prices to rise. Or as pointed out earlier they simply want to live in as nice a place as they can.

I am afraid they then completely lose the plot.

These effects can be powerful, especially when interest rates are already very low.

Absolute rubbish and a clear case of imposing theory on reality rather than the other way around. Otherwise house prices would be surging in the UK right now in response to the fall in Gilt yields.

They use the CPI inflation measure to give an idea of real house price growth which is revealing as I would argue you learn as much and maybe more by looking at real wages.

First up, the grey bars show the role of CPI inflation. If house prices rose at the same rate as goods in general, they’d have risen by 50% since 2000. So what explains the remaining 60pp of real house price growth?

On this road they discover this.

By far the largest contributor is the lower discount rate (green bars), which accounts for almost all real house price rises since 2000. We completely shut down any role of interest rates beyond 20 years.

I have quoted the second sentence because this highlights a flaw in this sort of approach which is that the answers you get are invariably driven by the assumptions that you make.

David Miles

For those of you who are unaware Professor Miles was on the Monetary Policy Committee until 2013. If you look at his voting record and apply the logic above he did everything he could to pump up house prices. In a example of the ” I can see for miles and miles and miles” lyric of the WHO not applying he was voting for more QE in 2013 as UK economic growth was lifting off.

Now he has written this as part of a blog for the Resident Landlords Association.

there are few signs it has benefited those hoping to become home owners

He seems to have missed that in recent times for the first time in quite a while both wage and real wage growth is faster than house prices. Most ( maybe everyone except David ) would see this as a benefit and many will join me in hoping for more of it.

I am sure the RLA lapped this up but if you look at what rents are actually doing the statement below looks pretty evidence free.

But aspiring first-time buyers are hardly helped by squeezing the supply of rental property and driving rents up.

More than a few will be wondering about the rising real incomes point below.

And there are good economic reasons for believing that in a country with a rising population and where real incomes tend to increase over time house prices might well rise at least as fast as incomes.

The problem for David is that he was a supporter of every policy which would pump up house prices and in an irony mostly failing as the rises happened afterwards. But what he ignores is that the rental business model shifted from income/rent to capital gain or profit.

Oh and in an irony by stopping house prices falling the policies of David Miles pushed more people onto renting. Perhaps that is what is bothering him now.


Let me now explain what I think determines house prices and let me start with something not addressed by the Bank of England. That is the number of cash purchases. These have accounted for between 30 and 40% of all purchases in the credit crunch era. Why?

  1. Somewhere to live and they presumably like it
  2. They think house prices will rise further. After all the perception that they can only rise has been reinforced by Bank of England policy
  3. Some of this is international as we see foreign buyers who may be applying points 1 and 2 or using the UK as a safe haven

Whilst there may be an indirect effect from lower interest-rates and yields in terms of opportunity cost there is no explicit link here for many. Some may rent the property out though.

Next we get to those taking out a mortgage and we see that the same 3 points apply. But I think that point 2 gets stronger as the belief that house prices can only rise, and lets face it for millennials they pretty much only ever have, trumps nearly everything. So they borrow as much as they can partly because these days they get so little for it. I know that the explanation is perverse but reality is that perverse demand curves do exist. As much of that borrowing these days is via fixed mortgage-rates you come to a similar answer to the Bank of England but without the spinning to suit its Ivory Tower theories. The same theories independently held by HM Treasury. the UK Statistics Office and the Office for National Statistics in a happy coincidence.

Lastly we have the rental model for the buy to let investor. They are much more likely to be influenced by the rental model and hence the discount rates of Bank of England theory.

However there are also regional factors as we often observe on here which includes the balance between supply and demand. We never get a full answer to the latter which is illustrated by the area near where I live. Prices surged driven partly by foreign buyers so now more properties have or are being built, just in time for at least some of the buyers to disappear.




11 thoughts on “What does drive house prices?

  1. In three words SUPPLY AND DEMAND.

    Supply and demand affects nearly everything we buy although there are other factors which affect both supply and demand.

    1. Affordability in a particular area

    2. Type of houses and demand demographics in a particular area, the richer the households the higher the prices the poorer to households the lower the prices.

    3. Buy to let demand

    4. Low interest rates

    5. Government subsidies like HELP TO BUY

    6.Crime-low crime areas affect the price of houses

    7. Transport links, schools, shops, places to go-parks and entertainment, the list goes on

    8. Culture-birds of a feather flock together

    9. Safety and insurance risk, flood plains and risk of floods affect house prices so does subsidence risk

    10. Weather !

    These are my 10 most ten pointers I suppose number 9 could include war regions and earthquakes but readers get the gist.

    • Supply of cheap and easy debt is the main contributing factor.

      Places such as Spain, USA, Ireland were building houses like never before in the run up to the crash in 2007/8 …. yet prices were going through the roof.

      Certainly no issue with supply then.

      Remove QE and raise interest rates and prices would crash, hence why they don’t.

      • I disagree Arthur but won’t vote you down.

        What also I missed out is supply versus population but that could be covered by supply and demand.

        To be honest about all this there are just loads of different factors and things can change from one era to another.

        If the council decided to build one of the largest prisons or waste treatment plants next to a high value property area the houses would fall.

        They would also fall if suddenly a nuclear reactor kept having leaks

        Cheap debt is a problem dependant which side the fence you are on. At the end of the day the lack of supply should be the determining factor but bear in mind if all the houses were owned by one conglomerate supply could be restricted.

        Some of the highest sky scrapers still lay almos empty the owners not wanting to sell at a lowe price thus governing the price of the property and limiting the supply.

        In the UK there has have been many foreign investors building and buying large blocks of flats and they could if they wanted sit on them for a while if they thought property was still undervalued.

        As for cheap dent if interest rates rose then inflation would likely rise as well and then in turn further push property prices higher.

        I remember in the 70s buying a flat for 25k and interest rates went over double digits my flat trebled in value in circa 3-4 years so had experience of that.

        Inflation causes high interest rates which amounts to dear debt which in turn increased property prices.

      • Yes Arthur, its supply and demand of cheap credit , plus demographic pressure, that applies to the mass market.
        However in Prime London and one or two other spots in the UK its about asset value and wealth protection, as it is in Prime Paris, NY, etc etc. There the equation has nothing to do with credit, this is where most cash purchases happen, its about spreading risk. The owner looks upon the property as just one if his/her asset classes in their portfolio.
        These apply to both owner-occupied and BtL properties. However the DIY BtLers just look at capital appreciation as their costs and risks generally outweigh the revenue especially after changes to mortgage tax relief. This will only get worse if Jeremy is PM. A lot of the DIY BtLers are leaving the market, which of course helps depress their capital gains.

        • Jim,
          Yes I agree high wealth area is the key in London, the desire to live in a relatively safe country where there are the best restaurants and theatres, and shops and the wealth like to live in an area where they feel affluent.

          However if the world did implode credit dry up and shares and other assets started to collapse London prices would indeed fall.

          I also believe the higher the prices they more they fall they lower the prices the lower they fall in percentage terms that is.

          • Peter, some live in them , most don’t they invest in them like any other asset class. Prices might fall for a time , but its part of a portfolio, they expect that. These are rich global players, they are just risk managing their wealth.

      • Indeed it is Arthur, I am in California with work this week. I was sat at a collegaue meal table alst night. Someone I would count as a peer group professional. She confessed that the rather small home she had bought in Cupertino cost $2.5M 6 years ago. Although it is now valued ar $4M. She shops at discount malls and says that she does not feel particulalry rich. I do not see this as simpy “supply and demand” driving prices. As an aside, there are lots of poorly maintained shacks and 1970’s buildings here in California.

  2. Hi Shaun
    Thank you for an interesting topic,
    Their are many people who own,in it’s
    correct sense, properties that are empty
    because of bad experiences with former
    tenants. even though they pay extra
    property tax and get letters from their local
    councils offering “help” it doesn’t make much
    sense to re-rent or sell these properties in the
    current market with ZIRP. I suppose it’s a
    similar position to large investors looking for a
    safe haven.
    Lets suppose that a new government raised
    funds to build thousands of new homes very
    quickly, what percentage of rental income
    would have to be funded by the welfare system?
    If this happened demand would be reduced but
    would prices fall?
    I await the downticks, but this is reality.


  3. Hi,
    I disagree slightly about whether people consider rental value. People who *are* renting certainly look at what they’re paying compared to what they would pay on a mortgage per month (with the huge improvement in security and of course long-term value that paying that mortgage off brings).

    Landlords do have to cope with bad tenants, but at the same time the rental market in the UK treats renters like dirt so it’s hard to see why tenants would extend basic courtesy to a landlord who fobs all their responsibilities off onto an agent and who reserves the right to thrown them out on the street on a few months notice after years of living in a house. Renting in the UK is a mugs game where the renter is basically paying for the landlord’s lifestyle and getting very little back for their money compared to what they would get for the same money if they could scrape together a deposit for a place of their own.

    Well, I’m starting to rant now so I’ll stop.

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