Some features of the UK Housing Market and why the UK often experiences Housing market failure.

1. Volatility. The UK Housing Market is characterised by boom and busts. There is a cycle of rapidly rising house prices followed by a sharp crash. This volatility in house prices creates problems for the real economy. When prices rise rapidly it causes a rise in consumer confidence, equity withdrawal and inflationary pressure. In the boom of the 1980s, the rise in house prices was a key factor in the inflationary growth which resulted in the boom and bust of 1991. Volatile House prices also create problems for homeowners, especially for those who buy near the peak and then face several years of negative equity.

Why Are House prices so Volatile?

• Supply is inelastic. Supply is unresponsive to rising prices because it takes a long time to gain planning permission to build new houses. Demographic trends mean demand for housing has risen at a faster rate than the supply of housing.
• Confidence Factor. When prices are rising, people are keen to make capital gains. When prices are rising, lenders are willing to loosen criteria and lender larger mortgages with small deposits, because rising prices effectively creates a deposit. Therefore rising prices encourage more to come onto the property ladder. Any change in the confidence of the housing market is exaggerated by the media who often make house prices front page news.
• When prices start to fall, the opposite occur. Lenders become nervous over negative equity so require large deposits. Consumers don’t want to buy when prices are falling. Therefore, a small fall in price becomes a large fall in price.

2. Sensitive To Interest Rates.

Despite the hopes of the government, UK Homeowners are still reluctant to take out long term fixed rate mortgages of 5, 10 or 20 year rates. This means many homeowners have variable mortgages or 2 year fixed rates. Therefore, fluctuations in the interest rates cause a significant change in demand and affordability. This is another reason why UK house prices are volatile.
(It would also create a problem if UK joined Euro and had a common monetary policy where interest rates may not be suitable.)

3. Shortage of Supply

The UK population is rising and is forecast to rise. Also demographic changes mean there are more single people because of:

• higher divorce rates
• more old people
• people leaving home early
• getting married later.

Yet, despite the predicted rise in population, the government frequently fails to meet its own targets for building new houses. The reason is that local councils and local communities often vigourously fight any new housing developments. There is a strong attachment to protecting the environment and reducing congestion (and perhaps an unconscious desire to protect value of house prices in the area) The long term shortage of supply creates a climate where rapidly rising house prices can occur with a small rise in demand.