The housing market is the term we use to describe the process through which individuals purchase and sell homes, whether for personal use or as investments like buy-to-let and renovation projects. Many people’s most important financial asset is their home. Our homes are likely to be the most expensive things that we ever purchase over the course of our lives.

Two-thirds of British households own their home outright, with half of those still making mortgage payments (2020 figures). A third of UK households are renters, split about evenly between private and social renting.

What is the importance of the UK housing market to the economy?

Consumer spending of any kind has a direct impact on the property market. When the value of a property increases (sometimes called a “rising market”), homeowners feel more secure and assured in their overall financial situation. With consumer confidence riding high due to a buoyant housing market, some will borrow more against the value of their property to spend on goods and services, repair their home or pay off existing debt.

On the other hand, homeowners face the possibility of their property being worth less than the mortgage they owe if house values fall. This is called “negative equity.” As a result, there is a greater chance that people will not make personal investments and cut back on their spending because of a downturn in the economy.

In the United Kingdom, mortgage loans constitute the highest level of personal debt. The banking system may be put at risk if a significant number of people take out loans that are well beyond their means to repay or compared to the value of their homes, on which the mortgage is secured.

The amount of money spent on housing investment is a modest but erratic percentage of the economy’s total output. The purchase of a newly constructed home (sometimes called a “new build” and which is popular with off-plan investors) adds to total production (GDP), for example, through investments in land and building supplies and the creation of employment. This wealth creation, in turn, will also benefit the areas where the new builds are constructed through added business to local shops and services.

Purchasing and selling existing stock of homes, on the other hand, does not have the same impact on the UK’s GDP as building new homes. It’s not all bad news for the economy, however. Estate agency fees, lawyers’, or surveyors’ expenses, as well as the cost of new furniture or paint, might all be included in these costs and contribute to the economic engine of society. All this economic activity creates monetary velocity as it moves around the system.

What causes home price fluctuations?

If there is one area of the economy where prices have changed dramatically over the years, it is house prices.

When I was a kid back in the mid-to-late 70s, the typical cost of a home was around £10,000. The average price has climbed to a staggering £200,000 during the past 40 years. Although the overall cost of goods and services has increased, housing prices have risen by about three times what they were in the late 1970s.

Many factors contribute to the fluctuations in house prices, both up and down. For starters, if individuals believe they will be significantly wealthier in the future, they will have more consumer spending confidence and house prices will often rise to reflect this. When the economy is performing well, more people are working and their incomes are rising, which leads to this type of situation.

The more individuals who can afford to purchase a property by borrowing, the higher the price will rise in response. Of course, this will depend on the willingness of lending institutions to lend, and more individuals will be able to purchase a home if lending institutions and building societies increase their willingness to grant mortgages.

Key interest rates imposed by the Bank of England also influence property values. Buying a home becomes more affordable for more individuals when interest rates are low and the cost of borrowing money to do so is reduced. That means prices are likely to rise as a result, since lower borrowing costs will mean more money circulating in the system chasing the goods and services available.

Furthermore, there are other more important factors involved in the rise or fall of house prices.

For example, as the population grows or the number of single-person households rises, the demand for housing will likely rise to reflect this. In general, rising demand for a product, including property, will result in higher prices, depending on the number of new houses coming onto the market.

According to Jamie Johnson, CEO of FJP Investment, “If fewer homes are developed, the supply of housing stock will be reduced, and prices will rise as a result. Indeed, the chronic UK housing crisis is intimately related to insufficient new-build housing entering the market for buying and renting. If too few houses are being built, homebuyers and renters will have to compete by raising the amount of money they are ready to spend in order to acquire a home.”

Psychological factors also play a role in house prices. For example, there have also been occasions when property prices have risen significantly due to people’s belief that prices will continue to climb and a housing market bubble will be created. When a housing bubble bursts, it is invariably followed by a slump in the housing market.

This occurred back in the 1980s, by the way. Between 1984 and 1989, house prices rose at a rate more than twice the rate of wage growth. Over the course of the following five years, property values fell at an unsustainable rate. After that, it wasn’t until 1999 that property values returned to 1989 levels.