Demand Curve Shifts And House Prices example essay topic

Economist points out that investors have turned away from the stock market to investing in bigger houses or second homes to let. This is so, because the housing market offers higher profits than the stock market. While in the past house and share prices moved in the same direction, recently, this relationship has been reversed with equities falling and house prices rising. The authors are concerned that the demand curve for houses shifted too far. Once share prices recover and investors expect relatively higher returns in the stock market, funds will shift away from the housing market. This could be viewed as de stabilising speculation.

Even if houses are mainly bought for people to live in and the number of houses bought solely for speculative purposes is very low, the author may look at a wider problem. This is so if people have borrowed every penny they can in order to buy bigger and more expensive houses (than they may actually need) in order to use their family houses simultaneously for speculation. Times points out that a measure for affordability should be the ratio of monthly mortgage payment as a percentage of monthly disposable income. Then, buying houses has never been so cheap: historically low interest rates and real incomes have risen significantly. 'Put simply, if interest rates are a third of the level of 15 years ago, then on the basis of the average monthly pay packet, the typical household can afford a house that is three times the price of the last peak'. They stress that the average house price is less than double the average house price in 1980's, indicating that households do not make full use of the increased affordability.

Further, they expect that interest rates will only rise moderately and thus will only have a small effect on affordability. The authors conclude that there is no imminent danger of a bubble at the moment, although they expect house prices to fall regionally. In contrast to this stands the more recent BBC News article, which points out that the generally calculated affordability ratio ignores e.g. endowment policy contributions. Taking those and others also into account, the ratio is much higher. Times mentions that the loan advance to income ratio has slightly risen on average to 2.5 times the income. However, recently, lenders are competing to offer loans 4 or 5 times the gross income.

Lenders also provide re-mortgage possibilities on capital gains without borrowers having to invest funds in house improvement. Further, UK households' debts on credit cards have risen sharply (see e.g. this Tuesday's Guardian). It appears that only a small disturbance in the market could lead to a chain of negative events. Authors of all articles ignore the role of expectations. If buyers expect interest rates to rise, they may become less willing to enter into long-term mortgage contracts. At least, they may reduce the amount of their commitment.

If buyers are expecting house prices to fall, they will hold back buying now. In both cases, the demand curve shifts and house prices will fall.