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Determinants of house prices in Britain

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Britain is bound for recession within the next year, and the only way to avoid a 1990s situation is to cut interest rates now. To fight the recession, The Bank of England need to cut down the interest rates. Every day all the economist and news paper are saying that all the warning signs are pointing to a mini slump but to make sure it does not turn into something more major, the Bank of England needs to act now.


The last few years have seen the UK housing market and house prices grab many headlines in the media. Large changes in residential property prices has become one of the most frequently discussed issues, even by the common man on the street. London and the South East have seen the biggest price hikes in the property market in the country since 2004. However, the emergence of the credit crunch in late 2007 has seen house prices come down from their record high levels. In this report we analyses the movements in the housing market over the last five years, discuss the reasons behind these large movements, by considering the demand and supply factors and forecast the path that the housing market is likely to follow in the years to come.

How the housing market works:

Sloman describe "if you are thinking of buying a house sometime in the future, then you may well follow the fortunes of the housing market with some trepidation. In the late 2004 s there was a housing price explosion in the UK: in fact, between 2006 and 2008house prices doubled. After several years of falling or gently rising house prices in the early and mid-1990s,there was another boom from 2006 to 2009, with house prices rising by 26% per year at the peak(in the 12 months to January 2007). For many, owning a home of their own was becoming a mere dream."(p46).

The Determinants of House Prices:

Sloman further describe "House prices are determined by demand and supply. If demand rises (i.e. shifts to the right) or if supply falls (i.e. shifts to the left), the equilibrium price of houses will rise. Similarly, if demand falls or supply rises, the equilibrium price will fall. (p47)

Demand and supply for housing

The determinate for the pricing of both local and national housing markets is a typical example of microeconomics at work! What is evident is the direct communication between the purchaser and seller with prices being offered and agreed upon before a final transaction is completed. In this section we concentrate on the demand and supply side factors that help establish the value of properties within a given market.

A Sellers Market

A market where the demand for properties within a given region is high and the supply for such properties is scarce is often referred to as a seller's market. If such a property is made available for purchase there is likely to be increased interest, this providing the seller to maximize his/her profit. This scenario is often synonymous with what takes place in popular regions such as central London, with little space to carry out further construction to house people, properties on the open market are in high demand thus inflating the purchase price.

A Buyers Marker

On the contrary when the demand for housing within a given region is low and there is a considerable volume of housing available on the open market is referred as a buyers market. A buyer is in a position of strength having the possibility of being able to negotiate the purchase price to a greater extent. This scenario is currently a reflection of what is taking places within regions of greater London, with people unable to service their mortgages a glut of properties are available for sale, and with buyers struggling to raise the capital to purchase properties due to banks offering costly mortgages house prices are falling and buyers are able to further negotiate prices.

When the demand for houses in a particular region increase (possibly due to an influx of people into a given area, or due to an increment in earnings following a reduction in unemployment), there is upward pressure on market prices.

Frequently the supply of obtainable properties in the market is relatively inelastic. This is due to there being time lags between a change in price and an increase in the supply of new properties becoming available, or other homeowners making their properties available on the housing market.

When the demand shifts outwards and supply is inelastic the result is a greater increase in the market price and a relatively minute expansion of the quantity of housing traded. As supply becomes more elastic over a period of time, on the assumption the conditions of demand remains similar, we expect to see downward pressure on prices and a further rise in the equilibrium number of houses purchased and sold. Extract the information from the website called www.tutor2u.net

The demand for Housing is based on:

  • Expansion of real incomes - As the person's income increase his standard of living increases as well. And they look for more expensive property to move for which increase the demand for houses.
  • Consumer confidence - Confidence plays a very important role for any type of investment. If the prediction that market perform well in future home buyer will invest which push the demand upward direction. But the condition is supply should remain the same.
  • Jobs - Job is a very big factor. Financing a house is a long-term contract with a mortgage company. A person can only pay his mortgage if he is earning. Without a job neither he can pay nor lenders will offer him a mortgage.


There are a lot of mix trend in the house market since 1980s. Some time market booms and sometime crash. In general, market actually effects by a number of different factors such as income, competitors, population, unemployment etc. As we are discussing London house market.

London is the biggest and busiest place in UK. It calls as a business hub. As there are a lot of opportunities in London, everyone wants to work in London and because of the increase population house prices are going up and up. It will increase more in future as more counties are joining in European member. But the supply is less than the demand for limited land.

Let analysis the last five years in the London housing market. As we see there is a mix trend in the market because of good or bad events. Before 2006 the market was very slow especially in London as compare to other market, but from September to October 2007 house price rise by 2.0% from 15.5% to 16.1% according to Nationwide(source: www. nationwide.co.uk/hpi/historical/MPR0310.pdf) Date: 09-AUG-2008, time 05:33pm.

This indicates that some strength has returned to the housing market. And London market is improving and getting stronger. The house market remained firm in November with the price of the typical house rising 1.2% during the month. The housing market finish strong in 2006 and carry forward much of the momentum to the beginning of the next year.

In the beginning of 2007 the demand for houses remains up. And the forecast for the year 2007was 9% according to nationwide (www.nationwide.co.uk/hpi/historical/2004Forecast.pdf) access on 08-AUG-2008 at 07:00pm. But the house price fell in August after a 7 month increased. Due to high interest rate which rises so many times during the year shaken buyers' confidences. After a three month disappointing period house price again starts breathing and rose 1.0% in November as annual price inflation eases to 15% according to nationwide price index. But because of the market instability the price goes down in December by 0.2%. The overall price was satisfactory as compare to 2007 because of improved prospects for city jobs and supply shortages kept house price rising.

The determination of price in the housing market is based on demand and supply, therefore the price the seller is willing to sell the property to the buyer and the price the buyer can afford and willing to purchase the property. If there is a great demand for property in a locality then the seller has a greater amount of power than if there is a large supply of properties with little supply then the power shifts to the buyer. Demand can be affected by internal and external factors which will be mentioned later.

Demand and supply (Increase in demand)

Housing demand can increase, due to an increase in the local population, rise in incomes from lower unemployment. Supply of housing is relatively inelastic because of the time lag between a change in price and an increase of supply of new property becoming available or sellers deciding to put their house up for sale. When demand moves outwards and the supply is inelastic, then there will be an increase in the market price over a small expansion in the number of houses.

Slow economic growth and weak financial markets, has meant interest rates will unlikely move significantly upwards from their twenty-five year lows in order to promote growth within the UK. One reason why people were attracted to buying a house at the moment is because of the low interest base rate. As the interest rate has increased recently (November 2006) due to an increase in economic growth will this have an impact on house prices.

The cut in interest rates from 7.5% in October 2006 to 5% in June 2006 was said to be a major factor in the acceleration in housing market activity during the summer of 2006. Equally the series of increases in interest rates from 5% in June 2005 to 6% by February 2007 helped to take some of the excess demand out of the market, and to curb the steady house price inflation during the summer of 2006.

When there is a cut in interest rates the lower mortgage rates should stimulate an increase in new mortgage approvals and generally cause an expansion in housing market activity.

Interest rates can affect consumer expenditure. If we have low interest rates we are more inclined to borrow money for buying houses (mortgage). From the AD graph you can see that if we spend more then GDP rises. If the government increases the interest rates we will get more money back when we save. This will slow down the economy because consumer does not spend as much. This can be seen on the AD graph if we decrease consumer expenditure the AD goes down and so does GDP.

As far as the year 2005 is concerned, prices in the UK increased by 3% as compared to 12.7% in 2004. During the past 12 months the average home in the UK had seen its value rise by just over £4500 to £157,250 roughly the same level that house prices were at in May this year. That improvement in the London market had to do with the reduction of interest rate by the bank of England in combination with growth in employment and high demand. Another factor that added confidence to the buyer was the successful Olympic bid. The economic condition in that time favour the housing market but still there was a question mark for the first time buyers on how they can effort to make a new step towards the market .The prediction for 2006 was a stable market and small increase between 0-3%( source- www.nationwide.co.uk/hpi/historical/2006Forecast.pdf).

Commenting on the forecasts, Fionnuala Earley, Nationwide's Group Economist, said:

"According to Gordon Brown, 2005 was the "toughest and most challenging year for the economy since 2005". But even then, the UK housing market has been very well behaved. This is remarkable given its volatile history, often with several years of increasing prices followed by severe falls. Many predicted the same for the housing market in 2005 following 9 years of rising house prices, but at the end of 2005, a crash hadn't occurred. Instead the annual rate of house price inflation is at a far more modest and seemingly stable 2.4%. Looking forward, we now expect that the housing market will remain fairly subdued with house prices in 2006 rising by 0-3% when accessed on (www.nationwide.co.uk/hpi/historical/2006Forecast.pdf)

There was an impressive start at the beginning of 2006 in the House market with price increasing by 1.4% in January. This is the strongest monthly rate of growth since July 2004 when it was 1.9%.when accessed on

(www.nationwide.co.uk/hpi/historical/Jan2006.pdf). The whole 2006 was favorable for housing market especially for London where house price in Q4 was £269,327 more than one and a half time higher than the average price in the UK of £172,065. During the final quarter, the rate of house price growth in London accelerated to 4.1% up from 2.6% in the previous quarter according to nationwide report. (www.nationwide.co.uk/hpi/historical/Q4_Full.pdf). access on 10-AUG-2008 at 11:00pm. And it's all due to decrease in interest rate and shortage of house supply. As London is the business hub, there are a lot of job opportunities than other regions. That's why all people were migrated from all around UK to London.

As you see the demand shifts upwards due to fall in interest rate.

When looking at is it possible to predict house prices? what certainness is there that those who predict will have an accurate account of what will happen. The most explosive action in the last few years was the boom and bust of the late 2000's to the The property boom was due to the deregulation of the financial institutions from the mid-2007s, this ended the quantity-rationing of mortgages, allowing banks to compete equally with building societies which increased the volume of loans, doubling between 2005and 2008, and increased availability of high proportion mortgages, (up to 100 per cent) and high loan to income ratios. Growth in incomes also increased the demand for home ownership, and tax cuts increased personal disposable income and expenditure. Domestic rates were abolished in the financial year of 1988/89 in England, which suddenly made housing; particularly at the upper end of the market appear more affordable. After Black Monday, October 1987, interest rates fell to a new low of 7.5%. Therefore this increased the demand for homes where a shortage of housing meant that the price of properties would have to increase to satisfy demand.

There was a worldwide recession also at this time. Unemployment was slowly rising, which reflected on real incomes. Inequality and poverty were both rising, and all this together combined to show a surge in borrowing and consumption, credit and house prices. The government in an attempt to slow down the economy put the basic interest rates up. It was hoped that this would slow down the economy and stop the rise in inflation. This failed for the government and resulted in a recession.

High interest rates made industries struggle and led to high unemployment levels. In May 2006, interest rates had been at 9.5%, two years later, increased to 15.4%. The increase in unemployment and interest rates meant that demand for housing. A vicious circle then formed, as jobs were being lost through the building trade, more households were being reduced to one income, and then more and more owner occupied houses were unable to pay the mortgage and the in turn ended up having arrears on the properties with eventual repossession. This shows that interest rates employment levels, government policies and worldwide economy all have to be taken into account when accessing house prices.

Time Series Graph

This time series graph is base on the above data in the table, for average house price in London from 2003 to 2008. Which shows a decline in the average price in 2008.

Forecast for House Price in London 2009-2010

The current state of the UK housing market. Prices (blue line) are seasonally adjusted and based on Kalman filtering of monthly Halifax house prices and estimates of house price inflation derived from monthly mortgage approval numbers. A possible future trajectory is based on spread betting prices for the Halifax Quarterly Index, mid-August 2007.

Update 7th August 2008

Source http://www.houseprices.uk.net/articles/house_price_predictor/

Well after all the analysis from 2004 to 2009 not only economist but also a common man can predict the movement of house price in next two years. As you see in the above graph the housing market predictor predicts a decline in the house price next year. Property prices in London will plunge by 12.5% this year, an influential housing report said today. And values will drop by a further 8% next year, according to property consultants company Jones Lang La Salle.The report said an average property in London will be worth £2266,000 at the end of this year compared with £300,000 last year. But there was one ray of hope for the capital's beleaguered homeowners by 2010; London is expected to be leading a UK property market recovery. The report said house prices in London would rise by 1.5% in 2010 according to the London paper. (www.thelondonpaper.com) Access on 08-AUG-2008 at 05:00pm.

If the market keep falling and financial crises don't disappear, people will start selling their houses and will move outside London which as compare seems cheaper and better option. Capital Economics predicts prices to fall by 5% in 2008 and 8% in 2009. www.timesonline.co.uk Access on 11-AUG-2008 at 1:30pm

The British Chamber of Commerce predicts a technical recession in its quarterly economic forecast out today. That means the country will see two or more quarters of declining output over the next six to nine months. (www.metro.co.uk) access on 10-AUG-2008 at 02:00pm.

Due to all these forecast frustrated vendors have been placing their property in the market to let as they have been unable to agree sales due to a lack of demand in the housing market.


Britain is bound for recession within the next year and the only way to avoid a 1990s situation is to cut interest rates now. To fight with the recession Bank of England need to cut down the interest rate. Every day all the economist and news paper are saying that all the warning signs are pointing to a mini slump but to make sure it does not turn into something more major, the Bank of England needs to act now.

Eventually the property market become stable but everyone is hoping that house market will be fine because of Olympic which is a wrong prediction because in Olympic visitors will come and rent the property or stay in hotels but not going to buy the property for the sake of Olympic. There are few factors by which hope is good for the future in property market which are:

  • Low Unemployment which at the movement is high especially after credit crunch.
  • Low inflation
  • Low Interest rate
  • Demand will exceed due to a good return in rental market
  • London city is still ,was and always be a first choice for local migrant due to good work opportunity
  • A lot of migration from whole Europe after signing European Union push the demand upward and will push in future as well due to more population but the supply for houses are limited.

Will help to improve with 2012 Olympic.


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www.nationwide.co.uk/hpi/historical/2006Forecast.pdf Access on 09/06/2009 at 8:00pm

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www.metro.co.uk Access on 10/06/2009 at 02:00pm

www.houseprices.uk.net/articles/house_price_predictor/ Access on 11/06/2009 at 08:15am

http://www.investopedia.com/university/economics/economics3.asp Access on 11/06/2009 at 09:35am

http://www.guardian.co.uk/business/2009/oct/19/fsa-tough-new-mortgage-... Access on 11/06/2009 at 09:50am

http://www.kent.ac.uk/ESRC/munro.html Access on 11/06/2009 at 11:50am

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