Why are house prices so high? And what could make them more affordable?
House prices in the UK are at an all-time high – but they just keep going higher. And that’s not because of rich foreign buyers or a lack of supply, says John Stepek. It’s for the same reason every other asset class is so expensive.
House prices in the UK keep going up. This is nothing special – rising house prices are a problem everywhere.
And yes, they are a problem. I don't think it's healthy for the vast majority of the population to be worried about the cost – and huge indebtedness required – to attain then keep a roof over their heads. But what's the solution?
Here's the simple reason house prices are so high
Why are house prices generally high? That's obvious. It's for the same reason that every other asset price is high: interest rates are low.
Here's how it works. Let's say you can afford to pay £1,000 a month for your mortgage; if interest rates suddenly plunge to 2% from 10% (and let's assume it's not because there's been a massive crisis, which clearly is the only way that this scenario could ever happen), you'll be able to borrow much more money than if interest rates are at 10%. In other words, £1,000 a month gets you a much bigger mortgage at 2% compared to 10%. So off you go into the market, wielding what looks like absolutely massive amounts of buying power.
But guess what? Everyone else has the same increased buying power. So the same house you wanted to buy when rates were at 10% is still the same house when rates are 2%. But the amount you can afford to pay for it has shot up, so the house price shoots up. It really is that simple.
So this is the primary driver of prices, not physical supply and demand. You could literally pave the entire country over and put rabbit hutches for humans in every corner. House prices might fall – but they'd still cost more with interest rates at 2% than at 10%.
If you struggle to believe this then you need only look beyond the UK's fair shores. Almost everywhere in the world right now is struggling with some level of political irritation or other because residential property prices have gone up to the point where the “wealth effect” enjoyed by the owners is being outweighed by the “deprivation effect” being endured by non-owners.
New Zealand is currently at the cutting edge of acknowledging this problem and is telling its central bank to take house prices into account when considering monetary policy. Whether they can do anything about it is another matter, although mortgage controls are the most obvious tool (that said, New Zealand is only now phasing out mortgage interest relief on investment properties – the UK started doing that five years ago, which did help to bring London prices in particular down for a little while).
How the pandemic could ease some of the pressure in the property market
Anyway – where does physical supply fit into all this? I'm honestly not convinced that it does. London is the place that's most out of step with the rest of the UK. As Martin Wolf pointed out in his FT column yesterday, in which he argues for more physical supply, London is even less affordable than the rest of the country.
However, again, take a look around the world. Big cities everywhere – global cities – have seen their prices boom, often in spite of efforts by national governments to crack down on “wealthy speculators” – ie, rich foreigners.
On the one hand, these are cities where people like to own trophy properties. So the top-end house prices are more comparable to works of art, and other assets whose sole value derives from the amount of money sloshing around in the world at any given time.
On the other hand, these are the places where the jobs are. People have a certain monthly budget for commuting expenses and for housing costs. If you cut the commuting cost (and stress) you pay more in housing costs. The further out you go from London, the cheaper your property, but the higher the cost of your season ticket (and the more hassle you have to put up with).
This is where the pandemic might actually have a silver lining. If interest rates are going to remain low for the foreseeable future (which seems likely, even if they nudge up a bit), then the best way to improve affordability surely has to be to extend the viable commuting distance.
If working from home remains a permanent fixture to any extent (which seems very likely) then some of the pressure will be taken off the big cities. We've already seen it happen in London rents. That won't last forever – much of that is due to lost tourist traffic which will return at some point – but you'd expect it to feed into the capital's house prices at some point.
Meanwhile, places outside London will get more of a look-in as people realise that they really can broaden their geographic horizons without restricting their career choices. As far as I can see, in the short term, that's the most hopeful outcome in terms of making house prices generally more affordable. Spreading the pain, as it were.
In the longer run – well that very much depends on inflation and whether we get enough of it to hack away at "real" prices without being too destabilising. What are the odds of that?
That's something we'll be writing a lot more about during the course of this year in MoneyWeek magazine. Get your first six issues, plus a beginner's guide to bitcoin, absolutely free here.