During a period of great speculation and uncertainty, I have decided to write this blog as a reminder of why we still believe property is one of the best asset classes for long term wealth generation. Over the next three blog posts, I’ll very briefly cover a few key concepts and tools that are vital for any potential investor to be aware of. This week, I will provide a quick overview of some of the major factors that affect house prices in the UK.
Supply and demand
Historically, the supply of new housing hasn’t been able to keep up with the demand. Reports vary however it is the general thought of many industry and government experts that we need to build around 340,000 homes per year over the next 10 years to keep up with demand as well as address the current backlog. Over the last 15 years, the maximum number of houses built in a single year was 241,000 in 2018. Some years saw far less new housing, the lowest figure being from 2013 when only 125,000 new homes were built. So even in its most productive year since 2005, the UK was 100,000 below this target!
Our population is also growing. The size of the UK is relatively small and there is only so much space available. Since the 1990s the biggest contributor to population growth has been immigration, something that has a huge impact on the property market. Over the past few decades, changes in living preferences within the UK population have also exacerbated the need for more houses. For example, the younger generation tend to live in smaller groups, thus increasing the need for more 1 and 2 bedroom units rather than the 3+ bedroom dwellings that used to be more popular. Our aging population and improved healthcare also means that people need their homes for longer.
Supply and demand is the main reason why the UK property market has and will continue to rise in value over the long term. However, other factors affect the market in the short term.
Access to credit
In the years before the 2008 financial crisis, banks were involved in what was essentially uncontrolled lending. It was extremely easy to get a mortgage, and prices soared. Part of the reason that prices fell was the fact that banks changed their policies and made it extremely difficult for people to borrow money. Mortgage lending supports more than 70% of the purchases in the UK, so when it became harder to get a mortgage, transactions slowed dramatically and prices dropped.
When deciding whether you should purchase a property or continue renting, the availability of credit will be a huge factor when weighing up the economic advantages and disadvantages of either option. If credit is cheap and available, this could mean that it is better to buy than to carry on renting. More people buy and house prices go up until it is more economically viable to rent in this particular area.
For investors, it is equally important. When debt is cheap, there is greater potential for more profitable deals. This encourages investors to pay more for properties.
At any given time, the views expressed by the public towards the housing, be they positive or negative, can have a short-term effect on house prices.
If the average person on the street forecasts a healthy and buoyant economy and property market over the coming years, they are likely to pay slightly higher for the asset. Alternatively, when the public is thinking that an event is coming up that may harm the market, they will put in lower offers to account for this or hold off on buying completely. This was seen in some areas after the Brexit vote in 2016. Transactions slowed because of the perceived negative economic implications of Brexit.
Although the public should be quite confident prices will continue to rise in the long term, at least whilst the supply and demand issue is still prevalent, people tend to ignore this and make decisions based on what they are reading in today’s news. It is important to remember that public sentiment is always changing and will only ever have a short-term effect on prices.
It is important to detail how rents impact on property values. If rents are on the increase, or already sitting high, both investors and owner-occupiers will be willing to pay more for properties. The former will do so as higher rents mean greater cash flow. On the other hand, the idea of paying high rents themselves is likely to make buying appear a more attractive option to owner-occupiers
We can be relatively confident that rents will rise in the long term because they are determined by wages. Rents increase when wages increase. Wages will increase in the long term because of a mix of inflation and productivity growth. The private sector experiences productivity growth from the introduction of new technologies and improvements to their general systems.
Inflation also influences house pricing in the UK. When more money is injected into the economy by the government, typically in the form of Quantitative Easing, prices will adjust themselves upwards. I’ll cover inflation in more detail in a later installment of this blog series as it has other major effects on property investment that need to be discussed in greater detail.
The reason investors need to understand these factors is because they can be applied at a micro level to help potential investors decide where and how to invest their money. We want to provide ourselves with the optimal conditions for capital growth and lucrative returns with minimal risk. Therefore, we should be looking at locations that have supply constriction and high demand. We also want rents not too high in relation to wages and the potential for these wages to increase.
In the next blog in I will be taking a more in-depth look at leverage/mortgages and why they must be understood by investors.