Why do house prices keep going up?
Why do house prices keep going up? Well, ask a few different people and you’ll probably get a few different answers.
And that’s because contrary to popular belief there is more than one reason for the constant increase in house prices.
In fact, (spoiler alert!) there are five major reasons property prices constantly increase.
- Demand exceeds supply
- UK Government legislation
- House buyers can use a mortgage to buy properties they couldn’t otherwise afford
- People are willing to pay more than houses are worth to buy them
- The value of the pound is in perpetual decline
This week we’ll take a look at each one of these in a bit more detail and see if we can get to the bottom of who or what to blame for overpriced property?
House-builders, the Government, banks, house buyers themselves and even the Great British Pound all contribute.
Let’s get into it.
How much do house prices go up each year in the UK?
Have a look at the chart below:
| Year | Q1 | Q2 | Q3 | Q4 |
| 2022 | 1.78 | 0.07 | -0.75 | -5.24 |
| 2021 | 0.61 | 3.45 | 0.99 | 0.37 |
| 2020 | 0.83 | 0.83 | 1.54 | 2.26 |
| 2019 | -0.51 | 0.48 | 0.04 | -0.59 |
| 2018 | 0.07 | 0.36 | 0.24 | -1.45 |
You can see quarterly changes in house prices adjusted for inflation.
You don’t have to look too long to see the numbers are all over the place. Those five years aren’t an anomaly. Go back a decade, two decades or even a century and you’ll find a similar pattern.
But here’s the thing. For most people, most of the time, house buying is for the long term. Or it certainly should be.
We all know that house prices drop from time to time. In fact, sometimes they plummet, but at the same time, over the long term on average house prices go up.
The question we need to be asking is by how much?
Here’s a quote from the London School of Economics based on over 150 years of data.
Between 1845 and 2016, UK home prices grew at an average annual rate of 3.8 percent in nominal terms and 1.1 percent in real terms.
LSE
Though we can’t predict the future, I think it’s pretty reasonable to use the past to give us some kind of idea of what the future holds.
I also think a century and a half of upward movement is as near to conclusive as we are going to get.
In other words, on average, and over the long term, it’s pretty safe to assume that house prices move skyward.
But why?
Supply vs demand
Perhaps the most common argument given for why house prices keep going up is this. Demand for UK housing is greater than supply.
In fact, according to Centre for Cities, when we compare the UK to the average European City there’s a backlog of 4.3 million homes in the UK.
Whilst that certainly sounds like a lot, the significance only becomes clear when you realise that the Government’s current target is to build 300,000 per year.
Not to mention the fact that target is never hit.
And just before you get your calculator out, dividing the shortfall by the government target doesn’t tell the whole story because houses are continually getting demolished too.
As a result, we’d actually need to build 442K every year for 25 years to get things back to normal.
Simply put, there ain’t enough houses!
The question then becomes why?
House prices continue to rise because of UK Government legislation
Enter stage left, the UK government.
Some people argue that the UK housing shortage began in 1980 with Right to Buy. Others suggest it began with the Town and Country Planning Act of 1947. Both are reasonable.
Right to Buy negatively impacted council house-building and the Town and Country Planning act introduced all kinds of hoops to be jumped through before new construction can take place.
Another theory goes that a small number of large property developers keep supply low by limiting construction on land they own. They do this precisely to keep prices high.
I’m not the only one who suspects the government could put the kibosh on this if they really wanted to.
There’s also the small matter of banking regulations to discuss.
People keep borrowing more and more money to buy them
64% of UK homes are owner occupied and just under half of those are owned with a mortgage.
But that doesn’t tell the whole story because most people take out a mortgage with a view to paying it off in the future. In other words, you can only assume that the half that are owned outright now contain a large number that were mortgaged before.
This suggests more people than not use a mortgage to buy property.
There’s nothing wrong with this per se but here’s the bit that gets a bit grey.
The amount of money people can borrow moves up and down depending on bank policy.
So there’s an argument that the demand for housing is only limited by banks’ willingness to lend. They control who buys what and for what price.
If a bank feels like it, they can lend you more money. If you’ve got more money you can spend more on that house you want.
It was only recently that Skipton Building Society announced some borrowers can take out 100% mortgages to buy property.
This means if you qualify you can buy without a deposit. But here’s the thing. It also means that same buyer can suddenly buy a house they couldn’t afford before. The house in question now has more buyers than it did before and all things being equal more buyers means higher prices.
People pay more than they are worth to buy them (without even knowing they are doing it)
If you are like me and pretty much everyone else out there, the only financial question you ask when looking to buy a house is ‘How much can I borrow?’
You then leave it up to your lender to decide whether or not you can afford your mortgage or not.
And who can begrudge people stretching themselves for their dream home?
That doesn’t help house prices one bit. At least it doesn’t help them stay reasonably priced because it hides the price people pay for their house within their monthly mortgage payments.
And this is true to such an extent that unless you are particularly finance savvy you probably have no idea how much you paid for your house. Let me explain:
Have a look at the numbers in the table below:
It compares the impact of different interest rates on a £300K house bought with a 75% LTV mortgage ie £75K deposit with a £225K mortgage.
| Interest rate % | Monthly Repayments £ | Total interest £ | How much your house really cost you |
| 1 | £848.00 | £29,000.00 | £329,000.00 |
| 3 | £1,067.00 | £95,000.00 | £395,000.00 |
| 5 | £1,315.00 | £170,000.00 | £470,000.00 |
| 7 | £1,590.00 | £252,000.00 | £552,000.00 |
As interest rates increase so do the other numbers. Of particular interest is the total interest you end up paying back to the bank because this severely impacts how much you end up paying for a house.
Even if we could go back to the glory days of 1% interest rates your house would still end up costing 10% more than if you’d paid with cash. By the time you get up to 7% the price you pay is nearly double the purchase price. Ouch!
Is it really any wonder house prices keep going up when people are willing to pay double the asking price to buy them?
You are looking at it from the wrong side
That said, would you believe me if I said there’s an argument that property prices don’t really increase at all? That instead, it is simply the price of the pound that is depreciating.
Basically, some believe a house today is worth pretty much the same as it always was. It is the value of the pound that has dropped rather than the value of a house increasing.
And there’s some truth to that. Have a look at the table below:
UK housing vs gold
Source: Priced In Gold
House prices in pounds are shown by the green line. House prices in gold are shown by the blue line.
Whilst there’s been a bit of fluctuation up and down from time to time, the remarkable thing is you need more or less the same amount of gold to buy a house today as you did back in the 50s.
House prices haven’t gone up at all (when priced in gold).
If you are interested in gold as an investment we’ve talked more about that here.
Is it the right time to buy a house?
As long as we are talking about valuations in terms of the Great British Pound, I think we’ve established that house prices do go up. But as mentioned at the beginning, house prices move up and down pretty continuously in the short term.
Because of this you could be asking is it the right time to buy a house?
Whilst nobody knows what the future holds for property prices at any moment in time, there are three key questions you can ask that can help you value UK property at a particular moment in time.
- What is the average house price to earnings ratio UK residents have to contend with?
- What is a good rental yield UK residents should expect?
- Where are we in the 18 year property cycle?
And it’s worth dealing with each of those in a bit more detail.
What is the average house price to earnings ratio in the UK?
The house price to earnings ratio describes how many years average salary are required to buy an average house.
If the average UK property price was £100K and the average salary was £25K then you’d need four years average salary to buy one house. That’s a ratio of 4:1, which incidentally is the UK average.
In an ideal world, you’d want to buy below the average.
Right now it’s 9:1 which suggests things are looking a bit pricey right now.
What is a good rental yield for UK property?
Another measure used to value houses is rental yield.
And whilst it’s more commonly used by property investors, there’s no reason why you can’t use it to value a home you intend to live in.
To calculate the rental yield, you divide annual rent by property price and then multiply by a hundred.
(ONE YEARS RENT / PROPERTY PRICE) x 100
So a property that generates £6K annually and costs £100K has a 6% property yield.
It’s generally accepted that 6% and above is good, whereas 4% and below is bad. Anything in-between being debatable.
Even if you were buying property to live in, the fact that it could generate a 6% or above rental yield would suggest it could be good value for money.
Where are we in the 18 year property cycle?
The 18 year property cycle describes a sequence of repetitive events that impact supply and demand for property which in turn impacts house prices.
To cut a long story short, house prices go up for a bit and then crash. The key is there’s a timing element to the cycle which in theory means you could sell when prices are high and buy when prices are low.
This is a topic in itself which you can read more about here if you are interested. However, if the 18 year property cyclists are to be believed we maybe in for a boom over the next couple of years followed by a bust.
Why do house prices keep going up? – the bottom line
So why do house prices keep going up?
We covered the five big reasons:
- Demand exceeds supply
- UK Government legislation
- House buyers can use a mortgage to purchase properties they couldn’t otherwise afford
- People are willing to pay more than homes are worth to buy them
- The pound is in perpetual decline
What we didn’t do was discuss how each any every one of them is related to all the others.
Did you join the dots?
It begins with Gover… and ends with …ment!
Whilst item two is pretty self explanatory, it seems to me that the government has a lot to answer for here.
Can we really believe the government couldn’t incentivize house building if they really wanted to? I think they could. And whilst we do have a nasty habit of paying over the odds for properties, that’s because we use mortgages.
And whilst banks control mortgages, it’s pretty clear that the government controls the banks. Not to mention interest rates.
And could it be that the fact the pound is in perpetual decline is because the government wishes it to be so. That’s a story for another day, but I think most economists would agree that money printing equates to inflation which equates to governments being able to get rid of their debt.
I’m just saying……