Very simple models: house prices
Ask people what has driven UK house price growth and many of them will answer that it is a lack of new supply versus demand. This may be true when explaining the differences in price at a local/regional level but my model suggests another factor as the main driver of national house prices, particularly during the 2000’s.
My model is constructed using only household incomes and mortgage lending criteria (specifically loan-to-income and loan-to-value ratios) and the chart below suggests that these components can explain a significant part of recent UK house price movements.
This is particularly true for the period 1999 to 2006 when prices increased an average 12.5% a year. This was due to a loosening in mortgage lending criteria, particularly with regards to loan-to-income ratios, and the FSA even warned mortgage lenders about lax lending criteria in 2000. With an increase in the amount lenders were prepared to offer against income, households took up the offer and drove prices upwards.
As with any model this simple, it doesn’t explain every aspect of house prices. In particular there is divergence between the modelled and actual house prices during the late 1980’s which can generally be explained by government policy and large numbers of cash purchasers and the subsequent under-performance during the early 90’s by repossessions and market sentiment holding back consumers.
Current house prices are below those suggested by the model and with the market operating at very low turnover levels (only those able to access mortgage finance or have cash are able to transact) the model helps explain why we have continued to see price growth in equity rich markets as mortgage lenders continue to support current price levels.