Housing markets and what drives them

Housing is the largest asset most households own and the one whose market dynamics are least like those of financial assets.

What drives prices

The main factors.

Credit conditions: the availability and cost of mortgage finance, which determines what buyers can pay.

This is generally the dominant short-term driver, since prices are set by what buyers can borrow rather than by what houses cost to build.

Interest rates, which affect affordability directly and which transmit with different speed depending on whether mortgages are predominantly fixed or variable in that market.

Supply, which is slow to respond and which is constrained by planning, land availability and construction capacity.

Household formation and demographics.

Incomes.

Tax and policy: transaction taxes, relief for buyers, treatment of investors, and rental regulation.

And expectations, which can become self-reinforcing.

How it differs from financial markets

Structurally.

Illiquidity: transactions take months and cost a substantial percentage of value.

Heterogeneity: every property is different, which prevents the arbitrage that keeps financial markets efficient.

Infrequent transactions, meaning prices are inferred from a small sample.

Leverage is normal and substantial.

Sticky prices on the way down, since sellers withdraw rather than accept lower prices, which means transaction volumes fall before prices do.

And emotional attachment, since it is also a home.

The affordability measures

Which are commonly cited.

Price to income ratios, which compare prices with earnings and which have risen substantially in many markets over decades.

Mortgage payment as a share of income, which incorporates interest rates and which can look reasonable at low rates with very high price-to-income ratios.

Rental yields, comparing rents with prices.

Which together indicate stretched affordability in many markets and which have indicated this for extended periods without a correction, illustrating the limits of valuation as a timing tool.

Why supply responds slowly

The structural constraint.

Planning and permitting processes take years.

Land availability is constrained in desirable locations.

Construction capacity and skills are limited.

Developers control the rate of release to protect prices.

And existing owners have interests in restricting supply.

Which means demand shifts translate into prices rather than into quantity in the short and medium term, and which is the core of the affordability problem in most high-cost markets.

What happens in downturns

The pattern.

Transaction volumes fall before prices, as sellers withdraw rather than accept lower offers.

Nominal price falls are historically smaller and slower than equity market falls, with real falls larger once inflation is accounted for.

Forced sales — from unemployment, rate rises or repossession — are what produce actual price declines.

And recovery has typically taken years, with some markets taking a decade or more to recover in real terms.

The leverage point

Which is what makes it consequential.

A mortgaged property is a leveraged position, which magnifies both gains and losses on the equity portion.

Negative equity — owing more than the property is worth — restricts mobility and refinancing options.

Which means the personal consequence of a housing downturn depends heavily on the loan-to-value ratio and on employment.

And which is why housing downturns coinciding with recessions are considerably more damaging than either alone.

What it means for a household

Practically.

The purchase decision should be based on affordability under stressed conditions rather than on current rates, which lenders now test for in many jurisdictions.

Transaction costs mean short holding periods are expensive, which argues against buying if you may move soon.

A home is consumption with an investment component rather than an investment.

And it should be counted in the overall asset picture, since it is a large, leveraged, undiversified, illiquid, domestic holding.

Timing the market

Which is as difficult here as elsewhere.

Forecasts of housing markets have a poor record.

Transaction costs mean acting on a forecast is expensive.

And the personal circumstances — needing somewhere to live, a growing household, a job move — generally dominate the market timing consideration.

Which means the practical approach is to buy when it suits your circumstances and is affordable under stress, rather than when a forecast suggests.

The policy dimension

Worth noting.

Housing costs are the largest component of most household budgets and the largest driver of measured inequality between owners and renters.

Policy interventions — transaction taxes, buyer support schemes, rental regulation, planning reform — have substantial effects and are frequently debated.

Which means housing is more exposed to policy change than most assets, and that exposure is a genuine risk factor for a leveraged position.

General information only, not investment advice. Property is illiquid and leveraged positions magnify losses. Consult a regulated mortgage adviser.