So, what are the factors that affect house prices, in order of significance? As an investor, and as a potential home owner, understanding these factors are crucial to making a sensible and profitable investment decision, yet the answers far from clear, and rarely understood. Here's my take on it.
The biggest factor affecting house prices is, IMHO, the percentage of daily effort required place and maintain a roof over one's family. For want of a better term, I'll call this the "shelter factor", and I'll approximate it at 25% of disposable household income. Rental prices closely reflect the concept of the "shelter factor", and so the two can be considered equivalent.
Looking at real house and rent price's over long time frames, we notice that rental prices stay very flat. That is because the "shelter factor" is quite constant, for a given geopolitical region.
The second most significant factor affecting house prices, apparent in the more medium term, is "easy credit and restricted land supply and a belief that prices always go up". When all those conditions (all three are required) are present, bubbles tend to form. This can take house-price-to-income ratios from 3 up to 10.
Note that "restricted housing supply" isn't (necessarily) an upward force on house prices - it is an amplification force, increasing the impact of both increases and decreases in price.
The third most significant factor affecting house prices is "the price of fish in China". The reason that most people believe that house prices always go up, is because they don't understand inflation, and although, by definition, inflation doesn't impact the real price of houses, it does contribute to so much rhetoric regarding house prices that it does impact people's buying behavior. In a world without inflationary monetary policies, and hence without inflation, people would have a very different attitude towards house prices.
So there you have it, the top three factors affecting house prices, and no mention of demographics, interest rates or tax concessions, (I think that these are less significant than the above three factors) and certainly no mention of population growth. Steve Keen has already shown that there is a negative correlation between population growth and house prices.
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There are many factors which are commonly quoted as affecting house prices:
ReplyDelete1. Restriction of land (government bureaucrats stop you building a house on your own land).
2. Rising incomes and inherited wealth (people can pay more so they will).
3. Increased population (more houses needed to shelter the population).
4. Demographic factors (decreasing family size means more, but smaller, houses).
5. Interest rates (lower rates mean that people can borrow more).
6. Market confidence and speculation (the belief that 'real-estate prices always go up').
7. Finance availability (lending money to people with a dubious debt history).
8. The cost of stamp duty (which is a progressive scale).
9. 'Improvements' to building codes (making it more expensive to build a house).
10. The price of rented accomodation (which is an economic substitute).
Now let's consider what affects rent prices:
1 through 4 above, (and of course 11. the price of housing).
Given that real house prices have nearly tripled in the time that real rents have increased by only 25 percent, this suggests that items 1, 2, 3, 4 and 10 are not very significant factors in determining house prices.**
This leaves interest rates, finance availabiity and market confidence as pretty strong contenders. In short, people's expectation that prices will always go up has led them to speculate on their own homes, leveraged with low interest rates offered by ever more willing lenders.
Conclusion? We are in for a deflation. It may be a soft landing, but attitudes and expectations are going to change over the next few years.
[** Personally I would also argue that exhorbitant stamp duty has inflated house prices, because people now avoid buying a 'starter house', to avoid multiple stamp duties as they climb the real-estate ladder, but that's an argument for another time.]
Hi strawman. Agree we are headed for deflation. Us, uk, eu likely to have CPI inflation as "no deflation on my watch" policies reign. Not so sure au will fight so hard.
ReplyDeleteSorry for breivity. Phone ui only.
The reason that I started thinking about the significance of the factors, is that, during conversation, too many people kept raising less-than-significant reasons as to why house prices won't fall. Strawman has listed many of these "typical" reasons above. Other reasons that I heard included "new trendy cafes in the area", "planning permission changes", etc.
ReplyDeleteIt wasn't that these reasons were necesarily wrong, but that they simply didn't matter against the tidal forces of the more significant factors.
Back to deflation. I have thought that interest rates falls would be the next move, although I was hoping for another rise. Once the housing debt starts to get paid off, and house prices continue to fall, money will disappear, as will jobs. The RBA will then begin to lower interest rates.
Even so, I still think that cash is the best investment at the moment (AUD, Gold, Silver).
Ultimately, I will move in to equities - the best long term investment class - but not yet.