Why are house prices still rising?

It’s no surprise to hear that the country’s finances are ‘in a mess’.  It is surprising to learn that house prices continued to rise in May and are now just 9.5% below the October 2007 peak, according to figures from Nationwide.

This is more surprising as a higher unemployment level is usually bad for house prices.  When people lose their jobs, they find it difficult to keep their homes.  Higher repossessions and worsening bad debts for banks is one reason why the banks don’t want to lend money to lots of people now.

So, why are house prices still rising?  Basically, the number of sellers has dropped, increasing competition between buyers for those properties on the market. This situation is unlikely to last.  As more sellers join the market, prices will begin to drop.

Depending on the timing of the coalition government’s capital gains tax rise on the housing market, some second home owners and buy-to-let landlords may decide to sell before the higher rate is introduced.  This could alter the supply/demand balance to move in favour of buyers and ease the current upward pressure on house prices.  If the new rates are effective immediately after Budget day on 22nd of June, then potential sellers will not have time to react and this will be one factor that doesn’t then affect housing supply.

Another reason why house prices have stayed high may be that real long-term interest rates – measured by index-linked gilt yields – have been low.  A low index-linked yield means that investors expect real short-term interest rates to be low in the future, which means people can afford to take on higher mortgage debt.  Or a low long-term real interest rate means the net present value of future rents is high, which should mean house prices are high.

‘No real answers then’, I hear you cry.  To be honest, no.  But I don’t think this rise in house prices is likely to bring about a repeat of the early 2000s boom as this would need index-linked yields to fall sharply.  As they are already under 1%, this is not going to happen – thus eliminating one factor behind a house price boom.  However, I do believe house prices have now ‘bottomed out’, except for a short-term blip relative to the new CFT implications.  Buy-to-let might now be worth looking into.