Determinants of House Prices
House price dynamics are usually modeled in terms of changes in housing demand and supply. On the demand side, key factors are typically taken to be expected change in house prices, household income, the real rate on housing loans, financial wealth, demographic and labor market factors, the expected rate of return on housing and other demand shifters. On the supply side, factors include proxies of the location, age and state of housing or institutional factors that facilitates or hinder households’ access to the housing market, such as financial innovation on the mortgage and housing loan market ( 2007).
Determinants of Housing Demand
In trying to understand the concept of demand, it is helpful to imagine that the marketplace is populated by people acting in one of only two roles: consumers or producers. Consumers are those who hope to acquire and make use of goods and services. Producers perform the function of bringing these goods and services to market. In the housing market, it is simplest to think of households or families as the consumers and developers and builders as the producers. The price of housing, the prices of other goods and services, the financial resources and taste of consumers, and the number of potential housing consumers will influence the demand for housing (1988).
1. Price
For most goods and services, the quantity demanded by consumers increases as the price falls. If the demand for housing behaves like other demand relationships, holding constant all of the other factors that influence housing demand, lower prices should increase the quantity demanded. If the price of housing structures falls, consumer demands will rise. In the rental market, where housing services are bought and sold, the price is called the rental price or lease rate. Here should the rental price fall, the quantity of housing services demanded could be expected to rise (1988).
Price influences both the quantity consumers demand and the quantity producers are willing to supply. The quantitative effect on demand or supply may range from quite small to very large. The economic term to describe such responsiveness is elasticity. A high degree of elasticity implies a high level of responsiveness and vice versa (1998).
Price elasticity of demand – This represents a measure of the responsiveness of demand to changes in the prices of a commodity. Price changes will have opposite implications for expenditure and revenue, depending on whether demand is elastic or inelastic, and this information is of clear interest to producers. It is possible that demand elasticity could be equal to (−) unity, and hence neither elastic nor inelastic. Consequently, total, expenditure would remain unchanged whatever the change in price. The main factor influencing price elasticity if the availability of substitutes; food products for example are a necessity and there are no overall substitute for food. The demand of various types of meat (such as beef, pork, lamb and others) is clearly elastic as each represents and potential substitute for the other. The demand for housing, on the other hand, is inelastic, as there are no substitutes for housing and it is often considered to be something of a necessity ( 1998).
2. Income
The demand for housing is not only influenced by price. A household’s budgetary constraints also influence the demand for housing. One measure of the budgetary constraint under which households must operate is household income, the flow of cash from wage and salary employment, investments or the direct sale of goods and services. Without income it would not be possible for the household to meet continuing obligation associated with housing, such as mortgage payments, the cost of heating and lighting, or rental payments, It seems likely, therefore, that the demand for housing is amplified by increased income. If the demand for housing is positively related to income, then an increase in household income would cause the demand curve to increase. As obvious as income would seem as an influence on housing demand, the effect proves difficult to quantify in a consistent way. The reason is that the channels through which income influence housing demand are complicated. Income not only influences the ability of a household to afford the continuing cash-flow burdens of housing, but is also an influence on the household’s perception of its lifetime wealth prospects (1988).
3. Population and Household Formation
The number of consumers desiring housing also influences housing demand. The basic set of factors underlying the number and composition of households is a combination of sociological and economic forces. Trends in fertility rates and mortality rates over time determine the population’s age distribution at any point in time. This age distribution is by itself an important influence on the size and number of households formed. The greater the ration of young to adult individuals in the population, the greater is the probability that households are characterized by relatively large size. In addition, the high proportion of young individuals in the population is a string indication that there will be an increased number of household sin the future, everything else being equal. This is because sociologically, household formation tend s to be associated with the onset of adulthood (1988).
Determinants of Housing Supply
1. Availability of Land
The first essential condition for a vibrant and well-functioning housing sector is the availability of residential land, in ample supply and at affordable prices.
- land in growing and richer cities will be more expensive than land in shrinking and poorer ones;
- land in larger and denser cities will be more expensive than land in smaller and more dispersed ones
- land in more developed markets will be more expensive than land in more primitive ones
- land with legal title will be more expensive than either land with a clouded title, land in illegal occupation, or land threatened by clearance
- centrally located land or land near places of employment will be more expensive than peripheral land located away from employment opportunities
- land with good transport access will be more expensive than land with little or no transport access
- lands with a full complement of amenities will be more expensive than land lacking in such amenities
- land protected from environmental hazards will be more expensive than land in disaster-prone or hazardous locations
- land in cities with strict growth controls will be more expensive than land in cities with lax controls
- land in stable and safe communities will be more expensive than land in transient and crime-ridden ones; and
- land in cities with many nonresidential uses competing for it will be more expensive than land with few such competitors (2000).
2. Conditions in the Residential Construction Sector
The conditions in the residential construction sector requires a deeper understanding of house building as seen from the perspective of the builders themselves. Ample and affordable housing relies heavily on the builders’ ability to produce it inexpensively and quickly, as well as to respond creatively to changes in the context and the policy environment governing the sector. Whether or not conditions in the house-building industry allow it to do so is of fundamental concern to housing policy. An enabling housing policy should create conditions for that industry that, at the very least, lower construction costs for a given level of quality. From the perspective of builders, in a well-functioning housing sector licensing requirements, regulations, or monopolistic practices do not impede any builder or group of builders from engaging in residential construction. Regulations do not restrict producers from creating a large variety of housing arrangements and combinations, substituting among different inputs and characteristics to meet changing conditions. There are many entrepreneurs who can participate in housing production at all scales, there is sufficient incentive for them to enter the sector, and there is normal risk of business failure. Producers engage in building for all income groups, do not shy away from any segment of the housing market, and pay sufficient attention to renovation of the existing stock, as well as to rental housing. At the same time, dwellers themselves can also engage in self-help or self-managed building of houses, extensions, renovation, or repairs without necessarily requiring professional assistance (2000).
3. The Availability of Mortgage Credit
A third set of housing market conditions, the actual conditions in the housing finance industry, calls for a more thorough investigation of the housing sector as seen through yet another perspective – the perspective of those who lend for housing. Housing policy is intimately tied to the development of the housing finance industry because ample and affordable housing relies heavily on the ability of the financial sector to provide ample and affordable credit for housing. We can distinguish three stages in the development of lending for housing, each involving different types of lenders: (a) direct lending, (b) mortgage banking, and (c) securitization. Direct lending is a simple face-to-face transaction between a borrower and a lender. Mortgage banking is once removed: a mortgage bank lends the money for housing from deposits that it collects from savers. Securitization is twice (or more) removed: mortgage loans are originated by one institution, sold to a second institution that collects the mortgage payments and then sells tradable securities (backed by these payments) in the capital market to yet a third institution. The latter can be a pension fund, an insurance fund, or a mutual fund – either domestic or international – that then may sell shares to individual investors. The theoretical value of mortgage loans aside, there are several necessary conditions for mortgage lending to develop in practice. Three of them concern the legal environment for lending: titles must be clear and transferable, contracts must be enforceable, and foreclosure – the legal possession of the property by the lender in case of default – must be allowed to proceed without undue delay (2000).
Discussed below are some of the factors that affect house prices.
1. Growth of Bank Credit – One of the factors that affect house prices is the growth of bank credit to households.
2. Demographic Factors – Demographic factors play a role in housing demand and house prices. If there was a baby boom in the 1970s and the early 1980s demand will rise as these cohorts approach their prime earning age and enter the housing market.
3. Regulatory and Institutional Framework – Improvements in the regulatory and institutional framework necessary for the development of the property market have largely occurred as a result of the EU accession process. In particular, reforms in legislation and judiciary practices that make it easier for creditors to seize real estate collateral removed a key obstacle to buying and selling property.
Demand Curve
Demand can be defined as the quantity of a commodity consumers are willing to purchase at a particular price. The demand for most commodities will rise as their price falls and fall as their price rises and there is therefore an inverse relationship between price and quantity demanded. This can be understood more clearly when we realize that the market demand for a commodity is itself made up entirely of the individual demands of consumers or producers. Individual consumers will have a choice of alternative products in any single category (for example, different makes of cars), and they will be constrained by fixed levels of income. If the market price of a commodity rises, consumers will have to either reduce their consumption of the good or find a suitable alternative or they will have to reduce their consumption of another good. A similar pattern will emerge for commodities which are demanded mainly by producers. For example, if there is a rise in the price of bricks, producers (e.g. construction firms) will try to substitute other materials such as timber, cement or steel (the prices of which we assume have not risen) for bricks in the production process (in this case construction) ( 1998).
1. Purchasing power of the household which is mainly dependent on the level of income. With a rise in income, households can potentially purchase greater quantities of all of the goods they currently consume. In practice, however, demand for some commodities will rise faster than others as incomes increase ( 1998).
2. A change in tastes may influence consumption patterns. For example, a trend towards ‘green’ awareness may encourage households to consume more energy-efficient items—demand for roof insulation, double glazing, low-energy lighting, etc. may subsequently rise ( 1998).
3. The prices of other goods. Some goods may have close substitutes, for example tea and coffee, so that if there is a sudden rise in the price of either, consumers are able to switch and consume more of the (now relatively cheaper) alternative ( 1998).
Supply Curve
1. If there is a change in the state of technology which lowers the cost of production. For example, it was hoped that the introduction of industrialized building techniques in the 1960s would greatly reduce the cost of local authority house-building (1998).
2. If there is an upwards or downwards shift in the price of factors of production. For example, a rise in the price of oil would raise the cost of producing plastics used in windows and many building materials. It would also increase transport costs, thus affecting most industries in the economy in some way ( 1998).
3. If there is a change in the objectives or goals of producing firms. Normally, we assume firms have the same goals and aim to maximize profits. However, there may be other objectives which can override profit maximization; for instance, firms may accept lower prices to achieve higher market share, or they may accept higher costs to ensure security of supply of certain factors of production (e.g. raw materials). Other firms may accept lower prices or higher costs in order to achieve social or environmental objectives ( 1998).
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