The Underlying Factors That Influence Real Estate Market Growth

There are numerous factors which determine house prices. Some are based on economic theories while others are driven by geographical, political and demographical trends. One must also consider more intangible factors, like the feel of a neighbourhood and expectations for future growth. In this month’s article, I will outline some of the key factors that influence property prices, how they are determined, and what this means in terms of investment.

Economic Factors

Growing Economy

Demand for housing is dependent upon income. With higher economic growth and rising incomes, people will be able to spend more on property; this will increase demand and push up prices. A robust and strengthening economy, low unemployment and strong wage inflation all contribute to positive market sentiment which helps fuel price growth.

Supply & Demand

Simply put, a shortage of supply pushes up prices. Excess supply will cause prices to fall. For example, in the Irish property boom of 1996-2006, an estimated 700,000 new houses were built. When the property market collapsed, the market was left with a fundamental oversupply. Vacancy rates reached 15%, and with supply greater than demand, prices fell. By contrast, in the UK, housing supply fell behind demand. As such, UK house prices didn’t suffer as much as those in Ireland and soon recovered – despite the ongoing credit crunch.

This graph shows the profound effect that levels of supply and demand (and crucially the imbalance between them) can affect house prices.

Housing supply depends on existing stock and new house builds. It tends to be fairly inelastic because to get planning permission and build houses is a time-consuming process. Periods of rising property prices may not cause an equivalent rise in supply, especially in countries like the UK, with limited land for home-building.

Rising Employment Rates

Related to economic growth is employment. When the employment rate is rising, more people will be able to afford to buy. Increased job creation is in many cases linked to the emergence of new industries, developing new business districts and the inward migration of large corporations to the vicinity. Similarly, when unemployment is on the rise, the fear of losing one’s job or a recession dampens buyer sentiment and tends to discourage people from entering the property market, thereby reducing demand.

Interest Rates & Mortgage Availability

Interest rates affect the cost of monthly mortgage payments. A period of high-interest rates will increase cost of mortgage payments and will cause lower demand for buying a property. When borrowing money to purchase becomes more expensive, it naturally dampens buying sentiment and makes renting more attractive by comparison. Interest rate increases have a bigger effect if homeowners have large variable mortgages. For example, in 1990-92, the sharp rise in interest rates caused a steep fall in UK house prices because many homeowners couldn’t afford the rise in interest rates.

Affordability/House Prices-to-Earnings Ratio

The ratio of house prices to earnings influences the demand. As house prices rise relative to income, you would expect fewer people to be able to afford to buy. Another way of measuring the affordability of housing is to look at the percentage of take-home pay that is spent on mortgages. This takes into account both house prices, but mainly interest rates and the cost of monthly mortgage payments.

This graph shows that first time buyers in London face much more expensive house prices – over 9 times earnings compared to the North, where house prices are only 3.3 times earnings.

Demographics & Geography

Population Growth

Urban populations are forecast to increase in coming decades. Population growth is a major underlying factor for the demand of housing and without a new supply of homes, it pushes up the prices for both renting and purchasing property. The underlying reasons for population increase must also be understood. If the main contributor for an increase in population is births, then this will have less short-term effect, than if the increase is due to migration or employment. Net overseas and net intercity migration are key components for population growth as a majority of these people require accommodation immediately – fuelling demand and putting further restraint on the supply of city centre housing.

Young Population

Rising first time buyer average age coupled with low affordability has meant that more and more people are opting to rent rather than buy. This rise in rental demand and growing number of prospective tenants clearly benefits buy-to-let landlords, however if this trend persists long term, with fewer and fewer buyers (and therefore less demand), the property market in general will suffer.

The cities that consistently display the strongest price growth tend to be those with a strong university presence, a high student population and perhaps most importantly a healthy graduate retention rate. This results in growing populations of young, qualified professionals in need of conveniently-located accommodation, which naturally drives both buying and rental demand.

Location, Location, Location

A cliché but true nonetheless. Property located close to the CBD or with excellent transport links tends to command a higher price. If you look at a city’s property price heat map, the highest density of prime property is more often than not concentrated around the city centres. The majority of people want to live close to their place of work while also enjoying easy access to leisure and retail amenities. This naturally creates higher demand for property and drives up prices in these areas.

Infrastructure

Improvements in local transport infrastructure are generally seen as a good thing, both for the economic prosperity of an area and property prices. When local transport infrastructure is improved, it inevitably boosts house prices in the surrounding area, along with connectivity and employment. In recent years we’ve seen the impact of the “Crossrail effect” on London house prices. Property prices around the 41 stations on the Elizabeth line (Crossrail 1) are projected to increase by 25% more than the average price in central London.

In conclusion, any investors looking for buy-to-let opportunities in 2019 and beyond should try to bear in mind the factors outlined above, as history shows us that they play a major part in the rise or fall of property prices in any given market. If you are interested in property as an asset class and would like to explore our unique investment opportunities, please don’t hesitate to get in touch.