HOUSE PRICES AND ECONOMY

House Prices and Economy



House Prices and Economy

Introduction

A dramatic increase in demand created the housing bubble, as banks and other institutions lowered lending standards in an attempt to boost revenue. Banks increased lending activity by diversifying risk through secondary market transactions, including the packaging and sale of mortgage-backed securities (MBSs) and other collateralized debt obligations. Since 2007, the industry has been devastated by the housing market's collapse. Many individuals struggled to maintain loan payments and many homes went into foreclosure (IBIS World, 2011a). As delinquencies rose and home values dropped; the ability of banks and other institutions to lend money drastically declined. As this decline happened, credit markets tightened and the economy fell into a recession.

Because the UK economy depends heavily on debt, the tightening of the credit markets caused the recession. Real estate is no different; developers rely on debt to finance their land purchases and housing developments. As the economy started to decline and disposable income dropped along with employment, the ability of individuals to buy houses severely decreased (IBIS World, 2011b). Since consumers could not purchase homes due to income and tight lending standards, the industry's sales declined substantially. 

The Housing Developers industry is in a mature stage of its life cycle. Industry value-added is expected to decline at an average annual rate of about 5.9% in the 10 years to 2016, while UK GDP is forecast to rise by an average annual rate of 2.0% over this same period (IBIS World, 2011a). Typically, an industry is considered in a decline phase of its life cycle when industry growth falls below total economic output. However, this trend is skewed by the collapse of the real estate bubble and severe drop in real estate demand that has occurred since the subprime mortgage crisis.

Research Objective

The main objective of this research paper is to develop a testable model to explain the course of UK house prices since the early 1970's. It also estimates UK house price model using OLS technique and discuss findings on the key elasticity. It also produces a forecast of house prices for the next five years and explores the factors that are likely to affect the accuracy of forecast.

Research Variables

Following research variables have been included in the analysis.

PH = index of nominal house prices

PC = consumers' price index

PEGW = stock of nominal household wealth (£m)

RY = real household income (£m)

RBM = mortgage interest rate (%)

HS = owner-occupier housing stock (000s)

USERCOST = housing user cost of capital (%)

WSH = log share of wages in household income (log %)

HH = number of households (000s)

The Housing Price Index (HPI) aims at measuring the evolution of sales prices of houses. The house price index is an important indicator of residential real estate demand because prices rise when demand increase and fall when demand drop. At the same time, the house price index is also an important component of understanding the affordability of real estate (IBIS World, 2011b). If the index rises too high too fast, the ability ...