Housing – a simple model!

Observing the comments on various blogs and websites it is obvious that quite a lot of people have problems working out or understanding what the housing market is and how it operates.

Lets think of the conventional model used in economics that of supply and demand. It seems straightforward enough, there is demand for houses and then there is supply. The theory is that one balances the other such that supply generally equals demand.

But what do we mean by supply?
Well it’s not just building houses. Supply also comes from conversions and change of use – a barn developed for housing, a hotel re-used for apartments. But there is also another source of supply – as houses are left when people die.

Then there is demand. Demand is a far more tricky thing than supply when we examine housing. For one thing we also have need which is the fundamental requirement for people to be housed. But demand is far wider than need. Demand also includes a desire for a specific type of housing and a desire to live in a particular location. Demand differs from need in that it reflects the ability of people to purchase based on their income and or existing wealth.

It is rather obvious that people with higher incomes can create higher demand. It is also the case that those with sufficient wealth – either in the form of investments, cash in the bank or ownership of existing housing may well be able to purchase property without recourse to borrowing. [That is why desirable properties are often sold for cash as the purchasers are lucky enough to have the wherewithal to funds available]. For many however houses are purchased by borrowing the funds, how much is borrowed reflecting their income.

Some people cannot create demand despite having a need for housing due to lack of income or wealth which is why there has been and should be a set of policies to ensure that need is also met.

Demand does not however depend solely on the resources available. Demand can also be created, manipulated and distorted. There is a plethora of agents who operate to create demand. They do not simply foster demand for a particular site but for a type of housing in general. That is why we see estate agents extolling the virtues of a location to people who currently do not reside in the area. They appeal to the desire of people to seek out housing in another area and if that area is badged as being in a desirable location then they work to sell that location in both senses.

We now turn to the role of developers. Housing developers are concerned with running a business that turns in a profit. Developments that result in higher returns for the input are better than those that result in lower returns. But contrary to some people’s notions, developers do not sit around waiting for someone to turn up and ask for a house to be built, neither do they seriously look at local need and focus on just building houses to meet that need.

In fact developers intentionally and deliberately seek to create demand for their product just as car makers do. They know that there are people who have the resources to buy something different or to buy an additional property whether to use as a second home or to let out to tourists. They also know that affluent people may see housing as a safe asset – somewhere to park their funds in troubled time. Russian and Greek oligarchs spring to mind!

So we have a complex set of variables which influence demand and that of course means that any solution to the question of housing and house prices is likely to be complex as well.


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