Introduction

Whatever measure of affordability is employed, house prices and rents play a central part and, therefore, this chapter is concerned with their main determinants at national and sub-national levels, bringing in relevant findings from different countries, but with an emphasis on house prices in the UK. The determinants play a crucial role, particularly because they begin to show the limits to policy. We refer back to the central findings in later chapters. In fact, the previous chapter has already highlighted three of the key influences on the demand for owner occupied housing and house prices: incomes, interest rates and mortgage market conditions. House price to income ratios provide a flawed indicator for prediction and for policy, but this does not imply that incomes are unimportant for house prices; incomes are, in fact, one of the most important determinants quantitatively, but they are not the only influence and it is the neglect of other factors that causes many of the problems, even at the national scale. Chapter 2 hinted at the importance of interest rates: from Figure 2.2 house prices relative to incomes have been above trend since the beginning of the century, despite the GFC, reflecting low interest rates, which are capitalized into prices. At low interest rates, households can afford to pay higher prices. Furthermore, the chapter began to discuss the importance of credit markets: if households face restrictions in access to mortgages, then their consumption of housing is likely to be sub-optimal with consequences for house prices. For policy, credit restrictions are particularly important since their presence reduces the effectiveness of interest rate policy, an issue explored further in later chapters.

However, nationally, there are potentially other variables that help to explain changes in house prices over time; most importantly for policy these include the influence of housing supply. Further possible influences include household formation and, given our interest in low-income households and first-time buyers, changes in the income distribution. This chapter explores in more detail the quantitative impact of all these variables. The chapter also considers rent determination. Although in principle the relationship between house prices and market rents is well-understood, the practice is more complex because of institutional features of the rental market.