'Why have house prices been rising again?' is one of the most frequently asked questions about the property market. A popular explanation is by reference to supply and demand, with increasing housebuilding to around 250,000 homes per year widely cited as the solution.

Unfortunately, this view is based on an overly simplistic model and overlooks the wider complexities of the housing market. New build only represents around 10 per cent of all transactions so the second-hand market makes up the majority of available housing supply at any given time. More importantly, household projections aren’t a reliable indicator of housing demand and are only vaguely useful as a measure of housing need.

Actual housing demand is determined by the number of people willing and financially able to buy a home, second home or investment property. This demand will be dictated by a number of factors including aspiring buyers’ ability to sell their existing home, their access to housing equity or a deposit, their access to credit at an affordable price, their current income and future expectations, as well as the financial and tax implications of property ownership, expectations of future returns and market sentiment.

Of these factors, the cost and availability of credit has had the greatest direct effect on housing market demand over the last two decades. The graph below translates gross lending into transactions using the 1995 average debt to income multiple as a base. This suggests an additional 900,000 transactions would have been required in 2002 to ‘absorb’ increased levels of gross lending at 1995 debt (and possibly house price) to income ratios.

Housing transactions and gross lending

This model is an over-simplification. For example, the total difference in transactions since 1995 is over 11 million but increased supply and reduced price growth in any one year would most likely have reduced the appetite for additional credit from both lenders and borrowers in subsequent years.

Despite its issues, the model demonstrates the scale of credit availability during the boom and hopefully highlights that housing demand is more than just a number derived from demographic modelling.

Any calculations for the number of new homes needed in a local market should include serious consideration of other demand indicators such as house prices and land values. Only then will we ensure we are building the appropriate number of new homes in the locations where they are needed.

Further information

For more details read the Housing Market Note.