Your questions answered
Why are house prices so high?
It’s a combination of two factors – low interest rates and the high cost of building land. The lower interest rates fall, the higher that cost becomes. That’s because the market sees building land as an investment asset.
The value of assets rises as interest rates fall. Suppose the rate is 5% on bank deposits. If you invest in a house to rent out, you want a 5% return. So if the house cost you £200,000 you want a rent of £10,000.
Suppose bank deposit rates fall to 1%, or lower, as they’ve been for some years. If the market were working properly the rent would fall to £2,000. But it doesn’t. Because the rent is already set at £10,000, the value of the house increases, in theory to £1m!
That’s an extreme example, but the principle is sound. The benefit of low interest rates to home buyers is substantially offset by rising prices. When money is cheap it get sucked into asset prices, starving the real economy, making life much more expensive for home buyers and renters.
Why are high house prices so harmful?
High house prices are bad for all of us because they suck money out of the real economy. That’s the real economy in which we earn and spend money and make use of vital services. The more money that is salted away in assets such as housing, the less there is for the NHS, for our schools and to put food on the table.
Even people who own houses don’t benefit from rising prices. That’s because once money goes into houses most families keep it there, spending ever more as they move into bigger places or helping their children to get started in their turn.