Published in The House Magazine, No. 1199, Vol. 32, 18 December 2006

The British seem to be fixated with house prices and follow the development of the property market like the weather report or the latest football results. Prices have been going up and up in the past, and if annual house price inflation occasionally drops to a mere five or six per cent, one can already hear commentators becoming fearful of a slump.

As house prices apparently only know one direction, young people feel the need to make their first step on the property ladder sooner rather than later. On the one hand, they do not want to miss out on the marked increases in property values; on the other, they are afraid of not being able to buy a house at all if they wait too long.

To an extent, therefore, the belief in ever-rising house prices has become a self-fulfilling prophecy. But this excessive demand coincides with a highly restricted supply. For many years, the number of new houses built has been consistently below the net gain in the number of households due to increased longevity, smaller household sizes and immigration.

Both demand pressures and supply restrictions have an effect on house prices, and both are closely interrelated. It is only in the knowledge of a restricted supply side that prospective home owners can hold an expectation of substantial future price increases.

In light of this, what would be an appropriate response from the government and the financial sector to improve the chances of first-time buyers in a housing market that is characterised by both high house prices and high demand?

The reaction of the financial service industry is well known. Many mortgage providers have now given up their traditionally conservative lending practice of offering mortgages three to four times salary for a period of up to 25 years. Nowadays, it is possible to find banks such as Abbey that are prepared to lend for more than 50 years – and at up to five times salary.

While some first-time buyers may find this an option of last resort, such an ‘investment’ may turn out to be an extremely risky one. Besides, these lending policies will only fuel further house prices excesses, making it even harder for future first-time buyers. More aggressive lending practices are instead part of the problem, not the solution.

A real solution can only come from the supply side of the market. Here it is the Government’s task to ensure that the housing market can respond to increases in demand as markets normally do, namely with increases in supply. This would stop and perhaps even reverse the trend of rampant house price inflation, and it can be achieved by making the planning system more flexible. In a series of publications, Policy Exchange has demonstrated how to bring about such a shift in policy.

We will eventually have to disenthrall ourselves from the illusion that artificially inflated house prices make us richer. It is house price stability that we should strive for. Future generations of first-time buyers will thank us if we ever achieve it.