David Miles

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The increase in the cost of a house has outstripped the increase in the cost of most other things for the last 50 years. But why on Earth is that?

Average house prices in the UK have risen dramatically faster than average incomes over the past 30 years: relative to average disposable incomes, houses are almost three times as expensive now as they were in the mid-1980s. But this is not something specific to the UK and neither is it uniform across the UK. Recent evidence on house prices across a large sample of developed economies back to the mid-19th century revealed two things¹: first, on average house prices moved roughly in line with the price of other things between about 1870 and 1970 in most countries; and second, over the past 50 years, house prices have – again on average across developed countries – roughly tripled relative to the price of other things.

So there is nothing unique about the fact that, in the UK, house prices have in recent decades risen very much faster than the price of most other things and that houses have become much more expensive than cars, food, clothes, electrical goods, energy and travel. And the degree to which that has happened is very different across the UK. In London – the centre of the country’s most densely populated corner – average house prices have risen far faster than in most other parts of the country.

More fundamental forces are at work than just the much-quoted inefficiencies of arbitrary UK planning rules

Why has this happened? We can start by dismissing one theory: that the rising cost of constructing houses has driven up prices. In fact, the cost of building houses can account for only a tiny part of the huge rise in the relative price of houses. The price of land on which homes can be built, in contrast, has risen enormously and accounts for most of the increase in the value of houses. But “account for” does not mean “explain” – one has still not explained why house values have risen so fast. You have just pushed the question back to why land values have risen so much.

Part of that answer is connected to planning restrictions – and some people are satisfied to leave that as the answer. But those restrictions are not just arbitrary and they do reflect real effects upon quality of life of building more houses in already densely populated parts of a country. Such restrictions exist in most countries and are typically most binding in parts of countries where population densities and house prices are high. This suggests more fundamental forces are at work than just the much-quoted inefficiencies of arbitrary UK planning rules.

Over the past 50 years, house prices have roughly tripled relative to the price of other things

In recent work with James Sefton, I have tried to assess the extent to which these more fundamental forces might account for the relentless upward movements in house prices¹. Our focus is on the long run. We consider the housing sector within a model of the overall economy that aims to explain overall economic growth, saving and asset prices. Any long run analysis has to model the changing supply of housing taking into account the fixity of land mass and the way in which shifts in the cost of land relative to structures changes the way in which houses are constructed. Land is obviously not homogenous and the impact of the most important way in which it differs (i.e. location) varies over time as technological change means distance may have a varying effect on value. One obvious way in which this happens is if transport costs change.

We find there is great sensitivity over time in the pattern of development, the types of houses built and the values of structures to even small changes in two key parameters: the degree of substitutability of land and structure in creating houses; and the degree to which households substitute between housing and non-housing goods. We find it is not difficult to identify sets of assumptions about those things that are plausible in the light of existing evidence and which imply house prices can rise faster than incomes for periods spanning generations. This has nothing to do with planning restrictions.

Ultimately, housing over the long term could become increasingly expensive and perhaps increasingly rented. That would be more likely if:

  • population and productivity both grow steadily;
  • people are increasingly unwilling to live high in the sky or even underground, which will limit the scope to economise on land use;
  • people do not substitute much away from spending money on houses and divert it to other consumption as house prices rise; and
  • there is no improvement in transport infrastructure and travel times. That would limit how far from the most densely populated and popular urban centres people can live.

These four conditions probably all hold in the UK. That sounds like bad news. But major investment in transport infrastructure that reduces commuting times could mean future house price rises can still be limited.

¹“Houses Across Time and Space”, David Miles and James Sefton, CEPR Discussion 12103.

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David Miles

About David Miles

Professor of Financial Economics
David Miles is Professor of Financial Economics at Imperial College Business School. Between May 2009 and September 2015, he was a member of the Monetary Policy Committee at the Bank of England.