Housing shortage won't stop a housing crash

Neil Faulkner looks in depth at the demand and supply in the property market.

If there's a shortage of paper clips, stationery companies can easily supply more to meet the demands of people who've suddenly had an urge to sort out all their paperwork. It's not so simple with housing, which is why supply and demand is commonly assumed to be the reason house prices have grown so fast from the mid-90s onwards.

Apologies to the less populated UK countries

Before I go any further, I'd just like to apologise to readers in Northern Ireland, Scotland and Wales, because due to the wealth of separately calculated data I think the supply and demand issue is more easily looked at for each of the countries in the UK individually, and doing so would require four articles. Hence I've focused on England, which with 21 million households it's the biggest market.

What is housing supply and demand?

When I say 'housing supply' I mean the total number of properties to buy and rent combined, because all of them affect house prices. If there are more rental properties (social or private) then rents fall. If rents are lower, then more people choose to rent and less people demand to buy.

That was relatively easy, so on to demand. Everyone would like to own their own home, or even a streetful of homes. That's not really demand though; my economics textbook gives the technical definition of that as 'wishful thinking'. During this article I'm going to define demand as genuine need for property, which takes into account changes in population numbers and demographics (such as a shift to smaller households).

New households grow faster than the population

Here are some figures to whet your appetite. In England from 1981 to 2008:

• Couples and multi-occupancy households have increased by 1,050,000.
• Lone parents and single-person households have increased by 3,150,000.
• That makes the total new households over the period 4.2m.
• Meanwhile, the population has grown by just 1.8m, showing that households have managed to expand more than twice as fast as population growth thanks to more, smaller households.

Looking further back, the housing stock in Great Britain in 1900 was 7m and in 1998 it was 22m, more than triple, whereas the population was up just 52% over the period, from 38m to 58m.

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Unfortunately, the data on those areas is too sketchy, so we need another gauge for supply and demand.

How to gauge an imbalance in supply and demand

We don't have many options, but the best place to start might be to look at overcrowding in households. According to the 2001 census, 7% of homes were overcrowded in Great Britain. If England has an equal share of that (although it's probably a lot more according to a report from Ealing Council) it means 1.5m houses are overcrowded out of a total of 21.4m households. Mostly this overcrowding is in social housing, but lack of any sort of housing will have an impact on house prices.

That figure compares with around 560,000 overcrowded households in 1981 or less than 3.5%, according to a former Government's answer to a Parliamentary question. This big jump indicates there are probably increasing demand pressures.

If all those data are accurate then it's a reasonable sign of greater demand straining against a supply that's been growing too slowly. The shortfall is likely a lot larger than 1.5m, because there will be people stuck in homes that are big enough, but unsuitable, for example if you're 30 and still can't afford to move out. Hence, this isn't a measure of the precise imbalance but a broad gauge to how much it might have worsened, which could be two-fold since 1981.

Although we've been building more houses since 2001, it's still not as many as the Barker Review said was needed to meet new demand and catch up with the backlog, which would mean the imbalance has worsened.

I need to write a quick aside here. Near the beginning I explained that each country of the UK needs its own report, but a report is needed for much smaller regions, too. London has massive overcrowding, for example, according to an Ealing Council report. However, it also shows that for the rest of the country overcrowding has on average gone down, which may mean that demand for large parts of England is not rising at all and may even be sinking. This may not be surprising, but it's worth remembering.

There are other things we could use as measures or gauges of demand growing faster than supply, such as the increasing difficulty of getting social (affordable) housing or of good quality housing. I haven't yet read any reliable data on this, but it's hard to totally ignore the anecdotal evidence that swamps me as a finance journalist.

How has this affected house prices?

The Barker Review looked back over decades and saw a general trend of faster house-price growth than most of Europe over at least 30 years, and this general trend is most likely due to a supply and demand imbalance.

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However, the fast growth from the mid-90s to their (still high) current levels was way above even the trend outlined in the Barker Review, and that's without any dramatic change to the supply and demand issue.

Gradually worsening supply means house prices should continue to grow at a fair pace over the long term, but in the short term I think they've been pushed even higher for other reasons. Hence, my view is that average prices could still easily fall a fair bit from today's levels despite the shortage.

In other words, I don't think that the current housing shortage is capable of preventing a crash - although it may have played a role in delaying it.

So that's my view - what's yours? Please add your thoughts using the comments box below!

Read the other articles in this unofficial series

The future of house prices gives you a summary of the main possible causes of house-price growth.

The link between house prices and salaries explores one of those causes in more depth.

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