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What Makes House Prices Fall?

By Emelyn Hinrichs

Property is a large collection of assets. Along with the share value of companies, the stock value of housing is probably one of the biggest stores of wealth any country has. Property prices rise and fall, but why? Values are a function of what people are prepared to pay and most markets in capitalist countries, such as Australia operate on the principle of supply and demand. Many factors go into the pricing of property and the government has a lot of levers that it can pull to tweak values. External factors are beyond the control of governments and sometimes, what is going on in the world economy can cause Australian house prices to fall.

Supply and Demand

The straightforward mechanism that decides prices in any commodity or service is the principle of supply and demand. If more people want to buy something then demand for that thing increases. When demand starts to exceed supply of that thing buyers start to compete. Thus, prices rise. Usually markets correct themselves because when the short supply of something makes its price rise, an incentive is created to produce more. Eventually the increased supply will erode the shortage and prices will fall back down. If supply exceeds demand producers compete to sell and so prices fall. When prices fall too low, some producers will go out of business. This is when recessions happen. When enough producers have withdrawn from the market, the supply reduces to the level of demand and prices rise back to a point of equilibrium.

The Property Market

Property is an imperfect market because a sudden surge in prices can’t be dampened by an immediate rise in supply. There are procedures and laws in place that mean builders need to get land in the right place to build and that land may be in short supply. They then have to go through a planning phase and also seek permission to build, which is a time consuming process. The construction of new homes also takes a long time. So builders have to plan their capacity years in advance and can’t always react to unexpected circumstances that increase demand. Similarly, once a building is in the process of construction, they are unable to halt, because of finance commitments. So when demand falls unexpectedly, the market gets oversupplied and prices fall.

Shortages and Oversupply

The long horizon of property market is the main reason that property values fall. Governments can step in with tax incentives to buy and lower interest rates to reduce finance costs, and so make buying a property more affordable. However, these measures can take 6 months to a year to feed through to market improvements. During the time the excess property gets soaked up property prices will continue to fall, or stay flat.

Unexpected Circumstances

Developers and governments get caught out on predictions for housing demand if some external and unexpected shock occurs. There may be an event that makes people decide they don’t want to buy property. This is usually caused by financial insecurity. If someone feels she may lose her job soon, she is not going to risk committing to a big purchase. So, a contraction in the world economy can cause Australian house prices to stall. Similarly, people are less likely to buy if prices suddenly spike increasing the cost of living. An oil price shortage or a drought that increases the price of food are two examples of these problems. Sometimes property prices rise so high that they become unaffordable, so the people that would buy, can’t. This causes sales to dry up and prices have to fall before the market starts moving again.

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