The housing market differs from any other market

“Housing has a unique set of characteristics: necessity (housing satisfies a basic human need, shelter), importance (for most households it is the single most important item of consumption), durability (housing is the most durable of major commodities), indivisibility (households typically do not mix fractions of housing units), complexity and multi-dimensional heterogeneity (a housing unit has a great number of characteristics), thinness of the market (housing units and households are sparse in characteristics space), nonconvexities in production (rehabilitation, demolition and reconstruction, and conversion involve discontinuous changes that are caused by production nonconvexities) the importance of informational asymmetries (e.g. potential occupants are not fully aware of each housing unit’s characteristics, and landlord and tenant do not know each other’s traits), the importance of transactions costs (search costs, moving costs, and transaction fees), and the near-absence of relevant insurance and future markets.  Most goods contain some or all of these characteristics to some degree. But only in housing are they all so pronounced. These characteristics interact to cause the operation of the housing market to be significantly different from any other market.”[1]

The housing market is extremely sensitive to changes in demand. Prices are rising when the demand increases and price pressure downward becomes strong when demand falls.[2] This is because the supply can only change slowly. On increasing demand, it takes time to build new housing and when demand falls, it is difficult to adjust supply and individual players can make large losses. Many researchers have emphasized the high volatility (strong swings up and down) that characterizes housing prices and believe that housing markets seem to have an inherent tendency to create bubbles, which can become a serious threat to financial stability.[3]

Since a large part of the financial sector’s lending consists of mortgage loans secured on housing sector it is strongly affected by changes in the market price of housing. And because the financial system is an important part in the whole economic system bursting price bubbles could lead to crisis for the entire economy.

The current economic crisis, that began with the subprime US home loans, exposed the weaknesses in the financial sector, where banks were allowed to “create money” that far exceeded the real economy. Since the financial sectors in different countries are so interwoven to each other the US crisis also hit European banks. The economic downturn that followed led to several states with large debts that had difficulty to meet their commitments, putting the Euro’s credibility at stake.

The bubbles are based on the expectation that prices will increase, but price increases are usually followed by price declines and there are those who argue that the value adjusted for inflation is fairly constant. The economist Piet Eichholtz examined rates over time in real estate on the Herengracht, Amsterdam’s Finest Way, which was built in the early 1600s. The price trend was dramatic with ups and downs, but value growth over time low – 0.2 percent per year on average in real terms.[4]

The American economist Robert Shiller 2005[5] showed that the annual growth in value of homes in the US since 1890 had been higher than a few tenths of a percent and that it was only years prior to 2006 as housing prices soared.

The construction of new housing and other infrastructure investments, maintenance and energy-saving investments in homes and workplaces create jobs. Investing in existing properties to make money on capital appreciation creates in contrast no new jobs. But on the contrary the greater proportion of the total investments in already existing housing the smaller space will be left for investments in productive sectors of the economy for new jobs. In some countries it is today fiscally more advantageous to buy a home than to invest in a business.[6] Higher the prices and/or the rents mean less money for the households to spend on other commodities. A household’s expenditure on housing is usually the individual expenditure which takes the largest share of the household budget. All this together is the reason why the housing policy has such a great influence on the whole economy.

[1] Arnott R. (1987). p. 960.

[2] Wigren R, Wilhelmsson M (2007) pp. 133–154

[3]   Ibid. s. 117

[4] Eichholtz, Piet M.A. (1996)

[5]   Shiller R.J.,  (2005) Irrational Exuberance, 2nd edition, Princeton University Press 2005

[6] Öberg A ( 2008),  p.18


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