How are house prices determined?

As UK house prices rise further, there’s one question that many existing homeowners and prospective buyers have been asking. How are house prices determined?

Of course, the basic economic principle of supply and demand plays a significant role. Various factors also influence the supply and demand of the market, but it’s more nuanced than that.

There are also property-specific factors that will impact how it is valued. But, what are they?

That’s what we’ll take a look at in this article. We’ll examine the factors that go into valuing a home and how popular house price indices source their data for their statistics.

What determines house prices?

As you can imagine, numerous factors determine the value of a home, such as the overall market supply and demand, the property’s location, its condition, and the country’s economic condition.

You also have the property’s size, features, proximity to local schools, and mortgage interest rates. Whilst this list is far from exhaustive, the result of all these factors will affect whether a home’s value is above, below, or on par with the current market. Let’s take a look at these factors in more detail.

1. Location

Location is one of the major components in determining a property’s price. Of course, this applies to cities where a home in an economic hub such as London, Manchester, or Birmingham will be much pricier than in a smaller city such as Norwich or York. However, it also applies to different neighbourhoods within the city itself.

The property’s location and proximity to public transport lines, shops, entertainment, community centres, motorways, employment opportunities, etc., will impact a home’s overall value. Generally speaking, the closer a house is to these amenities, the more desirable it is, which in turn increases its value.

2. Property’s condition

The condition of a house drastically influences its price. A property that is run down has structural issues, mould seeping through the walls, and is almost uninhabitable in its current state, will sell for far less than a well-maintained property. This is because the valuation will factor in the cost of addressing the problems and fixing them back up to a new and liveable condition.

3. Mortgage availability

The ability to obtain a mortgage also affects the value of a home. When mortgages are readily available to the population, and the required deposit is low, demand for houses rises since more people can afford them. This means that a home will be valued higher since the overall property market has appreciated.

When the criteria for obtaining a mortgage become more stringent and people have to put up higher deposits, the pool of buyers shrinks. Naturally, this reduces demand which then has a knock-on effect on how your home is valued.

4. Mortgage interest rates

On the same token as mortgage availability, the interest rates charged on a mortgage will influence how a house price is estimated. When mortgage interest rates are high, the cost of monthly mortgage payments will also be high, which can price out many prospective buyers. This reduces demand, which in turn reduces the price that a house will be valued at.

However, suppose mortgage interest rates are low. In that case, monthly mortgage payments will be lower, thus increasing demand as more people can afford them. As such, this will drive up the selling price of a home.

5. Size of a property and its liveable space

Usually, the square footage of a property will impact its price. A bigger property will command a higher purchase price than a smaller one simply because it has more space and is more attractive to buyers. Alongside the size of the property, the amount of usable space will also affect the price.

Using the example of square footage, suppose you have two houses that are both 2,000 square feet big. House A has all 2,000 square feet as a liveable space inside the property. On the other hand, House B has 1,500 square feet of liveable space inside the property, with the remaining 500 square feet being taken up by the garage. Typically, House A will cost more than House B because it has more liveable space inside it. Sure, the owners could turn the garage into another room, but this will be a costly renovation. As such, the house valuation price will reflect this.

It’s not just the size of the house itself but also the size of the space outside, like its garden area. A bigger garden will increase the value of a property compared to one with a small garden. As a general rule of thumb, the more space a property has, the more expensive it will be.

6. Opportunity for upgrades

Another critical factor in determining house prices is if there is an opportunity for upgrades and improvements to the property. This can manifest in various ways. For instance, if there is the ability to add a loft conversion, buyers may be willing to pay more for a property as opposed to if this possibility doesn’t exist.

Meanwhile, the need for upgrades could also devalue a property. Suppose a house has not had a fresh paint job and makeover in over a decade and has outdated decor and furniture, requiring a complete makeover to modernise the property. Because the home will require significant renovations, the property’s value will be much lower as the renovation costs will be factored into the house’s overall value.

7. Features of the property

There are a variety of features that could increase or decrease the value of a property. An example is if you have planning permission to build an extension or annex to your home or if you have a cellar or basement when nobody in your local area does. These features will cause a home to be worth more than its neighbouring properties. On the flip side, if a house has a single garage, but the nearby properties all have double garages, this could significantly lower the property’s value.

8. Country’s economic condition

Whilst there are many factors related to the property itself that affect its value, there are also broader economic factors that play an equally important role. Suppose the country’s financial state is booming and wages are increasing at a healthy rate each year. This will typically cause the average house price to increase since more working adults are able to afford the deposit for a home.

Conversely, suppose a country’s economy is declining, and wage growth has stagnated for numerous years. In that case, there will be fewer people who will be able to afford a home. As such, the housing market will decline accordingly and cause property prices to fall.

The same applies to unemployment rates. High unemployment rates will result in fewer people being able to afford a home, thus lowering house prices. On the other hand, low unemployment rates will result in higher house prices as more people have the funds to purchase a home.

9. Local Schools

An overlooked aspect that can influence house prices is the proximity and quality of local schools. This is particularly relevant in the suburbs where you tend to find more families. If a home is located closer to a high-performing school, the market value of the house will be much higher than if it was located next to a low-performing school. Similarly, a house situated close to numerous schools is a much more attractive home compared to a house located far away.

One way to check whether a property is close to a good school is to look through its Ofsted reports. Here you will be able to find a detailed breakdown of the school, such as what it’s like to attend there, what the school does well, and what it can improve on.

10. Supply & Demand

One of the biggest factors that impact house prices is the overall property market in your area and its supply and demand. Regardless of your property size, how well it is refurbished, and its condition, if there are a large number of houses available in your area, property prices will be lower than if there were fewer available properties.

Basic economics states that if supply exceeds demand, it is a buyer’s market. This is where a potential buyer will have more options to choose from. Sellers will be fighting to ensure their property is the one that gets sold, and one of the main ways this plays out is by lowering prices in a ‘race to the bottom’.

Conversely, a seller’s market – one where demand exceeds supply – will mean sellers can hike their prices more than usual. They know buyers will engage in a bidding war to ensure they snatch up the property.

Why do various house price indices value properties differently?

There are numerous house price indices in the UK. They have one thing in common in that they all track the property market. However, they do so using different data and metrics. Some use data from approved mortgages and the price of a property sold. In contrast, others use data from estate agents and listing prices.

Consequently, these indices often have different values on UK house prices, such as year-on-year growth rates, the average house prices in certain regions, etc., which can be somewhat confusing to keep track of. To make it easier for you, we’ll explain how the most popular indices measure the property market so you can follow an index that is more relevant for you.

UK House Price Index

The UK House Price Index measures house prices based on completed sales. This is done at the end of the conveyancing process, which means that although they do not release data as fast as the others – usually every 4-6 weeks – it tends to be more accurate. The source of this data is the HM Land Registry which is an official government department, and its statistics can be broken down from a national level all the way to local authorities.

Rightmove House Price Index

The Rightmove House Price Index gathers data from properties that are advertised on its website. Additionally, it calculates its values using listing data, not the actual price that the property was sold for, making it slightly less accurate.

Halifax House Price Index & Nationwide House Price Index

Both of these indices publish their data using the approved mortgage values on properties on sale right now. This accounts for anywhere between 8% and 20% of all mortgaged purchases – which accounts for approximately 75% of all property purchases. This means that their data does not factor in cash sales and may not be representative of the entire property market. However, due to their indices using in-house data, these can be published much more quickly than, say, the UK House Price Index.

The Royal Institution of Chartered Surveyors (RICS) House Price Balance

The RICS publishes a report every month that outlines whether they are seeing house prices rise or fall. They calculate this by speaking to its members, which includes surveyors, estate agents, and valuers, which makes their report more of market sentiment rather than actual house price figures. This can be useful if you want to keep track of market trends.

Zoopla House Price Index

The exact methodology through which Zoopla calculates its house price figures is unclear. However, they claim to gather data from every home currently on sale in the UK property market, which is then run through its algorithm, which analyses millions of data points. This then churns out data such as average house prices, average growth, supply and demand, etc.