How a local housing market works

The phrase the housing market suggests something singular, like a commodity exchange with one price and one clock. On the ground it behaves nothing like that. Every dwelling is a one-off bundle of a building, a plot, a legal interest and a location, and no two bundles are interchangeable. What is actually traded is a long series of unique items, slowly, by people who mostly transact two or three times in a lifetime and who are therefore permanent amateurs in the market they are entering.

That single fact explains most of the market's odd behaviour. Prices adjust reluctantly. Information is uneven. Bargaining is personal. And the number that gets reported as the local average is a summary of whichever houses happened to change hands recently, which is not the same thing as the value of the houses that did not.

Stock and flow

The most useful distinction in housing economics is between the stock and the flow. The stock is every dwelling that exists in an area. The flow is the small proportion of that stock which is on the market at any moment, plus whatever new building is completed. In most established areas the flow is a low single-digit percentage of the stock in any year.

Because the flow is small, the marginal transaction sets the reported price for the whole stock. A handful of sales in a street of two hundred houses will be taken, by lenders, assessors and neighbours alike, as evidence about all two hundred. This is why local prices can appear to move sharply on thin evidence, and why they can appear to stall when in fact nothing is being offered at all.

New building adds to the stock slowly. From the point at which land is assembled to the point at which someone moves in, several years usually pass, and much of that time is consumed by consent rather than construction. The practical consequence is that supply cannot respond to a demand shock in the period during which the shock is happening. It arrives later, sometimes after the conditions that justified it have gone.

Submarkets

A town does not have one housing market; it has several running in parallel and interacting at the edges. A useful way to see them is by the constraint that binds each group of buyers.

There are buyers constrained by deposit, who are extremely sensitive to the cash sum required and comparatively insensitive to the monthly cost. There are buyers constrained by monthly affordability, who respond immediately to changes in borrowing costs. There are movers whose purchase is financed mainly by a sale, and whose real constraint is the gap between the two prices rather than either price alone. There are cash buyers, who are constrained by nothing except judgement, and who therefore behave very differently in a slow market. And there are buyers of rental property, whose constraint is the relationship between rents and financing costs rather than between prices and incomes.

Each of these groups clusters around different parts of the stock: flats and small terraces at one end, family houses with a certain number of bedrooms in the middle, larger and older property at the top. A change in credit conditions does not move all of them together. It can lift the bottom of a market while the top is falling, or freeze the middle while both ends continue to trade.

Price discovery in a market with no ticker

In a market of unique goods, price discovery has to be improvised. It happens through a chain of proxies: what similar properties were marketed at, what they were agreed at, what an assessor was willing to put on paper, and what a lender was willing to advance against it. Each of these is a different number, produced at a different moment, by a party with a different interest.

Because agreed prices are private until registration and registration lags by months, the public information available at the moment of a decision is mostly asking prices, which are aspirations, and completed prices, which are history. The most recent honest signal in a local market is usually not a price at all. It is behaviour: how long things sit before an offer, how often asking prices are revised downward, and how many agreed sales survive to completion.

Volume is the leading indicator

Transaction volume turns before price does, in both directions. When conditions tighten, sellers who do not have to move simply withdraw rather than accept less, so the number of sales falls while the average recorded price holds up or even rises, because the sales that still happen are skewed towards those who can afford to be patient. Only later, when the forced and semi-forced moves accumulate, do recorded prices follow.

The same asymmetry works upward. A recovery shows first as a rise in viewings and agreements, then as a shortening of the time between listing and agreement, and only afterwards as a movement in recorded prices, because those prices describe deals struck months earlier.

Anyone trying to read a local market from a single average price is therefore reading a lagging summary of a biased sample. Volume, time on market and the withdrawal rate are cruder numbers, but they describe the present.

Seasonality and the calendar

Housing markets have a strong and durable annual rhythm which has little to do with economics and a great deal to do with school terms, daylight and holidays. Listings and agreements typically build through late winter and spring, hold through early summer, thin out sharply in high summer, revive briefly in early autumn and then close down for the year.

This matters because a market can look as though it is deteriorating when it is only November. Comparing one month with the previous month, rather than with the same month a year earlier, produces a great deal of unnecessary alarm and unnecessary optimism.

Frictions that shape outcomes

Finally, a local market is shaped by the sheer cost of moving. Transfer taxes, professional fees, removal costs and the time consumed by the process together make a move expensive enough that people do it rarely and think hard first. High friction reduces turnover, which reduces the supply of information, which makes each transaction harder to price, which raises the perceived risk of moving. The loop is self-reinforcing.

It also produces a phenomenon that surprises people the first time they meet it: the same house can be worth noticeably different amounts to two buyers with identical budgets, because one of them is chain-free and the other is not. In a market where certainty is scarce, certainty is part of the price.