House prices are very sensitive to comparatively small changes in supply and demand. This, together with undertainties in the long term forecasts, makes long term prospects very uncertain.

Like anything else, prices depend on supply and demand. Demand for houses depends on population and the number of households. This is not something that changes much in response to prices.

Supply is a little more sensitive in that high prices will encourage house building (and pressure the government to loosen planning laws to allow it!), but building takes time.

In short, neither demand nor supply is price elastic, so a small change in either causes a large change in prices.

So, how well can we predict supply and demand? In the case of supply it depends on a mixture of economic and political factors. In Britain planning laws, and restrictions such as greenbelts, are the major constraint on supply. While high house prices are currently encouraging loosening, long term trends in politics are intrinsically unpredictable.

Demand appears to be equally difficult to forecast. A look at current and past forecasts by the government actuary’s department shows a great range on undertainty in current forecasts. The “principal” forecast shows populations growth slowing, but remaining positive, so that there is now actual decline.

However, if any of fertility, life spans, or net immigration is lower than expected, then Britain is only a few decades away from the first decline in its population in over 300 years. This is based on the 2004 forecast, the latest available.

Even worse, the forecasts change significantly over quite short periods. A look at the forecast based on 2000 numbers shows the population peaking in about 25 years time, and going into a steep decline a few years later.

There is one comment I want to make on the political factors. The higher prices go, the more pressure there is on governments to make housing affordable, which means that it is likely that laws will be relaxed to allow building. On the other hand, if supply does outstrip demand, there is very little the government can do about it, untill demand cathces up again.

Of the factors that drive population, immigration and emmigration are the most unpredictable. it not only depends on economic and political factors within Britain, it also depends on factors in other countries. It is hard to model because there are many intertwinned factors.

Living in Sri Lanka (which has one of the world’s highest emmigration rates), made me realise how many people have lived in Britain and left it again. Some had been permanent residents, other are British citizens or married to British citizens. Reasons for their choice varied: some were economic (if you have capital or a fixed income, it goes a lot further in the third world), some were personal (familly etc), and some were pure personal preferences. Obviously conditions in Sri Lanka (war or peace!) affect the preferences all three groups.

Now that we have look at what is unpredictable, it is worth considering what is reasonably predictable. The trend to smaller households is caused by an ageing population (more widows and widowers, more couples whose children have left home) and the decline of the nuclear familly (more single parents, more divorced people living alone).

This means that more homes may be needed even if the population declines, becuase fewer people ill live in the average unit. However it also means a change in the composition of demand (more city centre flats, more sheltered housing, fewer suburban houses). This will favour certain types of property, and brownfield land suitable for these types of development.

Another strong trend are the regional variations. The population of Scotland and of the Northeast of England are declining as people move to the Southeast. While everyone does seem to want to live in London, one wonders at what point spectacularly high house prices will become a deterent, and people will take their money elsewhere.

Finally, if you expect your house to make a significant contribution to your wealth in retirement, then pray for high immigration, high fertility, and high divorce rates!