Sunday, 4 September 2016

Economic Myths: Additional supply in the housing market.

In the comments to this post, L Fairfax put up a spirited rebuttal of my statement that:

Observation tells us that in the medium term, additional supply in high demand/high wage areas creates its additional own demand and the overall effect is to push up rents and prices, but his point stands.

The evidence he gave was as follows (I hope I have summarised correctly):
- The Spanish seem to have proved that if you build enough new flats on the outskirts of towns they become cheap
- my family in Spain live in a city of 228,000 people and mass house building has caused prices to go from EUR 100,000 to EUR 35,000 for starter flats
- £120pcm for the mortgage on a flat in parts of Spain.
- wages have fallen not that much


To which my reply is:

1. Perhaps I should have focussed on rental values rather than prices in my original statement. The agglomeration effect I referred to apply only if the population of the town increases in response to the additional supply; in which case added supply and added demand cancel each other out and we would expect no downward movement.

2. Golden rule: rents are the Maypole around which house prices dance. Rental values are a far better reflection of the absolute "location, location, location" value (average local wages minus time cost of travel to place of work etc) and, unless something in the real economy changes, are fairly stable.

3. House prices are rental values divided by the prevailing interest rate, plus or minus expectations of future price changes, so booms and busts are self-fulfilling. People who paid EUR 100,000 for a home which only has a rental value of EUR 2,000 a year must have been gambling on massive rent or price increases, this is completely irrational short term behaviour which is difficult to factor into economic models.

4. Rational people will buy if the initial repayments on a mortgage are roughly the same as the rent, plus or minus a bit.

5. Flats cost EUR 35,000, so you'd expect the annual repayments on a mortgage to be around 5% of that = EUR 1,750 = EUR 150 cpm = £120 = looks about right.

6. So I would assume that local rents for a starter flat are about EUR 150 pcm, give or take a bit. It's not going to be much higher or else nobody would rent, they'd all buy instead.

7. So the missing bits of information here are:
- what has happened to rental values since the building boom started? If they have fallen by two-thirds, then that puts a hole in my theory, if they have remained stable (or merely fallen in line with GDP), that supports my theory.
- what has happened to the population of that town since the building boom started? If it has increased by less than new supply, that puts a downward pressure on (average) rents and prices (supply exceeds demand and no agglomeration benefit).

26 comments:

Dinero said...

There is a lot of unemployment with young people in Spain and the GDP is lower than 2008.

The building in Marks comment is , building to satisfy demand or maybe even create demand. Hence the scope for agglomeration effects.

LFairfax said "build enough" and "mass" bulding. Well that is building beyond demand, and no suprise that would decrease sale prices in the short term.

Dinero said...

Spain GDP down 27% from 2008 http://www.tradingeconomics.com/spain/gdp

Sean Vosper said...

Yes. It's rental values that are the ultimate driver of prices. In the US the national economic statistics use the concept of imputed rent - the rent that a homeowner is effectively paying themselves - by not paying rent increases if they were renting. Not sure if we use that calculation in UK statistics. An LVT effectively taxes that.

But as to the debate. As Scott Sumner likes to say "Never reason from a price change"

Ben Jamin' said...

I think we all agree that in the UK supply is not being matched with demand. The market can only match the two when everyone pays the same costs for their right to exclusive use of a valuable location .ie rent or a LVT(same thing).

At the moment, due to a dysfunctional market, no one can possibly say how many extra homes the UK needs, if any. Or even where those homes should be built, if at all.

Building loadsa homes does not treat the problem of market inefficiency, it just dilutes it. As a consequence, selling prices will remain higher than they otherwise should, and any reduction will come with a cost of adding to existing inefficiencies.

So yes, of course building more homes will reduce prices somewhat. But in and of itself, is by far the second best solution to affordability issues. Which is why I'm surprised its universally endorsed by economists, journalists and politicians.

They probably just haven't thought about it.

Mark Wadsworth said...

D, SV and BJ, ta for input and agreed, however without the missing bits of info from 7, we can't test whether the theory applies to Spain. I am 99% sure it will, but hey, you have to be open minded.

Mark Wadsworth said...

SV, in response to your question, yes it appears that the UK now also includes imputed rent in GDP figures (source).

Which is nuts of course - rents are an appropriation of GDP not in addition to it*. And their estimate of £158 bn is a bit on the low side, I would have thought at least £200 bn or so for owner-occupied.

* Consider a very small country that is owned by one single farmer. He grows and sells £50,000 of wheat every year. His GDP is £50,000, easily measured. You could split it into £40,000 labour and £10,000 rental value of fields, but you can't add £10,000 rental value of fields to £50,000 wheat = £60,000 GDP.

Dinero said...

Their way of doing it may be wrong , But , If the farmer left the fields fallow for one year , but succesfully maintained the productive quality of the land in every respect for that year , would you not want to still have a measure of that rental value.

Bayard said...

"So the missing bits of information here are:"

Also, 1) did the "mass building" occur before 2008, when people could reasonably (or indeed unreasonably) expect wages to go up and up and so it would be worth paying £100,000 for a starter home on the grounds that, when you came to sell, people could afford to pay even more than that, and did the building come to a grinding halt with the crash? and
2) was the fall in prices in line with the fall in local wages and GDP?

DBC Reed said...

The UK taxed the imputed rental income from house ownership under Schedule A of Income Tax until 1963 when the Conservatives , at a politically low ebb, abolished it as a bare-faced electoral bribe and ushered in the Homeownerist era culminating in the present mess wherein Cameron or Osborne told coalition partner Clegg "I don't know why you keep going on about the need for more social housing; it just creates Labour voters."(Guardian Weekend 3.xi.16)

Mike W said...

DBC Reed, Yup I read that. It was the next paragraph I found interesting and had to carefully go over and over with my Lutheran wife so that she could grasp the balanced budget bollocks we hear from the Neo Libs all the time.Tax was born out of fines and punishment was it not?

Clegg -'What I found offputting was the callousness to his political calculations, particularly around welfare. Welfare for Osborne was just a bottomless pit of savings, and it didn’t really matter what the human consequences were, because focus groups had shown that the voters they wanted to appeal to were very anti-welfare, and therefore there was almost no limit to those anti-welfare prejudices. I found that very unattractive, very cynical.”

To be fair DCB, MarkW has always said that these 'savings' were designed to appeal to the Daily Hate reader etc. Osborne had to make the squealing very, very loud. This was the only calculation involved.

Mark Wadsworth said...

DBC, we have rehearsed the descent from the common sense post-1945 package into Home-Owner-ism many times, and as you say, scrapping Schedule A was a first tentative step.

But at present, I am waiting for LF to get back to us on how wages, population and rents in that particular town have changed over the last ten years. That is what I wanted to discuss.

MW, yes, it's all about the squealing and appearing tough, as if the Financial Crisis can be blamed on Labur govt deficits (too high, but the Tories are worse) and the unemployed, who played no role in the house price and credit bubble.

L fairfax said...

@Dinero
"LFairfax said "build enough" and "mass" bulding. Well that is building beyond demand, and no suprise that would decrease sale prices in the short term."
Free markets often over supply, this is a good thing for the consumer - of course we do not have a free market in housing in the UK. If we did many people in London would not live there.

I am sorry I can find the rental values in Spain (the town is Elche by the way).

Has there ever been two similar cities where one let people build on a large scale and one didn't and the other did not and the city which had lot scale building became more unaffordable?).
(BTW I don't really care about prices I care about affordability.)

L fairfax said...

Large scale building was still going on last year. They are also seem much quicker at building flats than in most parts of London.

Mark Wadsworth said...

LF, rental values are the missing piece of the puzzle, although change in local average earnings and local population would be useful back up.

As to your question, yes there are loads of examples. Within any country, towns with the largest number of homes and the highest population seem to have the highest rents (London, Tokyo, New York, Paris etc).

L fairfax said...

@"As to your question, yes there are loads of examples. Within any country, towns with the largest number of homes and the highest population seem to have the highest rents (London, Tokyo, New York, Paris etc)."
Perhaps I was not clear (although
I did say "(BTW I don't really care about prices I care about affordability.)"
)
Is there a case of 2 identical cities where one had planning/building controls and the other didn't and the one without controls became more unaffordable over time.
I don't think this has anything happened like this in the UK

London is of course not the most unaffordable place in Britain
http://www.telegraph.co.uk/finance/property/house-prices/11436459/Welcome-to-Britains-most-unaffordable-spot-its-not-London.html
Some say it is Oxford, is that because they have been building lots of homes?

L fairfax said...

They don't have to be 2 cities they could be 2 countries or two parts of the city.
Remember price is irrelevant, affordability is the important thing.

Bayard said...

"http://www.telegraph.co.uk/finance/property/house-prices/11436459/Welcome-to-Britains-most-unaffordable-spot-its-not-London.html"
That article is not comparing like for like. It says "The average cost of a house in Oxford in 2014 was £426,720, with the city’s workers earning on average £26,500 a year." but goes on to say "Oxford’s house prices have been driven up by the number of London commuters who have moved out of the capital to escape eye-wateringly high house prices." So of course Oxford's houses are unaffordable to Oxford's workers, because so many of Oxford's inhabitants are London's workers, where they are paid more than Oxford's workers. Presumably the same could be said about the other four "unaffordable" towns, all within commuting distance of London.
Nice bit of Homeownerist propaganda from the Torygraph.

Lola said...

Observationally, the flats and houses in Spain are vacant, some of which I witnessed in Spain in 2013 (?)*. Hence rental value = zero. I saw the same thing in Ireland in 2008 (?)*. Lots of houses had been built (but not all finished) and they were standing empty.

This is classic evidence of the 'mis-allocation of capital that always follows the unwarranted expansion of money and credit at to low a price' thingy.

However I have also seen the same thing in recent times in some Midlands/Northern cities where houses have no possibility of tenants and are on the market for a few thousand.

So as MW says, prices do dance around rents.

* Not sure exactly of my dates.

Mark Wadsworth said...

LF, if you go back far enough, it must be pretty obvious that London, Tokyo etc were not always so big, in fact, were not much bigger or smaller than any other towns in the same country.

From that stage on, more homes (and more of everything) was built in London, Tokyo rather than Nether Potterton or [some small Japanese hamlet]. Does it matter that the lack of additional development in other places in England or Japan was not necessarily down to planning restrictions?

The whole "build more and they will come" phenomenon works for large towns regardless of whether more or fewer homes are being built elsewhere and regardless of the reason why more or fewer homes are being built elsewhere. So I don't see the relevance of your question anyway.

But this whole thread is pointless until somebody comes up with changes in rents in Elche.

L fairfax said...

@"LF, if you go back far enough, it must be pretty obvious that London, Tokyo etc were not always so big, in fact, were not much bigger or smaller than any other towns in the same country. "
Yes although in the case of London several centuries.
However London has not always been unaffordable. In fact until recently it was quite affordable to buy in many parts of London. My home could have been bought by a couple working at McDonalds about 20 years ago.
As I keep saying I am not disagreeing with agglomeration increasing prices but I don't care about prices I care about affordable.

Bayard said...

LF, if the houses in London were truly unaffordable, they would be empty. Nearly all the housing stock in London is occupied. Someone thus has been able to afford to buy them. They are, de facto, affordable, just not by the couple working in MacDonalds. What has happened in London is that richer people than the McDonalds couple have come in and been prepared to pay more for the housing, because it's affordable for them.
Twenty years ago, none of the well-off wanted to live in your part of London, so prices reflected the earnings of the people who did. Now its full of people who have high-wage jobs in the city and prices have gone up to reflect this, plus twenty years ago, prices had not recovered from the postwar dampening that Mark keeps having to elucidate time and again, presumably because no-one listens to him.
In any case, there have always been parts of London that were unaffordable to those on a small wage. Even twenty years ago, your Mcdonalds couple would not have been able to afford to live in Knightsbridge. Similarly there are still places today, even in London, where such people can afford to live, just not where you live.

DBC Reed said...

I know I will get my usual going-off-topic clubbing, but this minute examination of home rental patterns in Elche covers only the mathematical aspect of the problem.
We cannot do anything in the UK when social attitudes are so right-wing that focus groups show that anti-welfare prejudices are almost limitless. Doubtless, the idea that social housing only creates Labour voters is also as deeply entrenched. And then there is the enthusiasm for Brexit as a means of deporting foreigners and speeding them on their way with street violence.
An argument for LVT on the basis of disputed economic facts is not going to be enough in the present political nadir.

Mark Wadsworth said...

B, thanks, saved me the bother.

DBC, we are not arguing on the basis of "disputed economic facts". This whole debate hinges on whether rents in Elche also fell by two-thirds, LF has admitted he doesn't know and I cannot find any sensible source of data on it. If somebody comes up with actual reliable facts then nobody is going to dispute them.

L fairfax said...

@Bayard
"Twenty years ago, none of the well-off wanted to live in your part of London, so prices reflected the earnings of the people who did."
Actually well off people did want to live where I live 20 years ago. It is actually relatively cheaper compared to other parts of London than it was. It is also more difficult to buy than it was.
@"In any case, there have always been parts of London that were unaffordable to those on a small wage. Even twenty years ago, your Mcdonalds couple would not have been able to afford to live in Knightsbridge."
Isn't that a truism? It doesn't change the fact that is harder to buy than in the past, the fact that renting - which is used to be more expensive - might not have gone up so much is not really much consolation.
@"where such people can afford to live, just not where you live."
where could they live like they could 20 years ago?
Obviously people can afford to live, they just live at a lower quality than in the past.
@dinero
"Well that is building beyond demand, and no suprise that would decrease sale prices in the short term."
If the market wants to do it, why not let it? I think it is kind of people to protect house builders but I think they can look after themselves.

James Higham said...

Depends what you wish to rent in Elche. I make it 390 euros to 1792 pcm.

Physiocrat said...

Residential rental values in Brighton and Hove hardly moved between 2003 and 2013. They have risen by about 20% in the past three years.