Sunday, 23 October 2016

Economic Myths: Falling GBP will push up UK house prices

From The Independent:

Estate agents in the UK have been swamped with calls from Chinese, Middle Eastern, Italian and Spanish buyers looking for a bargain after the pound tumbled to more than 30-year lows, making the exchange rate very favourable for foreign buyers.

With global commodities like oil, if GBP falls and world price of oil stays the same, then the GBP price of oil goes up, obviously.

Not so with land and buildings. Land and buildings sell for a multiple of the rental income and the rental income is in GBP. So if GBP falls, the rent falls in foreign currency terms and so the price which a foreigner is prepared to pay also falls in his own currency terms, and by definition is unchanged in GBP terms. The two effects neatly cancel out.

So in practice, GBP levels against other currencies have no little no effect on the selling price of UK land and buildings (in GBP terms). This is easily observable, or more to the point, is not observable at all because the effect does not exist, or the effect is so faint it is masked by 1,0001 other factors.

I can see the obvious counter-objections to this and I might as well deal with them.

1. "Ah, but wealthy foreigners aren't snapping up London homes for rental income, they are buying them to show off to other rich people."

Quite true, but when wealthy foreigners are bidding, the baseline is that they have to outbid the locals i.e. people who earn GBP and will be paying in GBP.

Further, it is a similar set of factors which influence GBP levels as influence the price of land and buildings, the two seem to move in tandem rather than in opposite directions (interest rates being one exception, a cut pushes GBP down but pushes the price of land and buildings up).
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UPDATE: Inevitably, people appear to believe that wealthy foreigners don't care about underlying i.e. rental values, or even showing off, they are doing it because it is a safe haven for their money and they are hoping for capital gains. The first part is clearly not true, if they wanted a safe haven for their money, they could buy 100 ordinary homes instead of one mansion in Westminster. So perhaps the second part is true, they are gambling on capital gains - and they have been right so far.

Nonetheless, put yourself in the position of a wealthy foreigner who wants to speculate in high end London homes. Two come up for sale, a smaller one with an annual rental value of £100,000 and a larger on with an annual rental value of £200,000. Which one would you bid more for? Not difficult, is it?

And of course, in all cases, it is local - earning and paying in GBP - who set the baseline for what you have to pay for the top couple of percent, even if we ignore the fact that homes sell for a multiple of rents.
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2. "Foreigners will gamble on GBP bouncing back."

Sure, but everybody can do that and there are simpler ways of speculating on currencies than buying land and buildings, with far lower transaction costs. And at any one time, we have to assume that whatever the FX rate (or any other random financial market variable) is, half of people expect it to fall and half expect it to rise.

33 comments:

KJP said...

"Land and buildings sell for a multiple of the rental income"

Well, that’s true in that if you have a sale price and a rental value you can always work out a multiple: but that is not how the majority of dwellings are valued. The multiple on a flat might be 20 times but for a large desirable house in the countryside that has no real rental market it could be 100.

Mark Wadsworth said...

KJP, that's the same as counter-objection 1.

The price-to-rent multiple is higher at the top end, but that does not mean it does not exist.

So if country house A has a rental value of £100k and country house B has a rental value of £200k, then country house B would probably sell for approx. twice as much as country house A.

I accept that very few Stately Mansions are being rented out, but there are very few Stately Mansions, and these are and always have been purely status spending to show off.

Mike W said...

KJP, thanks for posting. I am very interested in these 'could be' special cases of yours. Can you help me with this.

My Granddad was born in 1889 the year Dante Gabriel Rossetti died. We have a couple of watercolours from my Grandad (Hastings in summer etc).We think are great, but the art experts use the technical term, of 'no particular artist merit' for them :(
They are insured for £25 quid all in. A Dante Gabriel Rossetti scetch he also owned is, rubbish I think, but is down for £3,000 on the insurance policy. Now all the pictures have been in the family for over 100 years, they have never been on the market for sale and never will be. How has the insurance company been able to value them for us with such assurance? Help

Lola said...

It might be that they foreign buyers are using the opportunity of a favourable exchange to them to shift out of sterling cash they've earned by selling us stuff they make to land and rental stream from the UK

Mike W said...

All right all right,

Settle down, which one of you horrible lot wrote this?

http://www.newstatesman.com/politics/uk/2016/10/has-brexit-burst-british-housing-bubble

'Housing prices are not determined by supply and demand because you do not have a choice about needing to be housed. Allow an unregulated market to develop when social housing is also being cut and there is no choice not to buy what is on offer, other than sleeping on the streets. Prices will go sky-high.'

Might have added, or if your young and talented leave. Touches on this thread at the end.

Lola said...

MikeW. Not be. I never put a negative comment about the lack of regulation in anything. I run a financial services business. I know how useless regulation is.

Bayard said...

"Prices will go sky-high"

Ypu can ask what prices you like. You will only get what people can afford to pay. I agree that "what you can afford to pay" is somewhat elastic depending on how desperate you are, but that's not a significant amount of elasticity.

KJP said...

"KJP, that's the same as counter-objection 1"

It really isn’t and your whole argument is, I’m afraid to say, ill founded. You can always work out a rent multiplier but you cannot value a property from it. All you end up doing is saying that different multipliers are applicable in order to justify your circular argument.

Forget about mansions, I was thinking about large detached houses. One in Surrey could have rental potential; one in Cornwall not much. The one in Surrey might be worth more than the one in Cornwall but it’s totally unrelated to the rental potential.

Mark Wadsworth said...

MW, yes, good question, but KJP appears to be a Homey and does not answer questions, neither does he present facts to support his assertions and so we are wasting out time with him.

And yes, that was a splendid article, a lot of it sounds familiar but I don't know who wrote it.

KJP, blah blah waffle, you argue like a typical Homey, you just make up things on the spur, on the basis of no hard facts or logic whatsoever, desperately trying to 'prove' the opposite of what I just said and sooner or later you will end up contradicting yourself but refuse to admit it. I know your sort.

KJP said...

To Mike W

They are not special or could be cases but were meant to be merely illustrative without labouring a point. Your post seems to be remarkably irrelevant. Oh, and Rossetti died in 1882 not 1889.

Mike W said...

To KJP,

Well done you, you checked the dates! Which, hands up,is more than I did. Nevertheless, would it be possible for you, to put me on your 'ignore list', on a go forward basis?

Ben F said...

Really it just shows how mental/desperate property speculators are.

Heads I win tails you lose. Foreign "investor" (investing in what exactly?) gets a property, sees the value fall 20% vs USD. Then what? Others are queuing up to see if they can join in the mess?!

Total delusion.

Bayard said...

I don't follow this.

Pre Brexit, house in London valued at £800,000. That's 1,120,000 euros, say. Post Brexit house valued the same, but that's now 960,000 euros. So without the vendor or the Spanish buyer doing anything, the price of the house has fallen by 160,000 euros. Now look at it the other way round. Our senor has a budget of one million euros and wants to buy a pad in London. Pre-Brexit, that house was out of his budget, now it is comfortably within it. His budget has gone up by £119,000.

Now one thing that is constantly repeated on this blog is that land is worth what people can afford to pay. Hence the fixed relationship between interest rates, the multiple of your salary the bank will lend you and the price of an average house. Our senor can now afford to pay a lot more. Therefore he will be able to outbid the native buyer and prices will start edging up to reflect this fact.

It is also an observable fact that property, especially London property, has been inflated in value over the last few years by "investors" (rich foreigners) being able to outbid the native buyers. Their reasons for doing so are irrelevant. It doesn't matter what the rental return is, if they think that they will be able to get a capital gain on the property, or simply want somewhere to park their money where their thieving government can't get their hands on it. They might even buy because they think that owning a London house will give them more success with the opposite sex, it matters not, the result is the same.

Mark Wadsworth said...

I have checked just to make sure, it appears there is a lively rental market in Cornwall.

Mark Wadsworth said...

B: "It doesn't matter what the rental return is, if they think that they will be able to get a capital gain on the property, or simply want somewhere to park their money where their thieving government can't get their hands on it. They might even buy because they think that owning a London house will give them more success with the opposite sex, it matters not, the result is the same."

You are just elaborating on my point 1. I said that the link between rental value and selling prices is weaker for these show off homes i.e. the rental multiple is higher/rental yield is lower. I am perfectly aware of that.

However, the housing market within a town or region as a whole is in some sort of equilibrium, the price of the most expensive one is determined by what people will pay for the second most expensive one etc all the way down to what people have to pay to share a bedsit in Barking and Dagenham.

So if the price which locals are prepared to pay remains constant in GBP terms, then that affects prices for all homes above it in the equilibrium.

I could of course argue that the price which locals can pay in GBP terms goes down, because with a weaker pound, some things will be more expensive so they have less disposable income, but that is only a very minor effect.

Mark Wadsworth said...

Anyway, we can just wait and see, can't we - will London prices shoot up by 25% over the next few months to match the 25% fall in GBP over the last few months?

Dinero said...

Foreign buyers are not necessarily bidding against domestic buyers - if its a "Dutch Auction" they are "bidding" against the seller , If its a sellers market, and the seller is prepared to keep hold of the property for the medium term , and the seller sets the asking price based on what the foreign buyer is willing to pay then the prices in sterling go up for the properties that are sold to foreign buyers.

Mike W said...

Bayard, re, your last paragraph about sex :)

When we were buying a house a few years ago in a city we had no idea about, I was desperate to find some metric that mean't I did not have to listen to RightMove or Estate Agents telling me that every house I visted was brilliant value or a great investment opportunity. I came across a tool called the 'American Investors, Rule of 15'. It is a simple device for quickly working out whether a property is sending a rent or a buy signal. I was uneasy because at the time I couldn't explain to myself or anyone else if asked, why the multiplier should be X over country, geographic distance, over time,specific economic conditions etc, etc. And I knew the finacial advice, never buy into a product you don't understand. But I was delighted with the relationship and thought if I applied it to the 40 or so streets I was interested in, I might gain some insight. So after doing some work referring to the metric, in a tight area, comparing like with like, asking what the signal was, I had a nice list on house prices/value bets.

Moral of the story:

My wife worked into the second house we viewed and said, I want this one!

Lola said...

MikeW. I could have told you that would happen before you embarked on all the 'science'. It always does.

Mark Wadsworth said...

Din, aware of the theory. But it has never been observed in real life so the theory is flawed or cancelled out by other factors.

Bayard said...

"You are just elaborating on my point 1. I said that the link between rental value and selling prices is weaker for these show off homes"

I'm not talking about Russian oligarchs or Chinese web millionaires, who are buying some glitzy pad to show off, I'm talking about the run-of the mill foreign investor buying a totally unglamourous flat in a new build block in Battersea, say.

Do you actually think that yer average homebuyer thinks at all about the rental potential of the property they are about to buy? Are they not looking for something they like/is convenient for a price they can afford? Most of these foreign-bought properties in London are left empty, so the owners can't be particuarly bothered what they will rent for. They have a budget, which is now 25% bigger than it was before, so they will be prepared to pay s little more for what they want. Obviously not 25% more, they will be looking to buy somewhere bigger/better/more conveniently located with that extra money.

I think you are putting the cart before the horse. The reason that the buying price is a fixed(ish) multiple of the rent is not because buyers sit down and work out whether the property is worth x, because it can rent for y, but the same psychology governs what people will pay to buy a place as they will pay to rent it. Therefore the rental value of a property is irrelevant when it is being sold to a buyer who's not interested in renting it out.

As an exercise, take a house in a nice location which has a restrictive covenant on it that forbids it being rented out (a leasehold from the Nazional Trust, say). By your reckoning this house would now be worthless, which it obviously isn't.

Mark Wadsworth said...

B: "The reason that the buying price is a fixed(ish) multiple of the rent is... the same psychology governs what people will pay to buy a place as they will pay to rent it."

Exactly. Where has anybody said otherwise? For landlords the rent-price relationship is more important. Owner-occupiers and landlords are competing for the same homes, so overall the rent-price relationship is quite stable and easily observable.

You are still banning on about point 1, that rich foreigners buy homes to show off and don't care about rents. That like saying "they don't care about the value of the house at all". Of course they bloody do, I don't see them paying £millions for a one-bed flat in Norwich. Even if they didn't care at all, they have to outbid the locals. The price which local bid is largely unaffected by changes in relative GBP value, so changes in GBP values do not affect house prices.

If I'm wrong, then can you honestly say that UK house prices shot up in the months following the devaluation in 1967, Black Wednesday in 1992, the pound falling about 20% in 2008 or falling 20% in 2016?

"As an exercise, take a house in a nice location which has a restrictive covenant on it that forbids it being rented out (a leasehold from the Nazional Trust, say). By your reckoning this house would now be worthless, which it obviously isn't."

Just because there is a rule against renting it out doesn't mean it doesn't have a rental value! That house very much has a rental value! Otherwise you might as well say that illegal drugs, elephant tusks etc have no value and wonder why people go to all the trouble and risk of smuggling them into the country.

More to the point, the selling price of your covenanted house will be pretty similar to the selling price of similar but un-covenanted houses, and the rental value will be the similar for all of them.

Bayard said...

"You are still banning on about point 1, that rich foreigners buy homes to show off and don't care about rents."

Mark, do try and read what I wrote before replying, especially after the abuse you gave the poster above for not doing so. I specifically said they don't buy homes to show off, they buy them as somewhere to park their money and for the capital appreciation. If they cared about the rents, why would so many of them leave them empty?

"That like saying "they don't care about the value of the house at all"

Oh, come on! Of course it's not. How many times have you castigated other people for stating non-sequiters like that? If you are not intending to rent somewhere out, why should you care how much it rents out for? Did you check how much you could hire your car out for before you bought it? It's like buying shares because you think they will go up in value, not for the dividend. Otherwise, why would anyone buy shares in say, Amazon?

"Even if they didn't care at all, they have to outbid the locals. The price which local bid is largely unaffected by changes in relative GBP value, so changes in GBP values do not affect house prices."

Again, RTFC! (read the fine comment) "they will be prepared to pay s little more for what they want. Obviously not 25% more, they will be looking to buy somewhere bigger/better/more conveniently located with that extra money." is what I said. Yes, they will have to outbid the locals, but also, to some extent, outbid each other.

"If I'm wrong, then can you honestly say that UK house prices shot up in the months following the devaluation in 1967, Black Wednesday in 1992, the pound falling about 20% in 2008 or falling 20% in 2016?"

No, because a) the effect is not huge, b) it is gradual, c) it is confined to a small section of the market (the sort of homes, mainly in London, that rich foreigners buy as an investment).

"Just because there is a rule against renting it out doesn't mean it doesn't have a rental value! That house very much has a rental value! Otherwise you might as well say that illegal drugs, elephant tusks etc have no value and wonder why people go to all the trouble and risk of smuggling them into the country."

Er, no, illegal drugs and elephant tusks only have a value because people do buy them, even against the law. Agricultural land in a green belt is worth a few thousands an acre. That's because, without PP, your chances of building on it and being able to sell the houses are very very, very close to zero . The fact that, if it wasn't in the green belt and you could get PP to build it would be worth a few million an acre is irrelevant. No one is going to buy it for millions unless they have a reasonable chance of getting that PP.

Dinero said...

whatever the effect on prices , the Papers have got the idea that there is a buyer effect and they are going with it

http://www.cityam.com/news/opinion

http://www.propertyweek.com/opinion/house-party-for-foreign-investors-in-london/5085477.article

http://www.thetimes.co.uk/article/the-foreign-buyers-snapping-up-prime-london-pads-3qjj73kbn

http://www.bbc.co.uk/news/business-37609114

https://www.theguardian.com/money/2016/jul/07/overseas-buyers-keen-to-exploit-weak-pound-to-buy-london-homes

Mark Wadsworth said...

B, I give in, every man is entitled to his own beliefs, even if in this case you yourself say "a) the effect is not huge, b) it is gradual, c) it is confined to a small section of the market (the sort of homes, mainly in London, that rich foreigners buy as an investment)."

I can't argue with that except to say "the effect is immeasurably small and masked and cancelled out by equal and opposite factors" ((see Brexit fear headline below) so I don;t really see what you are arguing with.

That NT house must have a rental value or else there wouldn't be a covenant against renting it out; if it didn't have a rental value then there would be no need for the covenant. I bet there's no covenant saying "You can;t build an airport in the back garden" either for the simple reason that it isn't big enough so nobody's gong to ever try.

D, good list, I'll see your list and raise you this oneBrexit fears see property owners slash asking prices by six figures. In this case, it is not falling GBP that is pushing down prices but the same factors push down GBP as push down asking prices.

Bayard said...

"B, I give in, every man is entitled to his own beliefs,"

Well yes, but where did I get these beliefs? From this very blog!

"That NT house must have a rental value or else there wouldn't be a covenant against renting it out; if it didn't have a rental value then there would be no need for the covenant."

Yes of course it has a value, if the covenant wasn't there, but that's like saying my field would be worth a million quid if I had planning permission to build on it. I haven't got PP, I could never get it, nor could anyone else, so it's not worth £1M, even though it could be, if I did have PP. Something is worth precisely what someone is prepared to pay for it in the real world, not in some alternative universe where annoying things like restrictive covenants don't exist. No-one is going to pay to rent a house where they can be evicted as soon as the freeholders find out.

Mark Wadsworth said...

B, I'm not sure what level of reality we are operating on here.

Always compare like with like. Our young couple has their hearts set on a certain type home with a certain view in a certain village. The ones up for rent go for £10,000 a year and the ones up for sale sell for £250,000 so they are pretty indifferent and will buy if they want to live there long term and rent if they want to live there short term. Those are just the market rents and market selling prices for those homes.

As it happens, your hypothetical NT home in the same village is also up for sale. Obviously there will be a small discount because they themselves can't sub-let if they buy and then wish to move elsewhere without selling it, and BTL landlords won't be bidding for it, the discount is maybe 10% or even 20%, but by and large, its selling price will be similar to the other homes without the covenant. It's not like the selling price will be zero. That 10% or 20% discount is like the discount you get for buying a listed home etc.

Ergo, there is a close relationship between rental values and selling prices, even for homes with such a covenant.

"No-one is going to pay to rent a house where they can be evicted as soon as the freeholders find out."

That's not true either, hundreds of thousands of council houses are being sub-let, that's just a fact. Quite probably, the rent is a bit lower because tenants have to take this risk into account, but again it is only 10% or 20% off market rent.

Bayard said...

Did I ever claim the selling price of our hypothetical house would be zero? No, I said that that is what it would be if you followed your reasoning. Of course it has a sale value, just not a rental value. Yes, its value is very similar to a house without such a covenant, why wouldn't it be? there are plenty of people who don't want to rent out.

Yes there is a close relationship between the sale price of such a home and the rental value of a similar place without the covenant, but that doesn't mean that the house with the covenant has a rental value, any more than the land without PP has a development value. Yes we all know what it would be worth if it did have PP, but that doesn't affect its price without PP.

Bayard said...

Oh yes and I did think of the council flats example after I had published my comment. Mind you the sort of person who'd want to rent a nice NT cottage is not the same as the sort of person who'd want to rent a illegally sub-let council flat.

Loan For Tenant said...

I had a great time reading around your post as I read it extensively. Excellent writing! I am looking forward to hearing more from you.

Bayard said...

"B, I'm not sure what level of reality we are operating on here."

Well, I am talking about the real world as it is. I don't know what theoretical world you are talking about.

You have been saying for years that if buyers have more money to spend, house prices go up. Why does it matter what that source of money is?

It is an observable fact that if interest rates go down, selling prices go up, as buyers can borrow more against their incomes. Rents however, remain the same, unless average wages go up, because, as you have said many many times, tenants can't pay more than they can afford. Why is it suddenly different if the source of increased buying power is now a change in exchange rates, not interest rates? It doesn't matter where the extra money came from, whether it's Mr Smith with his extra money borrowed from the bank, or Herr Schmidt with his extra money got from changing his euros at a better exchange rate, the market sees a buyer with more money than before.

DBC Reed said...

The Lively Rental Market in Cornwall, according to the site provided, consists entirely of holiday cottages aimed at the type of hard-faced property rich English middle classes who love to holiday where locals can no longer afford to live because of shit wages. " Its so unspoilt!".
In a little noticed clause of the Brexit agreement, these lovely middle class people are down for deportation under the CONTROL arrangements.Children will be separated from their parents and put into mainland public schools where child abuse will be connived at.

Bayard said...

DBCR, if Cornwall is anything like West Wales, all the locals live in the towns, because there's bugger all work in the countryside. Very few of your "hard-faced property rich English middle classes" would be interested in renting a holiday let in the towns.