Wednesday, 13 September 2017

"Pay outpaces house prices in many areas". Or not, as the case may be

From the BBC:

More than half of Britain has seen wages rise faster than house prices in the last 10 years, research by a mortgage lender has suggested...

"While some northern cities, such as Manchester, are less affordable than they were in 2007, in much of the north of England, Scotland and Wales, the gap between earnings and house prices is around a third of the average for London..."

In Scotland, wages rose faster - with the current house price five times the size of typical average earnings in Scotland, compared with 6.2 times in 2007. The same was true in Wales where the ratio has changed from 6.9 times earnings in 2007 to 5.7 times now.

This looks like good news for most of the country if you look at it this way round. Actually it's nothing of the sort.

You have to understand the Law(s) of Rent. The amount that people are prepared to pay in rent is their net wages minus the basic cost of living. The basic cost of living is the same everywhere in the country, but (average) wages differ markedly. The amount people are prepared to pay in mortgage repayments is broadly similar to local rents; you just multiply the rent by thirty-two (the inverse of just under 3% interest rates).

Let's take a baseline of net wages = £20,000, basic cost of living = £15,000, so rent is £5,000. Houses cost 32 x £5,000 = £160,000 = a price-earnings ratio of 8, which the article says is typical for England.

In London (upper extreme) average net wages are £35,000, living costs are the same so rent is £20,000. Times that by 32, houses cost £640,000, a ratio of 18 (like it says in the article).

That's why Scotland and Wales are more 'affordable'. Stick net wages of £17,800 for Scotland into the formula and hey presto, the ratio comes out at 5.0.

Further, the main reason why Scotland and Wales have become more 'affordable' since 2007 is because the basic cost of living has increased faster than net wages in those areas, so the amount going to rent has also fallen, ditto house prices and hence the ratio. That's not good news, it's bad news (especially for landlords, but that's another topic).


Francis said...

Do you think there are marginal areas in the UK, in the Ricardian sense?

ThomasBHall said...

Francis - how about those old terraces in northern towns being sold for pennies?

Mark Wadsworth said...

F, yes, loads, as TBH says.

Anonymous said...

Just to check that I’m following along MW, is the implication that “affordable” doesn’t mean much because rent(/capitalised rent) just soaks up whatever is left between income and basic cost of living in any case?

And what would a "marginal area" mean in this context?

I'm pretty new to this way of looking at things so just trying to make sure I understand.

Mark Wadsworth said...

JM, the answer to your first question is yes.

"Marginal" just means areas where cost of living soaks up average net wages, so location rent is nil. About ten or twenty percent of UK housing is in this category.

Jonathan Bagley said...

Thanks for that explanation of the law of rent.