Wednesday 11 September 2019

"Houses are assets not goods: taking the theory to the UK data"

From Bank Underground:

In yesterday’s post* we argued that housing is an asset, whose value should be determined by the expected future value of rents, rather than a textbook demand and supply for physical dwellings. 

In this post we develop a simple asset-pricing model, and combine it with data for England and Wales. We find that the rise in real house prices since 2000 can be explained almost entirely by lower interest rates.

Increasing scarcity of housing, evidenced by real rental prices and their expected growth, has played a negligible role at the national level.


Includes lots of lovely charts, tables and calculations.

As I have said many a time, all you need to know is
(1) local average wages in each area of the country, which tell you what local rents will be, and
(2) prevailing interest rates. You multiply local rents by the inverse of interest rates (or divide local rents by interest rates, same thing) and that tells you what house prices will be in each area to within a tolerable margin of error.

There is no need to factor in 'scarcity' to the equation, being impossible to measure once you have done the two-stage calculation.

This also explains why there is a larger variation in very local house prices within larger cities/conurbations. This is because there will also be a larger variation in wages in larger cities. Office cleaners earn the same everywhere, but the higher paid jobs are in the larger cities/conurbations, so there will be a wider range of wages in larger cities/conurbations, hence a higher range of rents and a higher range of house prices.

* "Yesterday's post" is also well worth a read, that also boils it down to the two-step calculation. They also include a section headed "Higher property taxes needn’t mean higher rents…".

23 comments:

James Higham said...

What will be the BofE’s first moves in 2020?

Bayard said...

Pity it's not the BoE saying this. That would be a reason to crack open the champagne.

Mark Wadsworth said...

JH, I can't guess that.

B, BU is written by named BoE employees with tacit approval of BoE.

Bayard said...

Ah, plausible deniability!

Lola said...

MW. Yes. Ain't that the rub.

But, when you are nationalised de fact government department your incentives are to please your masters and do their bidding. Hence if your employer runs out of money, and you have the power to print it, you print it. And if that employer needs interest rates lower so that it can pay less for any money it does borrow, your incentive is to lower interest rates, whatever.

This is, of course, all very easy when you have a monopoly, and is probably why you have a monopoly.

And the fact that these actions screw it up for everyone else; well you just don't care about that as they are not your masters. But to confuse everyone else you concoct complicated sophistry based distorted economic theory - punk Keynesianism in this case.

Personally I'd call that a racket.

Lola said...

I forgot to add. Superb work by bankunderground.

Now, will anyone, just anyone, read and learn?

Penseivat said...

Increased scarcity of housing is, I believe, less to do with rental values and more to do with the fact that many end up being occupied by illegal entrants into this country. Whether floating across the channel on lilos, and helped the rest of the way by the inappropriately named Border Force, or stowing away in lorries, luggage compartments of buses, or even in roof racks, once the authorities know about them, they have to be housed, especially if they have children - not necessarily their own - with them.
Even those who enter legally, such as ex Gurkhas, arrive with parents and grandparents of both sides, who go to the head of social housing waiting lists behind, apparently, Muslims and Somalis. I bet the holy Joanna Lumley didn't foresee that, though I doubt it bothers her as few are being accommodated in north London, especially Islington. Try and find a B&B in Farnborough, Aldershot, Fleet and Crookham not used by Social Services. Very difficult.
No matter how many houses or flats are built, the increasing number of illegal immigrants will always lead to a shortage.

Lola said...

Penseivat. It's a myth that there is 'increased scarcity in housing', save the economic truth that everything is 'scarce'. The ONS data evidences that we have built more than enough dwelling units over the last 10 to 15 years to house the increase in population.

However, there is no doubt that a lot of rental housing is being consumed by immigrants, the problem being that the rents are 'paid' by the local authority, that is a 'subsidy'. And as we all know from our economics subsidies always end up as 'rents'. In other words those rental subsidies to immigrants end up as inflated rents for landlords. If there were no subsidies to immigrants they would not have the disposable income to fund these rents.

In a sense this is proof that the welfare state does not work.

L fairfax said...

I heard on More or less that this is no official figures for rents. Is this really true (slightly off topic) but relevant to the discussion because if we don't know what rents are, how can we prove this?
@Lola
"However, there is no doubt that a lot of rental housing is being consumed by immigrants, the problem being that the rents are 'paid' by the local authority, that is a 'subsidy'. And as we all know from our economics subsidies always end up as 'rents'. In other words those rental subsidies to immigrants end up as inflated rents for landlords. If there were no subsidies to immigrants they would not have the disposable income to fund these rents."
Very true - it is also means that tax payers are making their own housing more expensive, which is wrong.

Mark Wadsworth said...

LF, there are only sparse 'official' figures, but plenty of privately collated ones, Rightmove etc. So we know rental values to within a tolerable margin of error.

Lapsed Agnostic said...

There seems to a discrepancy in some of their charts. In the chart for England & Wales, actual house prices at the end of 2018 are noticeably lower than the modelled ones - whereas in the charts for the North, Midlands & Wales and London, they are higher (significantly so in the latter), and only a smidgen lower for the South. I can't see that they've omitted any English regions, so I'm a bit puzzled.

I'm also not sure why they're faffing about with yield curves to model house prices. Surely the price of a contract to receive a pound a year for ever could simply have been estimated by the cost of buying the amount of undated UK treasury bonds (consols) that would give a £1 coupon - minus a 50+% discount to cover the considerable risk of the counterparty reneging on the contract over the course of time and it not being worth the effort of pursuing them through the small claims courts. The situation should be similar for house prices, except that the £1 a year income becomes the average gross rental return of around £8000 a year and, in this case, a discount of approx 30% should be applied to cover water rates, voids, Section 8 repos, buildings insurance, repairs, letting agents' fees etc. Note that this unrealistically assumes no increases (or decreases) in rents over decades.

That said, I believe that all consols have been redeemed by the government as of 2015, but 50-year gilts - the longest now available in the UK - should provide a reasonable proxy. These currently have a yield-to-maturity of around 1% p.a. In this case, applying the above logic means that the price of an average UK house with an average rental value should be around £550,000! If long-dated gilts are fairly priced (big IF), why are house prices so depressed? Is it because investors fear imminent LVT?


LA

Bayard said...

"No matter how many houses or flats are built, the increasing number of illegal immigrants will always lead to a shortage."

That can only be true if the only thing preventing an increase of illegal immigrants is the shortage of housing, in which case, how do they know? It seems very unlikely that, as soon as a new house of flat is built in Fleet, the news is flashed round the globe to all the places where illegal immigrants come from and someone gets the nod to start packing their bags to set off for the UK.

Mark Wadsworth said...

PS, tbere are 'good' immigrants (work, law abiding etc) and 'bad' immigrants (BTL landlords, dole scroungers, terrorists and criminals). Which ones do you think contribute to the economy and hence boost rental values.

L, the welfare system works OK for the most part, housing benefit is of course one bit that is completely wrong.

LA, sure, they are trying to reconcile a couple of main inputs to observed outputs, it's impossible to get the two to match perfectly, but the principle stands.

I don't think govt bond yields are a good discount rate. In practice, it's mortgage repayment rates (interest + principal) which are the most appropriate.

And then you have to knock off 'something' from gross rents before you apply the discount rate - there are running and repair costs, BTL landlords worry about void periods,FTBs are constrained by huge deposits required and keep a bit in reserve in case of unemployment etc. Your guess of 30% might well be the right figure, but either way, it's an unknown and different for everybody.

And you have to add 'something' to rents for future rental increases (also a wild guess, but safe to assume they increase with wages - but wage growth is also an unknown). That's maybe why price to rent multiples are higher in London??

Mark Wadsworth said...

B, we know that new additions are roughly equivalent to population growth. The anti-immigrant people then say 'Ah, what about illegal and undocumented immigrants?' Fair enough, by definition that number is unknown, but the point is that rents are increasing roughly in line with wages. If there were a genuine shortage, they would increase much faster.

L fairfax said...

@Mark Wadsworth
"B, we know that new additions are roughly equivalent to population growth."
Do we know that? Slough council -
https://www.thetimes.co.uk/article/come-to-slough-everyone-else-has-s25nccmk75w
Famously used the amount of sewage produced in the town to prove that official immigration figures were wrong.

I really am not sure we can trust these figures (incidentally a lot of these were legal immigrants).

Bayard said...

"If there were a genuine shortage, they would increase much faster."

Surely not, otherwise renting would become genuinely unaffordable and we'd either get lots of empty properties and some very thick or obstinate but definitely poor landlords or rents would come down again to be once more in line with average wages.

Thought experiment: There are twenty people looking for somewhere to live. None of them can afford to pay more than, max £700 pcm even if they lived on boiled spuds. The landlord of the single flat that is available to rent decides to take advantage for the huge demand for his property by shoving the rent up to £800pcm. Result is that the flat remains empty and the landlord is left scratching his head thinking "well, the law of supply and demand says that if the supply is low, which it is and demand is high, wich it also is, then I should be able to put my price up. What's gone wrong?"

L fairfax said...

To continue @Bayard's thought experiment.
The landlord then gets a bunk bed in and then rents the flat to tenants for £400 pcm each.
In real life house sharing is more and more common and age of sharers increasing - sign of a shortage.

Bayard said...

LF, two points:

1. I did not stipulate that the people looking for somewhere to live were on their own. I had imagined they were looking for somewhere to live with their families/friends/lovers and that £700pcm was the maximum they could come up with between them.

2. What is your evidence that house and flat sharing is becoming more common? Young people have always shared, indeed in the past when there was not supposed to be a shortage, they would even share bedrooms with members of the same sex. However, the effect of the greater preparedness of people to share is simply to increase the amount they are able to pay in rent and therefore increase the maximum rent chargeable. If rents and prices went up at a time of a shortage of accommodation, then you would expect them to go down at times of surplus, something which, historically, has never been observed.

L fairfax said...

1) If they are not on their own the landlord puts a bed in the lounge. People would rather flatshare than be homeless
2) There is loads of evidence that flatsharing is becoming more common
https://www.telegraph.co.uk/goodlife/living/living-in-a-flatshare-in-your-50s/
"according to property listing site SpareRoom, over the last 5 years the number of people living in flatshares between the ages of 55 and 64 has risen by 343 per cent. Additionally, the over 65s have seen a rise of over 600 per cent.
For a lot of people, they have this idea that flat sharing is like something out of Friends. It's not

Almost one in ten of flatsharers who use the website are now over 45 years old, bringing the average user age of the site to nearly 29 years old."

I don't think we have stastics for more than a few years so I don't know how you can prove rents never go down. People's ability to buy houses has improved in the past as the recent BBC radio series our house shows.

Bayard said...

LF, it's my thought experiment, so I set the parameters. One of these is that the landlord has already squeezed the maximum number of bedrooms out of his flat as he can. Re-running an experiment with different parameters doesn't invalidate the original experiment as any fule scientist kno.

I didn't say that rents haven't gone down in the past, I said they haven't gone down in the past as a result of a surplus of accommodation.

"I don't think we have stastics for more than a few years"

We don't? How about this: https://www.economics.ox.ac.uk/materials/papers/13922/number-134.pdf ? in which I find:

"The surge in both house prices and rents after the First World War marked the beginning of a period that would see another radical change in the housing market in Britain. Over 4,359,000 new houses were built during the interwar years, aided in part by the recovery of the private building sector which contributed to two-thirds of this increase."

So here we have a huge increase in the availability of accommodation, accompanied by nit a fall in rents and prices, as the "law of supply and demand" would predict, but a rise, which is what you always see at a time of increased housebuilding and as happened again in the 60's and 70's. You don't have to believe me, just look at the statistics.

L fairfax said...

@Bayyard
That was not a parameter that you mentioned before was it?
A bit pointless discussing an experiment which keeps on changing.
I take it that you agree with me that flat sharing has increased.
That paper you found looks interesting - I just skimmed it and found.
"House prices grew rapidly throughout the 1920sas the sudden demand for housing after the War outstripped supply that took until the end of the decade to properly respond to the excess demand in the housing market"
They seem to believe in supply and demand

L fairfax said...

Also they say
"rents rose even higher than house prices during the 1920s before stabilising throughout the 1930s(see Figure 15).This is not surprising given the surge in demand for housing from returned servicemen after the First World War combined with the relatively inelastic supply of housingin the 1920s. "

Bayard said...

"That was not a parameter that you mentioned before was it? A bit pointless discussing an experiment which keeps on changing."

Well, no I didn't, because I didn't need to. It was you who started changing things, by making false assumptions about my premises.

"They seem to believe in supply and demand"

So? I was disproving your point about the statistics being available. The fact that the people who produced them have some of their beliefs contradicted by them is neither here nor there. Like you they are clutching at straws to support these unfounded beliefs. Take this statement: "This is not surprising given the surge in demand for housing from returned servicemen after the First World War combined with the relatively inelastic supply of housing in the 1920s. " OK, so what happened in the First World War? Millions of soldiers left their homes to fight in the war. Hundreds of thousands of them were killed. The lucky ones who survived returned to the homes they had left. Many were not so lucky and their homes remained empty. From where does this "surge in demand" come?