Monday, 2 December 2013

The price elasticity of demand for rented accommodation

From The Evening Standard:

Charlie, 23, is studying for a masters in public policy at UCL. He spent his first year in London living in a poky two-bedroom flat in Battersea with two friends; they converted the living room into a third bedroom. “It meant we could live somewhere far closer to the centre,” he explains, “but it was horribly cramped. The flat was small anyway but it meant that when we had people around, we didn’t have anywhere to host them. There was always a queue for the shower and it was particularly busy when all our girlfriends stayed on the same evening.”

Charlie is part of Generation Rent —twentysomethings who bounce from lease to lease, squishing extra housemates into box rooms and sacrificing communal space for a Zone 2 postcode. It’s called “hutching up” and it’s exploding in the capital as young graduates flock to London to work but find starting salaries stretched to cover astronomical rents…

“Our surveys of tenants found that affordability is a key consideration but second to that is proximity to place of work or education,” explains Hudson. “So they’ll move down the line or bus route.”

The article is a long list of similar anecdotal evidence, but big picture wise it is true and this is how it works.

It is tenants competing against each other for the more convenient locations who dictate rent levels, the landlords just sit there and collect what they can get.

And tenants are very price sensitive. Price sensitivity is dictated by various factors, particularly relevant are items 5 to 9 on this list, all of which indicate that the demand for rented accommodation is price elastic.

So we observe that tenants respond to high rents by occupying less and less space, so the proportion of income spent on rent is not directly related to local rents in absolute terms - i.e. if the rent for a flat in London is twice as high as in Birmingham, London tenants do not spend twice as much per head - the tenant on a reasonable wage in Birmingham will rent the whole flat for himself or share with one other; the London tenant on a reasonable wage will share with two or three others.

All of which leads us to the conclusion that landlords cannot just "pass on" an increase in their costs or taxes on their income; they bear those entirely out of the rent, over which they have no influence whatsoever.