Why moderate rents are compatible with a housing shortage
Tim Leunig of the CentreForum think tank and the London School of Economics (pictured) has sent me an email in which he takes issue with Capital Economic’s analysis on house prices which I blogged about earlier, particularly the idea that present rental costs indicate that there is not a shortage of housing.
Here’s his argument:
“Capital economics have forgotten that rents should only move in line with prices if interest rates remain constant. As a starting point we would expect rents to equal the price of the house, multiplied by the interest rate, taking into account the expectation of further capital gains and the cost of maintenance. The long fall in rents after 1997, relative to house prices, can largely be accounted for by the secular fall in interest rates. I recollect that at the start of that period I was paying about 7% of my mortgage, compared with 3% I’m currently paying. This would lead us to predict that rents would fall to 3/7 of house prices. In your graph it goes down by slightly more, but not out of line with this prediction. In addition, an expectation of capital gain in the future leads landlords to accept a lower rent now, as they are getting a return from the capital appreciation. Since expectations of rising house prices were strong in the period after 1997 we would expect rents to fall by more than the ratio of the fall in interest rates. Your [first] figure is entirely in keeping with that analysis. If we had had an elastic supply of housing in this period then we would have expected house prices to remain constant in real terms and for monthly mortgage payments and rents to fall in line with the fall in interest rates. This would have been a huge benefit, particularly to young people. Sadly that did not happen.”
As a reminder, here’s the chart:
Tim is also sceptical of the notion that prices can only go down from here.
“I don’t think there is a bubble in property, although of course the very low interest rates may be preventing it popping. After all, many people are paying virtually nothing on their mortgage at the moment, and are therefore able to sustain their house even if their circumstances have changed for the worse. Banks are also likely to be tolerant of lenders who are able to pay something at the moment, rather than foreclosing on a loan and realising the loss.”
An important contribution to the debate.
Tim, by the way, is an indefatigable advocate of increasing the supply of homes. He was the brain behind the land auction scheme, creating an incentive for communities to bring forward more land for residential development, that has been adopted by the Coalition. The problem is that Eric Pickles, at the Communities Department, is sitting on it. And, sadly, that’s a very big weight to shift.Tagged in: CentreForum, house prices, rents, Tim Leunig
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