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.

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• Newsbot9

  Council Tax is 22 billion a year. You’re arguing that that 22 billion, which is paid by tenants, would be absorbed by landlords. It’s ridiculous.

  The overall cost to someone *stays the same* if they’re paying a LVT pitched at the same level as council tax. They’re just paying the Landlord more directly.

  “landlords keep rents low”

  What? Rents have risen above inflation for three decades. This is typical plain denial, and why I can’t support a LVT.

  Again, if the issues can be comprehensively answered – and you’ve refused to do so for even one of the points I’ve raised – then I’ll support one.

  But you’d simply cause mass homelessness and quite possibly close a lot of businesses as well, if you went ahead with any of the proposals I’ve seen seriously advocated.

• MahmudH

  I’m not saying that if we replaced council tax with LVT it would suddenly improve the situation for the tenant. Council tax is just a somewhat indirect and inferior version of a LVT, taxing the building instead of the land it is built on.

  Depending upon the rent agreement, either council tax is paid by the person renting, or if its a excluded tenancy agreement, then it is paid by the landlord.

  Where it is paid by the tenant, if we abolished council tax, then landlords would increase their rents by exactly the same amount – they would snatch the whole value from their tenants.

  Where LVT is superior is that council tax also has a ‘poll tax’ element to it, it taxes the number of people living in a property as well as the property itself. Council tax also gives a discount to rich people who own second homes. That is disgraceful.

  LVT would tax rich people who own a lot of land more than council tax does. It would tax landowners who leave land derelict, waiting for it to rise in value. It would reduce the tax on people who living in rooms or flats which use land more efficiently.
  Affordable housing could still be subsidised directly.

  The way things are prices young people out of home ownership. LVT would reduce the prices of homes, that’s important for reducing inter-generational inequality.

• Newsbot9

  “council tax also has a ‘poll tax’ element to it”

  Not for shared houses, which us by far the most common configuration for poorer people. You do need to consider a council tax replacement and how it would need to be structured as well.

  Not to mention the issue with students, who are currently exempt from council tax – if you add this to their bill, then you’ll need to raise maintenance grants again.

  Every proposal I’ve seen for LVT was revenue-positive, it was designed NOT to significantly lower tax for anyone, and to increase it selectively on certain kinds of usage.

  There is also absolutely no consensus among economists on what it’ll do to land pricing, given the *extreme* shortage of housing in Britain.

  It’ll lead, very likely, to a sharp rise in HMO’s and cram poorer people into ever-smaller spaces even faster that at present, but this ISN’T a bonus, despite your claiming so – it leads to all kinds of social issues not very far down the road.

• wattys123

  all those benefit dependent 3rd world immigrants plundering the NHS services they haven’t contributed to, you mean.