Ten times earnings?

The papers report that the National Housing and Planning Advice Unit is predicting that house prices will reach 10 times average earnings.
This, though, is not a description of a future reality, but rather a threat. To see why, consider the obstacles to such high prices:
1. They'll become unaffordable. At current mortgage rates, the monthly repayment on a £250,000 mortgage would be equal to all the take-home pay of a £25,000 salary. Even a couple with an income of £50,000 will be spending half their post-tax income on the average mortgage.
2. There's no reason to suppose interest rates will fall as house prices rise. Quite the opposite, if home owners increase their spending in response to higher wealth.
3. High prices will naturally induce selling, as home-owners sell up to buy a place in the sun.
4. High prices will also reduce speculative demand for housing. In a rational world, this'll be because high prices should mean lower expected returns. In the real world, it's more likely to be because of the huge cost of buying. The Beenyitis that's stoked house price inflation recently should therefore subside.
5. There'll be a political backlash. Discontent amongst frustrated buyers is likely to lead to pressure to relax planning restrictions, with the result that more places will be built. This will bid prices down.
Indeed, this is precisely the purpose of the NHPAU forecast - to agitate for more building.

Comments

[Mark Wadsworth]

I agree with all that.

What the government should do is wait until the bottom of the next house price crash, which is starting now and will bottom out in the next 3 - 5 years and then replace all existing property taxes (Council Tax, SDLT, IHT, CGT, TV licence fee) with a fiscally neutral Land Value Tax on site-only unimproved residential land values, basically the value of a property minus rebuild costs.

A fiscally neutral rate will be anywhere between 2% and 5%, I don't know how low prices will go.

This will prevent such ridiculous booms'n'busts that have been happening every 18 years since time immemorial.

[Heraklites]

But Professor Nickell is a highly respected economist. Would he put his name to a report whose conclusions are motivated by political concerns?

[Infoholic UK]

Ummm, minor quibble with your example - average house price is NOT the same as average mortgage - that'd assume an average of zero equity, which is clearly not the case.

However, I generally agree with the thrust.

[dsquared]

[Even a couple with an income of £50,000 will be spending half their post-tax income on the average mortgage]

A little bit less than this I think as the average mortgage is not 100% loan-to-value. But even if it was, this just means that the housing stock wouldn't be owned by couples with an income of £50k.

If you look at it in terms of rental yields, then a yield equal to index-linked gilts (about 2.5%) means that the average house would rent for 25% of the average income. So this is perfectly sustainable under a model where the majority of people rent rather than buying. Which appears to me to be the way we're headed - the owner-occupier model is not something that has to be taken as an inalienable fact of British life.

[Mark Wadsworth]

Paying 20% of your income in rent is "about right". And 2.5% yield may be "about right" if you compare it with gilts, but it is way below borrowing costs, so is unsustainable.

BTW, the "Ten time earnings" figure has been misquoted. Actually, they said "average of lowest quartile of homes is currently SEVEN times average wages of lowest quartile of earners" and that this would rise to ten.

Still pretty gruesome, but subtly different to what all the papers, and indeed this blog, said it said.

[Mark Wadsworth]

BTW, did anybody watch Beeny yesterday?

The developer (totally loopy) had absolutely fantastic boobs and was happy to let it show, so for the rest of the programme there was an arms race 'twixt her and Beeny to see who could wear the most revealing top. Things got hotter and hotter with each new scene.

Unfortunately I got dragged away about ten minutes before the end to read my little girl a story.

[dsquared]

[And 2.5% yield may be "about right" if you compare it with gilts, but it is way below borrowing costs, so is unsustainable.]

no, because you put the rent up each year, so the cash flows are negative at the start of the deal but grow going forward. The rental yield is a real yield, so you can't compare it like for like with a nominal one. It's not exactly rocket science to structure a mortgage to reflect this if you're worried about the yearly cash flows too.

The bottom line here is that it might be a sensible public policy goal to build more houses, but the gravitational forces pulling hosue prices down are much weaker than anyone suspects. (I'm always suspicious of the psychology of stock market or property market bears - we haven't had a crash for quite a while, but we haven't had a smallpox epidemic for a while either; does that mean we're due?)

[Mark Wadsworth]

dsquared, fair enough...

Gov't index-linked bonds yield is about 1.5%, as it happens. Would you (as a reasonably clued up person) buy a flat for £200,000 and rent it out for £3,000 a year (increasing each year in line with earnings, i.e. slightly faster than inflation)?

It's not a rhetorical question.

[dsquared]

Well, not at present because the actual yield on UK residential rental property is more like 4-5% so I can get three times that. But it's not an intrinsically crazy thing to do; substitute euros for pounds and that's roughly where prices are in Ireland at the moment (Irish house prices have been slowing down for the last nine months and fell in the most recent quarter, but they're not crashing).

[pommygranate]

Yes, except UK housing is now in its twelfth year of a spectacular bubble. All your arguments are rational, but people don't think rationally in bubble times.

[Roger Thornhill]

Interested to know how many terraces are left empty in post-industrial Britain while people are squished into SE England.

Housing might be less of an issue if we did not encourage idleness while importing unskilled labour. It might be less of an issue if we did not have large numbers of unemployables in the centre of London protected by their council tenancies.

[Mark Wadsworth]

Roger makes good points as usual.

[Matthew]

The rental yield though has to also cover maintenance, which is not the case with a government bond.

From my own limited experience this possibly 1% of the value of a house a year.

[dsquared]

if we're getting really anal about this (moi?), it has to cover 60% of maintenance because that's a deductible expense.

[Mark]

Er - why havent you even considered the whole issue of supply and demand? How about the Government brings in changes to planning laws - that will have a huge impact for example

[Mark Wadsworth]

Mark, the crashes of 1953, 1971 and 1989 had a much larger impact on affordability, as will the crash of 2007 (if it doesn;t kill us all).

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