Wednesday, April 25, 2018

Housing: Part 294 - Rent inflation in the UK vs. the US

Here is an interesting article about home prices and housing costs. (HT: NinjaEconomics)   It's titled, "How economists (should) think about the housing market", and I think it is correct.  The author, Ian Mulheirn, points to rent as the key factor to look at regarding housing affordability and supply/demand.

He is talking about the UK, and in the UK, he presents compelling evidence that there is abundant housing. This means that low interest rates are the reason for high home prices in the UK, not a lack of supply.  Here, in another article, he argues that the number of homes has risen more than the number of households, and that changing incomes have outpaced changing rents.  Here is a figure from that article.
There are a couple of points to be made here about the US market.

First, this is clearly not the case here, and in fact, this is at the heart of how our self-imposed financial crisis is the primary factor that makes us different from other countries.  We imposed a credit crisis on ourselves, inducing a decade-long housing depression.  So, our supply is certainly low, and our rents are rising.

Second, one of the reasons we got it so wrong and imposed such damaging policies in the US is because this was not the way the housing market was addressed in the US.  Rent had been high, nationally, after the mid-1990s, and it was especially high in the cities where prices were high.  The supply signal really was there in the US.  Yet, the conversation was maniacally focused on credit markets.

Third, this points to a subtle difference between rising prices in the US versus other places.  I think the analysis here would apply to Sydney, Toronto, and Vancouver, too.  I think that in those countries, total homebuilding has been adequate, and nationally, rent levels have been moderate.

Notice that London, here, looks like it has been roughly in balance regarding housing costs.  But, in the context of the broader UK housing market, I think there are countervailing forces.  UK building has been strong, and that has brought rents down in many places.  This is exactly what was happening in the US before 2007.  Rents were declining in places like Texas and Georgia because generous lending and low real long term interest rates were inducing more building.  Our mistake was seeing that as a threat instead of a source of stability and progress.

So, in much the UK, rents are low.  Now, at the same time, there are two other things happening.  First, low interest rates are raising the prices of homes across the UK, so that looking at prices, affordability looks much worse than if we look at rents.  That shouldn't matter.  It is rent that is important regarding affordability.  But, Mulheirn is right that, in this case, high prices aren't a sign of a shortage of supply.

But, notice that, while London looks well balanced in isolation, in comparison to the rest of the UK, it is an outlier.  So, the same sorting migration is happening there as is happening in the US.  London is still relatively more expensive than other areas, so there is a bidding war for London residence.  In the US, in 2005, the migration induced by that difference was strong enough to create bubbles in Arizona and Nevada.  Part of what was keeping rents lower at the time was the abundance of housing outside the Closed Access cities.

I think part of the difference between the US and other countries is that the US Closed Access cities are worse than their international counterparts.  One figure in Mulheirn's articles shows unit growth in London as on par with growth in other places.  This is definitely not the case in the US.  So, when low interest rates induced more building in the US, and induced expanded housing consumption among young aspirational workers in the Closed Access cities, those cities had to depopulate.  This led to the contagion that hit Arizona and Nevada.  Toronto, London, Sydney, etc., seem to be more like cities like Seattle.  They allow a reasonable amount of building, but it still isn't enough to handle the new wave of urbanization.

So, the international cities, like Seattle, still have relatively high prices.  They still have rent inflation that is higher than in cities like Dallas.  But, the problem isn't severe enough to induce a disruptive migration event.

So, in Toronto, Vancouver, London, Sydney, etc. it is reasonable to say that high prices are largely a result of low real interest rates.  But, more housing supply would still make the situation better, just as the country would be better off if Seattle could add units at the same rate that Atlanta or Dallas does.

In the US, we have a different issue than the UK.  We do have rising rents, and we have kept prices down through credit repression.  So, if we lifted the credit repression, we would have an affordability problem, both in terms of rents and prices, but that is the only functional way of solving the supply problem that has produced higher rents.  Continuing to remove the income tax benefits of owner-occupiers would help in that regard.  But, credit access for middle income buyers and new buyers would need to recover, and that would be related to sharp price increases in low tier markets.  A healing market would depend on that development happening without freaking out policymakers.


  1. We do not have "credit repression," we have supply constraints. Capital, always and everywhere, finds NPV-positive projects if they exist. No piece of legislation is going to stop that. Check out stocks like flows trending down, trading below NAV. Building/owning houses is simply not a great investment right now. The market has spoken. These guys could raise capital in an instant if the projects were there.

    1. You are correct about the investor market. The credit repression is targeted at the owner-occupier market.

    2. In other words, the CFPB doesn't have veto power over bonds issued by AMH.

  2. Great post.

    I still wonder why it is that cities which are attractive to China capital are also the cities with the greatest house price run-ups.

    Vancouver house prices famously cracked after mainland China instituted capital controls.

    But of course the basic thesis remains intact: supply and demand.

    There are no atheists in fox holes and there are no libertarians when the topic is neighborhood property zoning.

    1. Are you sure they are, or is that just where Chinese investments are most noticeable? For instance, does Tokyo get a lot of Chinese investment? Seoul?

  3. Kevin, London is limited by the green belt and height limits. Much of the city isn't that tall. A lot of the media claims housing is extremely expensive (across the country), but that might reflect their london-centric views.

    That graph is at odds with what you'd expect if you read the papers here.

    1. Well, I suspect that it is much like the US in 2005. Other places look expensive in terms of price, but they are cheap in terms of mortgage or rent affordability. So, I suspect that prices are moderated everywhere else by ample supply and they are moderated in London through substitution with other locations, which plays out in the sorting by income through migration.

    2. Kevin, I see a potential issue here. I don't think a (Open Access) + (low real rates) circumstance would have similar quality, similar rents, and higher prices than (Open Access) + (high real rates).

      If UK were Open Access, wouldn't we rather see a boom in quantity and quality, if anything slightly lower rents, and prices largely proportional to construction costs?

      Think about cars. Low rates shift consumption up in quantity/quality, but if anything monthly payments and/or rental costs go down.

      As long as housing prices and construction costs have diverged, on any more than a short-term basis, it's a sign something's broken. And whenever we create a huge debt market to fund something that cannot respond with productive investment, whether residency permits or work permits (degrees), we're in trouble.

    3. Yes. I think you're right. This is what was happening in the US before 2006. Where housing supply was elastic, prices remained moderate and building was generous. Rent inflation declined. And Americans were sorting into the Closed Access cities by incomes, so that rents and prices their increased as that sorting happened.

      I don't know enough about the foreign markets, but I think this is basically what is going on in the UK. I think the northern cities are fairly inexpensive.

      The differences are that interest rates are even lower now than they were in 2005. And, also, I think that the US Closed Access cities might be especially bad, in terms of housing supply, so that the foreign "Closed Access" cities don't induce as harsh of a migration pattern as the US cities did during the bust. But, if the foreign cities still have somewhat inelastic housing supply, then it doesn't expand enough to bring rents down. It may be the case, then, that rent inflation isn't as high in London as it has been in San Francisco. But, the lack of a full-throated supply response keeps rents from declining, which makes the local housing stock more sensitive to interest rates.

      In the US, it seems that home prices behave like something like an 8 year bond. That's a little odd, because they should behave more like a 30 year bond. But, I think what may be going on is that they do act like a 30 year bond, but the supply effect you mentioned means that when rates are low, rents decline, which lowers prices. So, I think instead of attributing Closed Access prices to expected rent inflation, it might be more accurate to attribute them to low interest rates. In any city that can't induce enough building to cause rent deflation, then home prices act like 30 year bonds. That might explain that Price/Rent levels in cities like Seattle, Toronto, and London are similar to LA and New York, even though it appears that they allow somewhat more generous building. The building isn't enough to lower rents, but it is enough to reduce the income sorting that was so strong in the US in 2005.

    4. OK so we both think Sydney, Melbourne, Toronto, Vancouver, London are Closed Access, just a difference of degree. I have so many issues with Mulheirn's reasoning it's hard to know where to start. So let's ignore it and look at prices vs construction costs; the Commonwealth cities in question aren't noticeably better than NY/SF. Such an analysis is also way less sensitive to timing, a serious problem for any analysis using growth or index comparisons.

      Do we know for sure that other countries didn't see domestic out-migration from their Closed Access cities? If so, I'd love to see the data, but considering the number of variables that would go into such a phenomenon, I would be careful of assuming that's mostly about real estate finance.

      PS Man, you can write a complex response quickly. I'll have to think more about your bond analogy ideas. Thanks for your blog, easily the best RE/finance I've seen.

    5. I think we're on the same page.

      I am not so adept at getting international data, but the data I see here and there has suggested that foreign "Closed Access" cities tend to look more like Seattle or Washington DC, than Los Angeles. I did not original think that was the case. The article I linked to seems to suggest that is the case. I have seen a few people express some skepticism about the article, which may be warranted. But, I did like his treatment of rent vs. price, which already bought him goodwill in my book, and put his analysis ahead of most of what I read. Whether the rest of the article is accurate, I could be persuaded either way.

      In either case, it seems clear to me that the "Closed Access" problem is international. The question with the foreign cities is what happens when you add some supply, like Seattle, but not a lot of supply like Atlanta or Dallas. Originally, I thought that should bring down rent inflation and prices pretty immediately. But, the experience of Seattle and Washington, and maybe some foreign cities, suggests that, maybe rent inflation doesn't come down that much, but even with some continued rent inflation, it is enough to stop much of the turnstile migration pattern. And, it could be that if that is as far as a city goes, prices will still stay high while long term real interest rates are low.

      This would explain why prices are so high in Canada, Australia, etc. It also has ramifications for how locals will react if half-assed solutions end up having minor effects on rent. They will only see the high income new tenants moving in. They won't see that 50,000 households didn't need to leave town that year because of the marginal increase in housing expansion. And, rents and prices will still be high.

      These issues don't really affect my estimation of the core story of Closed Access, but they might inform what we can expect in future scenarios with different building rates and different interest rates.

      Thanks for the compliment. It just seems that way because it's my conversation, based on my project. I've got 800 pages of research all crammed into "RAM". If I went to your blog, I'd sound like a bumbling idiot.

  4. Ian Mulheirn appears to be in a minority of one among qualified economists in believing that the UK housing crisis is not supply-driven.

    Their is copious evidence that:-
    -Most British housing markets are Closed Access (i.e. That supply responds to policy, not to prices) - Kate Barker did he most famous work on this, which Mulheirn does not respond to because his thesis is that the policy-driven supply level is correct.
    -Private rents are going up faster than earnings (Mulheirn acknowledges this, but argues that earnings are not the correct measure of affordability)
    -Private rents are becoming increasingly unaffordable to private tenants.
    -The negative social consequences of Close Access are being seen in London and a few other medium-sized cities that don't show up in regional aggregates (such as Oxford and Cambridge). Mulheirn again acknowledges the highly visible problem, but says that his fake affordability data proves that the problem is not supply driven.

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