As it is an interest rate decision day, I thought I would share some thoughts on the UK housing market:
A common theme at the moment from housing market bulls is that demand for property is higher than supply and that this factor is continuing to push prices upwards. We are given many reasons for why demand is high: immigration, city bonuses, buy to let etc.
On the supply side, we are simply told that there are not enough properties being built. Here is another reason: high prices are lowering the incentives for existing property owners to sell. Let’s take the example of George:
Imagine George bought a 3 bedroom terraced house in Tooting, South London in 2000. It cost £140,000. He was earning £40,000 at the time and he borrowed 3.5 times his salary to fund the purchase. Seven years on this property is worth £350,000. George’s salary is now £50,000.
Imagine, George sold now. He would make an equity gain of £210,000 from which he would take off £6,000 in charges for the sale. As interest rates have risen, he can afford to take out a mortgage of 4 times his new salary, i.e. £200,000. This gives him a pot of just over £400,000.
If we then take out £20,000 to cover stamp duty, mortgage fees, legal fees, etc. George’s target price for a house is £384,000.
At this level, he is not going to get a vastly different property for his money. He can only afford a property £34,000 more expensive than the one he lives in. There is little incentive for him to move. So he stays put and does not put his property up for sale.
Supply in economist terms is therefore sticky because the transaction costs of moving are high and the perceived benefits from moving are low. These are indeed interesting times.
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February 8, 2007 at 1:27 pm
Nick Thorne
I spotted this argument and put it to David Smith here:
http://www.economicsuk.com/blog/000433.html
I summed it up:
“Is it time to look at lack of supply from the point of view of reasons why people aren’t selling, rather than “shortage of stock” ?”
And Mr Smith agreed, that monetary policy “isn’t easy”.
So, the non-linear control method of monetary policy will most probably not bring about a steadying off of house prices.
Nick
February 8, 2007 at 2:13 pm
Wout
I’m not sure I follow…..
Following your arguments, if the house price drops, George probably wouldn’t move either, because he wouldn’t get enough money for his house to buy something better.
So then we’re saying that the price of his house, be it high or low, has little influence on Georges decision to move. In other words, higher or lower prices have no influence on the quantity of vacated objects available.
If that is true, the only influence on supply and price is the quantity of new houses being built. Which is exactly the opposite of what you’re saying!
I think George should sell his house and buy a farm in the country side, where it is cheaper, grow salads and keep chickens!
February 8, 2007 at 10:12 pm
By George! Should I Buy To Let? « The Reluctant Accountant
[...] let’ properties keeps on going. Taking the example of George from this morning’s ‘conundrum‘ posting, it is possible to see why the incentives still make this is a good decision for [...]
February 28, 2007 at 9:22 pm
The B Word « The Reluctant Accountant
[...] Firstly, interest rates have increased three times in seven months to 5.25%, a 17% increase in the interest rate burden. Secondly, first time buyers have all but dried up and the market is being propelled by speculative purchasers seeking to earn capital gains. It is already well documented that yields on ‘Buy To Let’ investment properties are now around five year lows and that it is increasingly difficult to cover interest payments on mortgages using rental income. Thirdly, supply is low, not just due to planning restrictions, but because high prices have disincentivised people from moving home (see this post). [...]