High rents, low house prices?

What’s happened?

In the past year, average rents in the UK have risen by 4%, about the same as the RPI but despite this, house prices have remained frozen at just above £160000 and are yet to begin moving

This seems strange, seeing as we expect annual rents to be a natural fraction of the house price, just as surely as the average yield on an investment reverts back to its risk adjusted rate of return.

Why is this happening then?

Supply Contraction..The Fall of Buy to Let

What was the craze of the housing bubble in the mid noughties was the idea of buy to let often when the deposit of house #2 was on mortgage refinancing.

Since the onset of the recession where the average house price has now fallen by around £30000 this craze, and the number of properties being rented out has fallen…

Composition of rented housing: The number of properties to rent, excluding council housing, surely depend on the size of property portfolios held by a relatively small number of landlords.

Think, when the average landlord has 20 residential properties, a higher ratio will be to rent than if they own 4 (only 1 or 2 will be lived in at all times)!

So this leads us to the idea that the recession has caused the average landlord to downsize their portfolio. It is easy to see how this can happen:

  • Business bankruptcies: If the landlord had a business which was bankrupted by the recession, selling a house may be needed to repay creditors.
  • Lack of job security/Unemployment: The rise in cyclical unemployment which appears to have now peaked at 2.5million means that, if the landlord worked themselves they may need to sell a house to cover their living. This will also cause more tenant arrears as the tenant is likely to be a labourer; rent incomes cannot be relied upon.
  • Falls in prices and negative equity: Landlords may rush to sell their residences when they realise houses have a long way to fall. May do so to eliminate mortgage debt and avoid -ve equity.
  • Higher maintenance costs: A smaller factor but yields on renting will fall with rising maintenance costs, such as repairs and insurance, reducing the attractiveness of being a landlord.
Landlords were overstretched

Now, the above factors would not be so much of an issue if the landlord was already wealthy, they could just ride out the storm (would be less concerned with arrears, have other funds to draw upon for example).

Rented housing supply is price inelastic….

There are 2 ways supply can rise.

  1. Build more residences
  2. Landlords buy more houses.

Either is unresponsive to a quick burst in rent inflation in the short run, and slightly so in the longer run.

Factor 1 is very unsensitive:

To build more residences, construction firms such as Taylor Wimpey must be sure that they can sell at a profit hence are concerned with the house price rather than the rent.

Time: Agreeing with council planners, finding contractors, until the process is complete can take up to 10 years.
The supply of rented housing depends more on house prices than it does rents..

Factor 2 is more sensitive:

A landlord looking to increase their portfolio is, again more concerned with the house price (can they afford it, are they expected to rise?). Rent yields are a significant factor here though.
Decision: Buying to let is a big decision and carries noteworthy sunk costs and risks. Supply response will still take some time.
Changes in Demand: 

Some of the factors causing a rise in supply for rental housing are also responsible for changes in demand. Rising demand is mainly down to..

Lack of mortgage lending: It wasn’t called the credit crunch for nothing and as first time buyers and previous owners cannot get the financing to buy, the only option is to rent.

Buying and renting being almost perfect substitutes, falls in demand for one means rising for the other.

http://www.bbc.co.uk/news/business-12504255 source says the average deposit for a house has near trebled since 2007

Inelasticity

Some factors causing rising supply of rental housing are now reversing. Instead of supply rising immediately it will rise, at a delay….First the demand curve becomes more inelastic:

Rising job security, greater business profitability make households slightly less strained if they were forced to pay a higher rent

Conclusion

For the market we can say the demand curve becoming recently more inelastic, combining with the already depressed and inelastic supply has caused rents to rise.


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