What does drive house prices?

One of the features of economic life is that central bankers are obsessed with wealth effects. I have various examples of this from just the last week and I do not even need to leave the UK to get them! Let me start with something from the Bank Underground site and this bit does point out some interesting thoughts.

The value of the whole stock of housing is given by the price of the (tiny) fraction that changes hands in any given month (less than 0.5% in 2017). On one level, those prices are set by what the buyers and sellers active in the market are willing to offer and accept. But, more fundamentally, what those customers are willing to pay or accept for a house depends on expectations about the future path of prices and rents, not to mention the (perceived) value of their own or neighbouring houses.

The opening salvo is a point I often make in response to those who publish figures about the value of the UK housing stock as I note one in the Financial Times from the beginning of last year claiming it was £7.14 trillion. Where I am only partly in agreement is with the expectations of prices and rents. Many people buy and take no notice of the rental value. I am one example of that and have only ever taken more than a cursory interest when I have been considering working abroad.

So whilst I have sympathy with the argument there are issues which have been pointed out in the comments to the piece.

Houses should be viewed as a place to live vs an investment.

Also a more subtle one which will matter more in a bit pointing out that renting and owning are different in more than just the obvious ways.

The flaw in the argument that each house sold by a landlord either goes to a landlord or a former renter is that renters are more likely to share living space. To understand this you don’t get too many houses of multiple occupation in the owner-occupied sector, whilst “spare rooms” are rarer in the rental market.

Why does this matter?

Well there was a second article and look where the logic applied leads to and the emphasis is mine.

In yesterday’s post we argued that housing is an asset, whose value should be determined by the expected future value of rents, rather than a textbook demand and supply for physical dwellings.

So in the two days after the announcement that the RPI measure of inflation will be changed by removing house prices and mortgage interest-rates and replacing them with rents that are never paid we get this.What a coincidence of timing! What are the odds of that do you think? If the blog wishes to claim that it is independent of Bank thinking then it does not advance its case with either the timing of this. It is like living an episode of Yes Prime Minister.

On a personal level I cannot recall ever thinking much about rents when I purchased my flat. Those I know who do let properties always seem more concerned about price rises than the rents. But let us suspend reality for a moment as we note they say”should be” which is rather different to is.

Where does this take us?

We get a type of explanation of rising house prices over the past 20 years in the UK.

Lower interest-rates raise house prices by increasing the present value of future cash flows.

Really? As for example you can argue that people often buy the maximum they can afford so prices rise because the payment now is lower and then expect house prices to rise. Or as pointed out earlier they simply want to live in as nice a place as they can.

I am afraid they then completely lose the plot.

These effects can be powerful, especially when interest rates are already very low.

Absolute rubbish and a clear case of imposing theory on reality rather than the other way around. Otherwise house prices would be surging in the UK right now in response to the fall in Gilt yields.

They use the CPI inflation measure to give an idea of real house price growth which is revealing as I would argue you learn as much and maybe more by looking at real wages.

First up, the grey bars show the role of CPI inflation. If house prices rose at the same rate as goods in general, they’d have risen by 50% since 2000. So what explains the remaining 60pp of real house price growth?

On this road they discover this.

By far the largest contributor is the lower discount rate (green bars), which accounts for almost all real house price rises since 2000. We completely shut down any role of interest rates beyond 20 years.

I have quoted the second sentence because this highlights a flaw in this sort of approach which is that the answers you get are invariably driven by the assumptions that you make.

David Miles

For those of you who are unaware Professor Miles was on the Monetary Policy Committee until 2013. If you look at his voting record and apply the logic above he did everything he could to pump up house prices. In a example of the ” I can see for miles and miles and miles” lyric of the WHO not applying he was voting for more QE in 2013 as UK economic growth was lifting off.

Now he has written this as part of a blog for the Resident Landlords Association.

there are few signs it has benefited those hoping to become home owners

He seems to have missed that in recent times for the first time in quite a while both wage and real wage growth is faster than house prices. Most ( maybe everyone except David ) would see this as a benefit and many will join me in hoping for more of it.

I am sure the RLA lapped this up but if you look at what rents are actually doing the statement below looks pretty evidence free.

But aspiring first-time buyers are hardly helped by squeezing the supply of rental property and driving rents up.

More than a few will be wondering about the rising real incomes point below.

And there are good economic reasons for believing that in a country with a rising population and where real incomes tend to increase over time house prices might well rise at least as fast as incomes.

The problem for David is that he was a supporter of every policy which would pump up house prices and in an irony mostly failing as the rises happened afterwards. But what he ignores is that the rental business model shifted from income/rent to capital gain or profit.

Oh and in an irony by stopping house prices falling the policies of David Miles pushed more people onto renting. Perhaps that is what is bothering him now.

Comment

Let me now explain what I think determines house prices and let me start with something not addressed by the Bank of England. That is the number of cash purchases. These have accounted for between 30 and 40% of all purchases in the credit crunch era. Why?

  1. Somewhere to live and they presumably like it
  2. They think house prices will rise further. After all the perception that they can only rise has been reinforced by Bank of England policy
  3. Some of this is international as we see foreign buyers who may be applying points 1 and 2 or using the UK as a safe haven

Whilst there may be an indirect effect from lower interest-rates and yields in terms of opportunity cost there is no explicit link here for many. Some may rent the property out though.

Next we get to those taking out a mortgage and we see that the same 3 points apply. But I think that point 2 gets stronger as the belief that house prices can only rise, and lets face it for millennials they pretty much only ever have, trumps nearly everything. So they borrow as much as they can partly because these days they get so little for it. I know that the explanation is perverse but reality is that perverse demand curves do exist. As much of that borrowing these days is via fixed mortgage-rates you come to a similar answer to the Bank of England but without the spinning to suit its Ivory Tower theories. The same theories independently held by HM Treasury. the UK Statistics Office and the Office for National Statistics in a happy coincidence.

Lastly we have the rental model for the buy to let investor. They are much more likely to be influenced by the rental model and hence the discount rates of Bank of England theory.

However there are also regional factors as we often observe on here which includes the balance between supply and demand. We never get a full answer to the latter which is illustrated by the area near where I live. Prices surged driven partly by foreign buyers so now more properties have or are being built, just in time for at least some of the buyers to disappear.

 

 

 

What is happening to house prices and rents in Ireland?

Yesterday brought us up to date with house price changes in the Euro area at least for the start of 2018. From Eurostat.

House prices, as measured by the House Price Index, rose by 4.5% in the euro area and by 4.7% in the EU in the
first quarter of 2018 compared with the same quarter of the previous year…….Compared with the fourth quarter of 2017, house prices rose by 0.6% in the euro area and by 0.7% in the EU in the first quarter of 2018.

As you might expect there are some swings from country to country but before we get there we see some interpretation of history.

House prices in the EU up 11 % since 2010

Actually they fell for a while due to the Euro area crisis and then responded to the “Whatever It Takes” measures.

Prices started growing again in 2014.

A particular disappointment to Mario Draghi must be that his home country Italy has ignored all his efforts to pump up house prices as they fell there by 0.4% over the last year and are down 15% since 2010. Meanwhile my attention was drawn to Ireland with its 12.3% rise in the latest year.

This is because the boom and then bust in Irish house prices took much of the banking system with it.  This meant via the usual privatisation of profits but socialisation of losses with respect to the banking system the Irish taxpayer found themselves in this situation described by its national debt agency NTMA.

That may bring Ireland’s high stock of debt – which at €213bn is more than four times its 2007 level – into sharp focus. Whilst our debt ratios are improving, our total nominal debt is still rising as we continue to borrow to pay interest.

This means that whilst the interest-rate or yield on Ireland’s bonds has fallen a lot mostly due to the bond buying or QE of the ECB (European Central Bank) there is a tidy bill to pay each year.

Almost irrespective of the external interest rate environment, we still expect Ireland’s annual interest bill to fall towards €5bn in the near term, from €6.1bn in 2017 and a peak of €7.5bn in 2014.

Ireland now only has an interest-rate of 0.81% on its ten-year benchmark bond so a fair bit lower than the UK which represents quite a change when we borrowed money to lend to theme to help them out.

House prices

The Irish statistics office or CSO brings us more up to date.

In the year to April, residential property prices at national level increased by 13.0%. This compares with an increase of 12.6% in the year to March and an increase of 9.5% in the twelve months to April 2017.

As you can see the pace has been picking up although it is no longer being quite so led by Dublin.

In Dublin, residential property prices increased by 12.5% in the year to April. Dublin house prices increased 11.7%. Apartments in Dublin increased 15.9% in the same period.

The reason why I raise the Dublin issue is that it has seen the widest swings as it had the biggest bubble then fell the most and then for a while picked back up more quickly. Or as it is put here.

From the trough in early 2013, prices nationally have increased by 76.0%. Dublin residential property prices have increased 90.1% from their February 2012 low, whilst residential property prices in the Rest of Ireland are 69.9% higher than the trough, which was in May 2013.

That is quite a surge is it not? Whilst the Dublin recovery started earlier nearly all of this fits with the “Whatever It Takes” policies and timing of the ECB, Of course it raises old fears as well although we are not back to where the bubble burst.

Overall, the national index is 21.1% lower than its highest level in 2007. Dublin residential property prices are 23.3% lower than their February 2007 peak, while residential property prices in the Rest of Ireland are 26.1% lower than their May 2007 peak.

Oh and maybe another issue is having an impact.

The Border region showed the least price growth, with house prices increasing 9.3%.

Rents

We can track these down via the consumer inflation numbers and we get a hint here.

Housing, Water, Electricity, Gas & Other Fuels rose mainly due to higher rents and an increase in the price of home heating oil and electricity.

Looking into the detail we see that rents have risen by 7.4% over the past year and by 0.5% in May. The larger private-sector market is currently seeing a faster rate of rise but there must have been quite a chunky rise in public-sector rents at some point in the last year as they are up by 10.6% over that period.

Mortgage Interest-Rates

I found these hard to track down as the Central Bank of Ireland changed its reporting system but the Irish Consumer Price Index gives us a guide. It must have been designed in a similar way to the UK RPI as it includes mortgage interest-rates. The index for this was 143 when Mario Draghi was giving his “Whatever It Takes” ( to reduce mortgage rates) speech whereas in May it was 99.1.

Although rather curiously the Irish Independent reports that many have not bothered to switch to lower mortgage-rates.

KBC Bank is due to tell the Oireachtas Finance Committee it has 36,000 residential customers paying variable rates, which are its most expensive home-loan option, when they could get a lower priced deal from a bank.

It comes after it emerged that more than 100,000 homeowners at Bank of Ireland and Permanent TSB are paying up to €3,000 more a year on their mortgages than they need to at the two banks.

Perhaps they do not realise they can get them as I recall Ireland having a situation where many could not switch due to the house price falls.

Comment

There is a fair bit to consider here and let me open by agreeing to some extent with Mario Draghi.

European Central Bank chief Mario Draghi has linked the current spike in Irish property prices to “the search for yield by international investors”.

Mr Draghi said the real estate market in the Republic and several other EU states was “overstretched” and vulnerable to “repricing”. ( Irish Times yesterday).

He cannot bring himself to say falls nor to acknowledge his own role in them being overstretched but he does have time to bring up the fall guy which is of course financial terrorists.

 being fuelled by cross-border financing and non-banks, and that it would be important to investigate whether new macro-prudential instruments should be introduced for non-banks, especially in relation to their commercial real estate exposures.

We can’t have banks losing profitable business can we? Speaking of macro-prudential so the 2015 measures did not work then which is not a surprise here but perhaps a suggestion from the UK might help.

Under such a target the Bank of England should aim to keep nominal house price inflation at (say)
zero per cent for an initial period – perhaps five years – to reset expectations, ( IPPR)

So the organisation which has pumped them up has the job of controlling them? Whilst the central planners would love this sadly it would not work and I say that as someone who thinks we badly need lower house prices and switching back to Ireland because of this sort of thing. From the Irish Examiner.

The scramble to find a home in the crisis-hit rental sector has led to people queuing to view a €900-a-month one-bedroom apartment on Cork’s Tuckey Street……..

Piet said last week they were the first people in a 50-person queue on MacCurtain Street and were refused the apartment because they did not have a reference letter with them.

Piet said the rental sector is a lot more expensive than it was a few years ago.

The average rental property in Cork has soared to above €1,210 a month — up almost 10% on last year.

“We pushed the boat out to €900 a month just to get somewhere nice. That is the very end of our budget,” said Piet.

Or to put it another way with both house prices and rents soaring the rentiers are quids ( Euros) in.

 

 

 

 

The China housing crisis builds up steam

This morning has brought news of something which would bring a chill to the heart of any central banker. It comes from China as we note this from Reuters.

 So far this year, the Shanghai stock index is down 14 percent, the CSI300 has fallen 12.4 percent while China’s H-share index listed in Hong Kong is down 4.8 percent. Shanghai stocks have declined 8.1 percent this month……The Shanghai stock index is below its 50-day moving average and below its 200-day moving average.

Not much sign of any wealth effects there at least not positive ones and there were signs of trouble in another area of asset prices too.

An index tracking major developers on the mainland slumped 4.4 percent following a near 5 percent drop the previous session, as a weakening yuan raised fears of capital outflow that could weigh on asset prices.

Actually they have missed something that Will Ripley of CNN did not.

China’s benchmark Shanghai Composite slid into bear market territory Tues, closing down more than 20% below its January high. Chinese stocks have come under pressure in recent weeks from concerns over the strength of the country’s economic growth & an emerging trade war w/ the US.

Of course the definition of a bear market is somewhat arbitrary and Chine’s stock market does tend to veer from boom to bust. But in  these times of easy monetary policy central bankers place a high emphasis on asset prices. This will be reinforced by the falls in the share price of developers as it reminds of the housing market and debt issues.

The Housing Market

Over the weekend the South China Morning Post offered an eye-catching view from Christopher Balding.

Real estate is the driver of the Chinese economy. By some estimates, it accounts (directly and indirectly) for as much as 30 per cent of gross domestic product.

There is something for Mark Carney to aim at as those of us in the UK have time to mull a familiar issue.

Keeping housing prices buoyant and development robust is thus an overriding imperative for China – one that is distorting policymaking and worsening its other economic imbalances.

At first I was not sure about his definition of a bubble.

Despite reforms in recent years, there’s little question that Chinese real estate is in bubble territory. From June 2015 through the end of last year, the 100 City Price Index, published by SouFun Holdings, rose 31 per cent to nearly US$202 per square foot.

However suddenly it looks very bubbilicious.

That’s 38 per cent higher than the median price per square foot in the United States, where per-capita income is more than 700 per cent higher than in China. Not surprisingly, this has put home ownership out of reach for most Chinese.

More than out of reach you would think as it must be multiples of out of reach. Also countries way beyond China’s borders face the issue below.

 Politically, homeowners have come to expect their property values to rise continually in a one-way bet;

There is a rather familiar response at least for UK readers.

Worried about these prices, and about growing indebtedness among developers, China’s State Council has hatched a plan to encourage rentals.

My first thought is that there is a clear opportunity for Gwen Guthrie to translate her hit into Mandarin.

Bill collector’s at my door
What can you do for me, oh?……

‘Cause ain’t nothin’ goin’ on but the rent
You got to have a J-O-B if you wanna be with me

Or to put it more formally.

Wages in China simply aren’t high enough to keep up with the credit fuelled rise in asset prices, and thus developers can’t earn a reasonable rate of return by renting out units.

In terms of the numbers the circle seems to be something of a rectangle.

 In big cities, such as Beijing and Shanghai, yields are hovering around 1.5 per cent (compared to an average of about 3 per cent in the US and 4 per cent in Canada). ……Worse, developers are heavily weighted down with debt, much of it short-term. Many are paying out 7 to 8 per cent bond yields, with debt-to-equity ratios of around 380 per cent.

So the circus requires house price rises of at least 6% per annum to keep the show on the road. But wait there is more and something which to western eyes seems rather extraordinary.

Typically, renters borrow from banks to make an upfront, one-time payment to developers that covers, say, five years.

A rental mortgage is a little mind-boggling. Perhaps though we should have a sweep stake for predict how long it is before we get those in the UK?! Also it is a case of the familiar establishment response to trouble which is to give that poor battered can another kick.

The upfront payment from the bank to the developer provides some short-term cash-flow relief. But otherwise, all it does is delay debt repayments attached to the unit and shrink the loss on unsold inventory.

On a deeper level I wonder how many ( well paid) jobs rely on can kicking and relate to operations which are unviable in profit/loss or balance sheet terms but generate cash for now. How many banks for example or shale oil?

At this stage it all looks rather like the cartoon characters which have to run ever harder just to stand still.

 New starts and land purchases have grown strongly through the first five months of 2018. Investment in residential real estate is up 14 per cent and development loans are up 21 per cent. Far from reducing leverage, banks are jumping back into the speculative bubble: Mortgage growth is now at 20 per cent.

A response

On Sunday, the People’s Bank of China (PBOC) said it would cut the reserve requirement ratio (RRR) for what some banks must keep in reserves by 50 basis points (bps), releasing $108 billion in liquidity, partly to spur lending to smaller firms. (Reuters)

The PBOC operates under a model where it adjusts quantity rather than price or interest-rates. It mostly leaves the latter to influence the value of the Yuan although of course interest-rate moves affect the domestic economy as well. In terms of time you could argue the UK moved away from that in 1973 but anyway the Thatcherite changes of 1979 ended it. In essence it is allowing the banks to raise what is called the money supply ( as it is really money demand) and no doubt some and maybe much of it will be heading in the direction of the housing market in spite of the claim that it is for business lending. In that they are very much like us western capitalist imperialists so shall we call it lending to small businesses in the property sector?

Oh and speaking of the Yuan.

The dollar bought 6.5240 yuan at the close of trading in China, meaning the yuan fell 0.4% on the day, reaching its lowest level since Dec. 28, according to Wind Info. The Chinese currency weakened further on Tuesday morning in Asia, hitting 6.5409 against the U.S. dollar. ( Wall Street Journal)

Care is needed though as whilst the Yuan has slipped over the past week it has still done better against the US Dollar in 2018 than the Euro or the UK Pound £

Comment

There is much to consider here. After all there have been scare stories about the Chinese economy before but it has managed to carry on regardless. The catch is that the western economies did this in 2005, 2006 and some of 2007 before it all went wrong. The size of the housing and development sector invokes thoughts of what took place in Spain and Ireland although of course China is much more systemic.

Meanwhile interestingly China seems to have spotted a way of making debt work in its favour. It started well.

Every time Sri Lanka’s president, Mahinda Rajapaksa, turned to his Chinese allies for loans and assistance with an ambitious port project, the answer was yes. ( New York Times)

But only really ended well for China.

Mr. Rajapaksa was voted out of office in 2015, but Sri Lanka’s new government struggled to make payments on the debt he had taken on. Under heavy pressure and after months of negotiations with the Chinese, the government handed over the port and 15,000 acres of land around it for 99 years in December.

Rather like the UK and Hong Kong?

 

 

 

What are the prospects for those who rent their homes?

We often look at what the state of play is regarding UK house prices but I think that it is past time for us to look at those finding themselves singing along with Gwen Guthrie.

Cause ain’t nothin’ goin’ on but the rent
You got to have a J-O-B if you wanna be with me
Ain’t nothin’ goin’ on but the rent
You got to have a J-O-B if you wanna be with me

Rather oddly if you take Gwen literally you may well live in Kensington and Chelsea.

 Kensington and Chelsea was the least affordable English local authority in 2016 with a median monthly rent making up almost 100% of median monthly salary.

Of course data from there begs all sorts of questions as it is heavily influenced by foreign purchases hence the nickname Chelski. Although it does show that if you work there you are extremely unlikely to be able to afford to  rent from a private source there. For a wider perspective here are the numbers which were produced by the Office for National Statistics last November.

 In 2016, median monthly private rent for England was 27% of median gross monthly salary. This means that someone working in England could expect to spend 27% of their monthly salary on private rent. London, the South East, East of England and the South West, all had percentages above this level. Overall, median monthly private rent as a percentage of median monthly salary ranged from 23% in the North East, to 49% in London.

Some local authorities are particularly cheap in relative terms.

The most affordable local authority was Copeland in the North West (12%) followed by Derby in the East Midlands (18%).

Although in the former case you may have to glow in the dark to get it ( and perhaps save on lighting and heating too).

 Higher median monthly salaries in Copeland are likely to be the result of a large number of relatively high-paid, skilled jobs at the Sellafield nuclear power station in this local authority.

What about social housing?

People also rent via this route and to the question how much? We are told this.

Average weekly cost of social renting for England in 2016 was £97.84, an increase of 2% since 2015. This is a smaller increase than in previous years, although the cost of social renting has risen by 40% since 2008. The average cost of social renting in Wales has increased at a similar rate, by 39% since 2008.

Which in affordability terms translates to this.

Average weekly social rent cost as a percentage of 10th percentile weekly salary in England for 2016 was 31.5%, a decrease of 0.7 percentage points since 2015. This means that someone earning at the lowest 10% of earnings could expect to spend 31.5% of their weekly earnings on social rent. In Wales for the year ending March 2017, weekly social rent cost as a percentage of 10th percentile weekly salary was 28.1%, a decrease of 0.4 percentage points since the year ending March 2016.

It is a shame that we do not get figures which are directly comparable. I take the point that those in social housing tend to have lower incomes as that is of course one of the main reasons they are likely to be there, but not always. On the measuring stick we are presented with it has got more expensive.

Social rent has become less affordable for both England and Wales since 2003. The differences between average weekly social rent costs as a percentage of 10th percentile weekly salary for England and for Wales have been within 2.3 and 3.9 percentage points since 2003.

What is happening now?

The latest official data on private rents is shown below.

Private rental prices paid by tenants in Great Britain rose by 1.1% in the 12 months to January 2018; this is down from 1.2% in December 2017.

That reduction in the rate of growth has been in place for a while now since the peak at 2.7% in the autumn and winter of 2015. This should not be a surprise as rents tend to move with wages and in particular real wages although sometimes there can be quite a lag.I will come to London which is both something of a special case and a leading indicator in a bit but if we exclude it then lagged rents and real wages fit reasonably well in recent times.

Thus in the current scenario with real wages having been falling we would expect lower rental values. This of course is a possible explanation for the rush to include rents ( which of course do not exist) as a measure of owner occupied housing inflation  in the CPIH. If you were wondering why it gives a lower answer that is it.

What about London?

The official data tells us that it has a different picture to the rest of the UK.

London private rental prices grew by 0.2% in the 12 months to January 2018, that is, 0.9 percentage points below the Great Britain 12-month growth rate.

So it has been pulling the rate of growth lower and there should be “no surprises” as Radiohead would put it about that if we look at the numbers earlier in this article.

Actually others think that the situation is even more different in London.

Average rental values in prime central London fell 2.1 per cent in the year to February according to Knight Frank – and the letting agency says rents in that area have been dropping now for two full years. ( Letting Agent Today).

Fascinatingly we are told this by Knight Frank.

“As new supply moderates and demand strengthens, we expect to see continued upwards pressure on rental values” claims the agency.”

Continued? Anyway we have of course seen if we are polite what might be called over optimism before. This is me quoting the Financial Times on the 4th of November 2016.

Rents in Britain will rise steeply during the next five years as a government campaign against buy-to-let investing constrains supply, estate agencies have forecast.

Actually it got worse.

London tenants face a 25 per cent increase to their rents during the next five years, said Savills, the listed estate agency group. Renters elsewhere in the country will not fare much better, it said, with a predicted 19 per cent rise.

I was far from convinced.

 We know that lower real incomes are correlated and usually strongly correlated with rents which means that a reduction in the rises and maybe some falls are on the horizon (2019 or so if my logic holds).

Comment

As we survey the situation we see a complex picture but a theme is that things have been getting tougher for many. I wonder how much worse things look for younger renters as for example even if the numbers above are the same some of them have student loans to repay? Another cautionary note can be provided by the official data which is far from complete and some statisticians think may be too low by around 1% per annum due to its flawed nature.

If we look ahead then the general trend is as I pointed out in November 2016 but as this year progresses there will be winds of change. There are ever more surveys suggesting a pick-up in wage growth but even if understandable caution is applied here due to element of deja vu inflation should fall back meaning real wages will stop falling and then should rise. After a lag that should affect rents.

Meanwhile I would like to remind you that the UK statistics establishment uses the rental data it knows is far from complete to measure owner-occupied housing inflation. This morning they have decided that a fantasy number based on troubled data is better than this.

this means that the RPI is heavily influenced by house prices and interest rates,

Not everyone is convinced this is a bad idea.

 

Me on Core Finance

 

 

 

What are the prospects for the UK house prices and rents?

One of the features of economics and economics life is that no matter how unlikely something is if it suits vested interests it will keep being reinvented. On that topic let us see what the Royal Institute of Chartered Surveyors or RICS has reported this morning.

Nationally, 61% felt landlords would exit the market over the coming year, while only 12% felt there would be a greater number of entrants. Moreover, for the next three years, 52% felt there would be a net reduction in landlords, with only 17% suggesting a rise.

Those of us who feel that the UK economy has been tilted too much towards the buy to let sector will be pleased at that but not the RICS which gives a warning.

Given the likely resulting supply and demand mismatch in this area, respondents predict that over the next five years rental growth will outpace that of house prices, averaging 3%, per annum (against 2% for house price inflation).

As to the deja vu element well let me take you back to November 4th last year.

Rents in Britain will rise steeply during the next five years as a government campaign against buy-to-let investing constrains supply, estate agencies have forecast.

Okay how much?

London tenants face a 25 per cent increase to their rents during the next five years, said Savills, the listed estate agency group. Renters elsewhere in the country will not fare much better, it said, with a predicted 19 per cent rise.

Whilst we are looking back to then there was also this.

JLL, another estate agency group, predicted a 17.6 per cent increase across the UK by 2021, with London rents rising 19.9 per cent, far outstripping predicted rates of inflation.

What has happened since last November?

If we look back I was very dubious about this and pointed out a clear problem.

If you look at the pattern of rental growth it follows the improvement in the UK economy with a lag ( of over a year which is another reason why it is a bad inflation measure) which means that it looks to be driven by improving incomes and probably real incomes rather than the underlying economy. Thus if you expect real income growth to fade (pretty much nailed on with likely inflation) or fall which seems likely then you have a lot of explaining to do if you think rents will rise.

In essence there is a strong correlation between income growth and real income growth and rental growth in my opinion. We now know that so far this has worked because back in November I pointed out that the official measure of rental inflation was running at 2.3% and yesterday we were updated on it.

Private rental prices paid by tenants in Great Britain rose by 1.6% in the 12 months to August 2017; this is down from 1.8% in July 2017.

Shall we check in on London?

The growth rate for London (1.2%) in the 12 months to August 2017 is 0.4 percentage points below that of Great Britain.

So we see that my methodology has worked much better than those in the industry as the phrase “vested interest” comes to mind. If you are struggle to predict capital profits ( house price rises) for your customers then promising some increased income (rents) works nicely especially at a time of such low interest-rates and yields elsewhere. The problem with this was highlighted by Supertramp some years ago.

Dreamer, you know you are a dreamer

If you look at the chart then it looks like the only way is down which looks awkward for the vested interests squad. Care is needed as it is a diverse market with rents in Wales rising albeit from a low-level and a variety of levels as shown below.

the largest annual rental price increases were in the East Midlands (2.8%),…….The lowest annual rental price increases were in the North East (0.4%),

But until we see a rise in real incomes then there seems to be little or no case for a recovery overall. At this point the UK establishment will be getting out the champagne as they will feel they put rents into the “most comprehensive” inflation measure CPIH at exactly the right time.

What about house prices?

As today is a policy announcement day for the Bank of England let us look at what house prices have done during the term of the present Governor Mark Carney. When he arrived in July 2013 the average house price in the UK was £174,592 whereas as of July this year it was £226,185 according to the Office for National Statistics. This replaced a three-year period of stagnation where prices had first fallen a bit and the recovered. So he has been the house owner and buy to let investors friend.

Some of the policy changes to achieve this preceded him as it was under the tenure of the now Baron King of Lothbury that the Funding for ( Mortgage) Lending Scheme was introduced. But Governor Carney could have changed course as he did in other areas. However he did not and I noted back then a fall in mortgage rates of around 1% quite quickly and the Bank of England later calculated a total impact on mortgage rates of up to 2%.

There are of course differences across the country as I looked at on Tuesday where the surges in London have been accompanied by much weaker recoveries all in other areas of which the extreme case is Northern Ireland  But the overall move has been higher and not matched by the lending to small businesses which the policy effort was badged as being for.

So if we now look ahead we see wage growth but real wage declines. We see that there has been an extraordinary effort to reduce mortgage rates from the Bank of England. There was also the Help To Buy programme of the government. All of these factors point to stagnation looking ahead and if anything the surprise has been that the various indices have not fallen further. Should London continue to be a leading indicator then perhaps more patience is needed.

The London* price gauge remains stuck firmly in negative territory, posting the weakest reading since 2008. Furthermore, the price indicator has turned a little softer in the South East of England,  ( RICS)

Comment

There are unknown factors here as for example we could see another wave of foreign purchases in London. The Bank of England could ease policy again however the power of Bank Rate cuts and indeed QE has weakened considerably in this regard. This is because if you look at countries like Sweden and Switzerland then with individual exceptions the bulk of mortgage rates hit a bottom higher than you might imply from the official negative interest-rates. This is in my opinion because banks remain unwilling to pass negative interest-rates onto the retail depositor as they fear what might happen next. So if the Bank of England wants to do more its action would have to be direct I think.

The other road that the Bank of England has been hinting at via its house journal the Financial Times is Forward Guidance about an interest-rate rise. Perhaps we will see more of this today and this is unlikely to support house prices as it would be the doppelganger of the last four years or so, especially of the “Sledgehammer QE” of August 2016. This means that today’s policy move could yet be putting Jane Austen on the new ten pound note. Perhaps the PR spinning around this will manage to put a smoke screen around the fact that there seems to have been a “woman overboard” problem at the higher echelons of the Bank.

 

 

The economics of the 2017 General Election

Tomorrow the United Kingdom goes to the polls for a General Election. Yesterday’s anniversary of the D-Day invasion of Normandy in France reminded us that the ability to vote is a valuable thing that people have fought and died for. Let me repeat my usual recommendation to vote albeit with the realisation that as far as I can see it has been an insipid and uninspiring campaign. Time for “none of the above” to be on the ballot box I think.

Moving to economics there have been a couple of reminders over the past 24 hours that some themes remain the same. From BBC News.

RBS has finally reached a £200m settlement with investors who say they were duped into handing £12bn to the bank during the financial crisis.

The RBS Shareholders Action Group has voted to accept a 82p a share offer.

The amount is below the 200p-230p a share that investors paid during the fundraising in 2008, when they say RBS lied about its financial health.

If you look at the sums you see that the compensation is nowhere near the problem if you feel that there was a misrepresentation back then. Also as there was a 1:10 stock split back in 2012 is this not really an 8.2p offer? As to the theme of there being no punishment for bank directors there is also this.

A settlement means that the disgraced former chief executive of RBS, Fred Goodwin, will not appear in court.

Of course the UK is not alone in such machinations as I note this from Spain today. From Bloomberg.

Banco Popular Espanol SA was taken over by larger Spanish competitor Banco Santander SA after European regulators determined that the bank was likely to fail…..

The purchase price was 1 euro, according to the statement.

Santander plans to raise about 7 billion euros ($7.9 billion) of capital as part of the transaction. ( Bloomberg ).

That much? The situation has been summed up rather well in a reply to the article.

Santander could be buying a time bomb filled with bad debt. What is the CEO thinking? Why should shareholders bail out Popular?! ( @ ken_tex )

We are left with a general theme that the banking sector carries on regardless and simply ignores things like elections. Democracy has not reached the banking sector. There is a British implication as of course Santander is a big player in UK banking and as an aside this sees the first bail-in of a so-called Co-Co bond.

How is the economy doing?

We have the Bank of England with its foot hard down on the monetary policy pedal with a Bank Rate of 0.25% which as far as I can recall has barely merited a mention in the campaign! Amazing how that and £445 billion of QE ( including the Corporate Bonds) can be treated as something to be pretty much ignored isn’t it? Partly as a result of this we are facing a spell of higher consumer inflation which will lead to a contractionary effect on the economy due to the way it seems set to reduce real wages. But again this seems to have been ignored. Of course the Bank of England will be happy to be outside of the political limelight but when it is such a major part of economic policy there should at least be a debate.

Fortunately the edge has been taken off things by the decline in the price of crude oil back towards US $50 in Brent Crude terms and the rally of the UK Pound to US $1.29. This is a factor in the Markit business survey telling us this on Monday.

The three PMI surveys are running at levels that are historically consistent with GDP growing at a robust 0.5% rate, albeit with the slowing in May posing some downside risks to the near-term outlook.

So the economy continues to grow but at a slow pace overall. Of course the Bank of England will be concerned about this reported this morning by the Halifax.

House prices in the last three months
(March-May) were 0.2% lower than in
the previous three months (DecemberFebruary).

The mood of Bank of England Governor Mark Carney will not be improved by this as it refers back to a time before it began its house price policy push in the summer of 2013.

Prices in the three months to May
were 3.3% higher than in the same
three months a year earlier. This was
lower than April and is the lowest annual
rate since May 2013 (2.6%). The annual
rate is around a third of the 10.0% peak
reached in March 2016.

The Bank of England will also be worried by this signal that emerged yesterday. From Homelet.

UK rental price inflation fell for the first time in almost eight years in May, new data from HomeLet reveals. The average rent on a new tenancy commencing in May was £901, 0.3% lower than in the same month of 2016. New tenancies on rents in London were 3% lower than this time last year…….This is the first time since December 2009 the HomeLet Rental Index has reported a fall in rents on an annualised basis. The pace of rental price inflation across the UK has been slowing in recent months, having peaked at 4.7% last summer.

Of course whilst there will be concern and maybe some panic at the Bank of England that the £63 billion of the banking subsidy called the Term Funding Scheme has run out of puff. Meanwhile over at HM Treasury someone will be having a champagne breakfast as they slap themselves on the back for starting a rush to get rents in the official UK consumer inflation measure ( CPIH) last Autumn.

Fiscal policy

Back on the 23rd of May I looked at this.

Labour promised £75 billion a year in additional spending and £50 billion of additional taxes. The Liberal Democrats are also aiming for tens of billions of pounds in extra spending partially funded by more tax. Yesterday’s Conservative manifesto was much more, well, conservative………The Conservatives do not appear to have felt the need to spell out much detail. But they have left themselves room for manoeuvre.

Whoever wins we seem set for a period of higher taxation and higher expenditure but we remain in a situation where there is a lot of smoke blowing across the battlefield. There is of course also this from Labour.

we will establish a National Investment Bank that will bring in private capital finance to deliver £250 billion of lending power.

Comment

This has been an election where the economy has been out of the limelight. In a way this is summarised  by the fact that we have heard so little from the current Chancellor of the Exchequer Phillip Hammond. This means that many important matters get ignored such as the apparent devolution of so much economic power to the Bank of England. An issue which is important as in my opinion it was captured by the UK establishment and now pursues policies that politicians would be afraid to implement.

Other important issues such as problems with productivity and real wages which have bedevilled us in the credit crunch era get little debate or mention. To that list we can add the ongoing current account deficit.

Yet some markets are at simply extraordinary levels and it is hard not to raise a wry smile at the ten-year Gilt yield being a mere 0.99%! Whatever happened to pricing an election risk? It also provides quite a boost over time to the fiscal numbers as it is well below the rate of inflation.

 

 

Negative interest-rates and QE have created a house price boom in Germany

A feature of these times is that is called easy monetary policy and this is particularly true in the Euro area. There the European Central Bank has a deposit rate of -0.4% and is undertaking asset or bond purchases of 60 billion Euros a month as well. This means that as of last week over 1.8 trillion Euros of bonds have been bought including some 216 billion Euros of covered bonds which support banks and then mortgage lending. Last week we discovered that some countries “have been more equal than others” in terms of where this 1.8 trillion Euros has ended up. From the ECB.

Excess liquidity has been persistently concentrated within a group of banks located in a limited number of higher-rated countries, i.e. around 80-90 % of excess liquidity is being held in Germany, France, the Netherlands, Finland and Luxembourg (see Chart 1) and even their country shares have been fairly stable across time.

It is fascinating that a country geographically as small as Luxembourg merits a mention. But Reuters updates us on the two main beneficiaries.

The study shows that 60 percent of the money spent by the ECB and national central banks on buying bonds ends up in Germany, where sellers, mainly UK banks, have their accounts. France accounts for a further 20 percent.

Okay and the consequence of this is?

But the fact that the money keeps accumulating in the bloc’s richest countries rather than flowing where it is needed the most risks undoing some of the ECB’s efforts and shows the European Union’s objective to create a banking union is still far from reached.

This makes me wonder about asset prices in the main beneficiary Germany as after all these QE ( Quantitative Easing) policies are claimed to have “wealth effects”.

House Prices in Germany

Let us step into the TARDIS of Dr.Who and go back to February of 2014 when the Financial Times reported this.

House prices in Germany’s biggest cities are overvalued as much as 25 per cent, the Bundesbank warned on Monday, adding to fears that international investment has helped to fuel a property bubble in the eurozone’s largest economy. The German central bank said that residential real estate prices in 125 cities rose by 6.25 per cent on average last year. In October, it reported that property prices in the biggest German cities were 20 per cent overvalued, suggesting the problem is getting worse.

If we move forwards to March 2016 then this from Bloomberg is eye-catching.

German house prices went nowhere for years. Recently they’ve grown faster than the UK.

So what had they done?

House prices have increased 5.6 percent a year over the past five years, according to UBS, which is double the average annual rate of increase since 1970.

As we see in so many other places the rises were concentrated in the major urban areas.

Prices are rising particularly fast in urban areas, where young people increasingly want to live. A gauge of advertised apartment prices in seven major cities including Frankfurt and Berlin rose 14.5 percent in 2015, the most since 2000, according to Empirica, a research institute.

As to “wealth effects” there was something else which is somewhat familiar to say the least.

So far the biggest beneficiaries have been Germany’s listed residential landlords. Cheap debt has enabled them to snap up housing portfolios and smaller rivals, thereby achieving cost savings through scale

What about now?

The Bundesbank calculates its own house price index which covers 127 cities and it rose by 8.3% in 2016 following 7.6% in 2015 and 5.7% in 2014. So according to its own index then prices must be very overvalued now if they were already overvalued back in 2014. Putting it another way the index which was set at 100 in 2011 was at 141.4 at the end of 2016. So quite a rise especially for a nation which has little experience of this as for example the period from 2004 to 2007 which saw such booms in the UK,Spain and Ireland saw no change in house prices in Germany.

In January my old employer Deutsche Bank looked forwards and told us this.

In 2017, we therefore expect rents and property prices in the major German cities, and across the country as a whole, to rise substantially once again…….Munich remains the most dynamic German city when it comes to property, with its fast-rising population and historically low vacancy rate likely to lead to further price increases for many years to come.

There is an element of cheerleading here which of course is a moral hazard issue for banks reporting on property prices which will not be shared by first time buyers in Germany. Those in Berlin will have particular food for thought.

Property prices in Berlin are now twice as high as they were in 2005 and have reached the level of some of the major cities in western Germany.

As of the latest news Europace have constructed an hedonic (quality adjusted) index which rose by 7.6% in the year to March.

What about rents?

These have risen but not by much if the official data is any guide. The rent section of the official Euro area CPI measure rose at an annual rate of 1.6% in March. Although Frankfurt seems to be something of an exception as Bloomberg reports.

The monthly cost of a mid-range two-bedroom apartment in Germany’s financial capital rose 20 percent in 2017 from a year earlier, while the cost of an equivalent living space in London fell by 8 percent, according to a Deutsche Bank study.

Frankfurt rent rises will of course be particularly painful for Deutsche Bank employees.

Comment

There is a fair bit to consider here but what is unarguable is that the easy monetary policy of the ECB has been associated with house price rises. These are noticeable in international terms but are particularly noticeable in a country which escaped any pre credit crunch boom. Also if we use the Bundesbank data above house prices rose by 41.4% in the period 2011-16 whereas real wages only rose by 6.6% ( Destatis) which is quite a gap! I think we know how first- time buyers must feel and yes there is a fair number as whilst Germany has fewer owner occupiers in proportionate terms than the UK they still comprise 51.9% of the housing market.

It is hard to avoid the thought that this house price boom is what central bankers would call a “wealth effect” from their policies, especially if we note that the liquidity seems to have mostly headed to Germany. Of course some of that will be the equivalent of a company name plate on the door but some will be genuine. Meanwhile as we note wealth transfers and inflation there is of course the near record high bond prices and the highs in the Dax 30 equity index seen last week.