No, I don't accept that. There is no justification for a higher multiple if real rates have not declined (and they are close to their average over the last 30 years). The only reason someone would (ir)rationally pay a higher multiple is if he believes house price inflation will continue.
"In Britain, where tax relief on interest payments has been scrapped, real after-tax rates are close to their average over the past 30 years, and so do not justify a higher price/rent ratio."
I suggest you take a look at the original article when you get an opportunity. If you disagree with that, rather than my brief summary, then I'd be very interested to hear why.
Of course there is - prices depend on what people can afford!
People *can* afford to pay a certain percentage of their earnings on housing (exactly what that percentage is, would be another debate - but for the point at issue here, it does not matter what the exact level of that percentage is).
Now, in days gone by - under the higher interest rate environment - the "percentage of earnings that people could afford" covered a mortgage for around 3.5 times earnings. But if you accept that interest rates are going to stay lower than the "1970's-1980's mindset", that same percentage of earnings will now pay for a mortgage much higher than 3.5 times earnings.
OK, I agree that with lower inflation this mortgage cost will stay closer to the inital proportion of earnings for longer than under the previous high inflation environment - when the mortgage cost as a proportion of earnings used to fall more rapidly (as salaries increased quicker). Which means that effectively, over the lifetime of the mortgage, people would be paying more in real terms under the low inflation environment (assuming they still start off paying the same proportion of earnings). C'est la vie! But that doesn't mean that they *can't*, and *won't* (they do!) pay as much as they can afford for the house which they want.
Under the earlier high inflation/interest rate environment, people
*couldn't* "bid-up" the prices - because they couldn't afford the high initial mortgage payments (due to high interest rates). Now that lower interest rates have effectively "flattened" the payment of mortgages in real terms (the real cost is spread out more over the period of payment, instead of paying the bulk of the (real) cost in the earlier years and a lower proportion of earnings later), it is now possible for the prices to be "bid-up" even more - and we have seen this happen since interest rates fell sharply in the late nineties.
"Sammy" wrote
"Sammy" wrote
Can't agree. House purchase is sentimental - most people don't buy them solely for an investment.
"Sammy" wrote
Perhaps I will when I get chance.
"Sammy" wrote
Do any ot the issues I mentioned above answer why?
Only in markets that are exhibiting bubble characteristics. You clearly do not understand basic financial theory. Sustainable prices depend on the yield the asset can generate.
Sentimental - means almost the same as irrational in this context. People wouldn't be so keen to buy if they realised that there was a very real risk that prices will decline.
Not really.
You seem to be basing your whole argument on affordability i.e. as long as the monthly cash flow works out, the buyer can bid-up to the level he is comfortable. Just because an asset is affordable at a certain price does not mean that that price is the asset's intrinsic value. This is a basic tenet of finance and is also common sense.
What we have in the current housing market is the logical conclusion of people bidding up prices beyond their intrinsic value to the point where first time buyers can no longer afford to get on the ladder. Prices have overshot and are now unaffordable for many FTBs and for many people wishing to trade up. As The Economist points out, the financially attractive alternative of renting is where the smart money is.
Why. There is no correletion whatsoever between the two, just the one claimed by those that use the arguement that house values are based on monthy costs.
The 'normal' interest rate for the 60's was about the same as it is now, what was the house price ratio then?
There are only a limited number of houses in the British Isles, there are restrictions on building new ones, and even when consent is obtained it takes a while to build them.
Then there's the fact that no new land area is being created within the country...
"Sammy" wrote
Really? [Anyway, why are you resorting to insults?]
"Sammy" wrote
Rubbish. I bought a couple of loaves of bread today - the yield that they can generate is patently zero. Did the shop give me the loaves for free? Fat chance!
"Sammy" wrote
Hmmmm. There is a *very* real risk that the price of PCs will (continue to) decline. Does that stop people buying them now?
"Sammy" wrote
Exactly!
"Sammy" wrote
No - the true value is whatever people will pay for it at the time!
"Sammy" wrote
That's what happens when there is only a limited supply of an item - the people prepared to pay more for them, get them! Which is to say, those people that cannot afford as much as others, are the ones who end up not buying when the supply runs out.
And we only realised this recently? What were people thinking before this great enlightenment? I haven't noticed the population doubling in recent years, but prices certainly have.
Could you run by me how a chain of sales would progress if no-one can afford to buy the property at the bottom?
OK, but you choose to ignore basic financial theory even if you may be aware of it.
Bread does not constitute most people's idea of a capital asset. It is a consumable in a highly competitive, liquid market whose price tends towards its marginal cost of production.
(continue to)
They might rent them instead. The average PC doesn't cost £180,000.
In which case the same rises should apply to rents as prices, but apparently they don't.
I'd also like to see your analysis explain 90% falls in house prices in Tokyo, while base rates have been at zero. There aren't many places more crowded than Tokyo. Your other argument concerning low inflation should also help there: they have deflation.
Not necessarily - perhaps we realised this back when high interest rates didn't allow people to "bid-up" the prices so far?? ;-)
"Sammy" wrote
The population doesn't have to double for people to want more houses - it may be the number of people *per houshold* that reduces (for instance, from
6 people per household to 3 people per household with the same population would need twice as many houses). In years gone by, children often used to share bedrooms. I wonder if more children nowadays enjoy their own rooms??
Just after ww2, two families would sometimes share the same house (one up & one down!).
"Sammy" wrote
But people *have* been buying property at the bottom! How else did we get house prices bid-up to current levels?!
"Sammy" wrote
No I don't. I'm applying it here.
"Sammy" wrote
Yes, and people don't buy houses for them to be a capital asset - they buy them to live in. I was just pointing out that not everything is bought as a capital asset, and hence your comment that "Sustainable prices depend on the yield the asset can generate" does not always apply.
"Sammy" wrote
If there were a short supply of flour, with a long lead-time for production of new flour, then the price of bread would rise.
Agreed, as they may rent houses. So what? Renting or buying a depreciating asset are both very similar.
Again, what is your point?
Yes, they are finding out that people are paying much, much more than they did just 5 years ago.
Good point. It indicates that shortage of available housing is not the problem. Homelessness is not a problem. It's simply that demand for owned property exceeds supply whilst demand for rented property does not. The popularity of buying to let is often said to be responsible for this; it is blamed by frustrated buyers for creating "unaffordably" high prices, and also blamed by BTL investors late on the bandwagon for causing "unrealistically" low yields. Blame is always easier to dole out than praise, but there ought to be a fair bit of at least silent praise coming from tenants who benefit from low rents and sellers abandoning ownership who benefit from liquidated equity.
Yet I doubt that BTL is really big enough to be the major driver of buying demand. People prefer to own the house they live in because of the advantages it gives them over renting even ignoring any hope of cashing in on future price growth. It frees them from restrictions landlords impose on them personalising their abode, and from the uncertainty of perhaps being kicked out when the landlord wants the place back, be it to sell, occupy for himself, do up to attract a better class of tenant, or to redevelop.
Because the lemming want to jump onto the house price conveyor belt before it goes over the cliff, perhaps.
Why did sane people pay silly money for tulip bulbs? (yes, I know that this is an extreme example)
Are you sure. Most people want to own their own house because it is cheaper in the long term. If this ceases to be the case (as I think it is currently) perhaps many will be happy renting. Renting certainly has some advantages over owning.
I think that there is more flexibility here than there used to be. Some landlords recognise it as a free way of keeping a tenant.
People who buy move on average every few years. Provided that the landlord is flexible about the termination process (and I accept that many aren't) this should be an issue for a large percantage of the population
That was my thought exactly, even before I read your post!
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"tim" wrote
Why do sane people, even now, pay silly money for stones out of the ground? (diamonds, rubies, emeralds, gold....) Oh yeh - it's because people want them, so - those willing to pay the most, get them.
Hey, Sammy - did you see the documentary (from the subject title) yesterday?
Care to comment, as to why - do you think - at the "meeting of minds" featured on the program, most people agreed with David Smith ("levelling-off of prices, with price:earnings ratio at a new - higher - equilibrium") rather than Roger Bootle ("20% crash") ??
I wouldn't try to use an argument that because the majority of people featured in the program agreed more with David Smith rather than Roger Bootle as a reason why house prices will not crash.
For anyone not familiar with David's site
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He discusses the house price debate here
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I believe that house prices will crash purely because of the greed and fear emotion. Some people have made (by selling) obscene amounts of money while others have straddled themselves with enormous debts. The majority though have seen a "paper" profit and some may have released a bit of equity.
It is far too early to call the top, we could go sideways for a few years before prices move in either direction. There will be other influences in the market to ultimately determine house prices that are not currently foreseen, eg inflation, recession etc
I don't think current house price are high enough to crash to cause serious concern, obviously some who have serious outstretched themselves will suffer, but so is life.
What I did find interesting was the buy to let guy who says that he is now losing money on his investments. Surely he is in the minority, he can't represent the majority or the crash would be happening. Maybe the BBC just found someone to offer an alternative perspective, shame they didn't find another buy to lettor who is still making money to balance the argument. What I did find funny about the buy to lettor was that he appeared to have bought all of his property on the same street. Need we say anymore.
No. I am genuinely interested to hear their reasoning though and to establish their vested interest. The straw poll was 2:1, so one third of the experts thought there would be a worse outcome than a soft landing. In a turning market, it makes sense to look at the growing number of dissenting voices. I'm also very interested to hear Bootle's private views on the state of the market, because a 20% fall from peak to trough seems laughably conservative to me.
On another point, you asked what would trigger a crash? A change in sentiment.
No, it's because they think that it will hold that value.
This is self perpetuating. If everybody in the market thinks that an item (of no useful value) is worth X then it is worth X. As soon as a significant part of the market thinks that the item is not worth X, then the price will drop.
Houses are more complicated than this because part of their value is the useful value (the alternative rental cost) and part of their value is the non useful (investment) value. The price of houses has rocketed over the last 5 years only because the investment value has increased (the useful value hasn't changed because rents have been static over that period). If that new part of the value is to remain there, then the market has to continue to believe in the investement value of the house.
ISTM that most people accept that the increasing investment value of the house has come to an end (if you don't think this then please say so) and are attempting to justify the current price by transferring this excess value to the useful value using the IMHO very spurious arguement of "affordable price". (As I said above, the useful value is dictated soley by rental alternative and affordability isn't going to change this). To me looks exactly like the investment bankers attempting to justify the price of dot com shares using the "new market paradigm" arguement. It is completely bogus.
Of course, the other difference with houses is that they are ill-liquid. If the non useful value of dot com shares or tulip bulbs plumments then most people off load their stock for whatever they can get and the fall is immediately obvious. If the investment value of a house plumments then most people have no choice but to stay put and it takes several years before the new value is apparent to the market.
Of course interest rates are important! My point is that a crash does not have to be started by an external trigger. All that is required is for sentiment to change. When enough people in the market no longer think prices will continue to go up then they won't: the bubble is pricked and the adjustment is brutal. The FSA made this very point and they are not known for their alarmist tone.
Don't forget that house price inflation, although not in the index, is a factor the BoE considers when setting interest rates. It's a circular argument to say which causes which.
As to this "affordability" nonsense, I'd much rather have a £100K mortgage at 10% interest rates than a £200K mortgage at 5%.
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