Housing is a topic that gets everyone riled up. Where you live is a sign of success, socially and financially; we take pride in what our houses are like and certainly their location. If you got in on the booming housing market at almost any time in the last forty years – especially in New York, London, Vancouver, or Sydney – you’ve done fairly well for yourself.
In the God-awful year of 2020, British GDP fell by an astounding 9.9% according to the Office for National Statistics, obliterating about 7 years of economic progress. Some of that will come back in 2021 and 2022 as we rebuild and disburse some of our pent-up savings, but some 80% of the British economy consists of services and those don’t store very well – a restaurant meal lost or haircut skipped cannot be doubly consumed in the future. Not to consider the people who have lost their jobs, skills, livelihoods, and lives.
Kristian Niemietz at Britain’s CapX.co asks us to consider what ought to happen to house prices after the worst economic performance on record, and mark our surprise when house prices rose last year rather than falling. What, indeed, would it take for British house prices to fall?
But houses, properly understood, did fall in price during last year, albeit in counterintuitive ways that it might take an economist to appreciate. So, indulge me.
Houses aren’t consumed in the sense of milk that spoils after a few days, or the coffee before me that gets cold in a few minutes. Even though they take upkeep (sometimes lots of it), houses perform a service to its owners: the service of sheltering you from the elements, having a place to keep your belongings, and spending your time – increasingly so during the work-from-home paradigm of 2020.
The sticker price that fuels Britons’ and Americans’ homeowning obsession is the capitalized value of the future stream of this service. In essence, you pay for the privilege of not having to pay rent to acquire the same service. For those 35% or so (higher among the younger population) who don’t own their homes, this is the other option available. And rents in the U.K. did fall during the pandemic, certainly in the major cities (London, Manchester, Edinburgh) to which most of us had been moving in recent years – for work, university, and the pleasures of urban life. In inner London rents fell by something like 15% last year; at the same time, rents in rural and suburban locations increased. What we saw in the pandemic wasn’t a quirky housing market misbehaving (aggregates deceive!), but a housing market realigning itself to housing demand changing in kind.
If house prices are the capital values of rental services they include, shouldn’t house prices have followed rents down, as rents are the interest rates earned on the capital asset that is a house (the perpetual flow of housing services I mentioned)? Yes and no.
First, regions matter. And here house prices did follow the underlying change in rents. Between January 2020 and January 2021, according to data by Her Majesty’s Land Registry, the UK’s regions with the fastest house price increases are precisely the same regions that saw rents increase the most – the Northwest, Yorkshire and the Northeast. London, where rents fell the most, fell behind.
Second, goalposts matter. Sometimes change happens on top of an already-moving target. An important economist question to always ask is “Compared to what?” Implicitly when we talk about house prices that comparison is 0% change – but there’s nothing special about zero, especially when many things affect house prices. London house prices still rose by 5% last year, but they fell relative to other regions of the country – and relative to New Zealand’s or Sweden’s 17-20% increases. While we think of an average property in the South East at £342,420 in January 2021 as higher (6.5%) than the £321,704 it fetched a year prior, at least two other things have also markedly changed in the meantime to make it less so: (real) interest rates and household savings.
A quirk of a market like housing is that we tend to pay only 15-30% of the house price out of our own pocket, with a bank or building society fronting the rest. That means that changes in the interest rate they charge us and the amount of our own funds available to use as deposit may overshadow changes in the overall housing market. To illustrate: if house prices increased by 10% yet mortgage interest rates fell by 50%, did housing get more or less expensive?
Probably less, but it’s a truly counterintuitive notion that a home can be easier to acquire (and so cheaper) even if the sticker price increases.
The Bank of England reports some of the reasons that house prices rose in the pandemic:
- The threshold exemption from the transaction tax (stamp duty) was lifted to £500,000 for 2020-2021.
- Aggregate household incomes, despite the recession, were up, largely because of government lavishing funds on the private sector.
- Average spending was down, creating a large wedge between households’ incomes and their expenses to the tunes of tens of billions monthly – savings that have mostly gone into bank deposits.
They forget the elephant in the room: inflation expectations are up a little bit. While mortgage rates have ticked up slightly during the second half of 2020, expectations of future inflation – and by extension nominal incomes – have increased much more, making the real cost of carrying a mortgage lower. Market-based inflation predictions, the best guesses we have as to the future path of inflation, price inflation at between 3.34% and 3.48% over the next five to ten years. Loans issued with future inflation in mind may charge a nominally higher interest rate but surrender some part of the principle when the loan is gradually repaid in weaker pounds.
Again: the relevant threshold in the world of economics is not zero.
Much like regions matter to disentangle aggregate numbers, many of these conclusions don’t hold for those at the lower end of the income spectrum. Among the bottom fifth, it doesn’t look like much (or any) savings have been amassed or debt been paid down in the last year. Quite the opposite, as reports from the House of Commons and the Resolution Foundation show. For that portion of society, sticker prices for houses and the pandemic have made the dream of A Room of One’s Own even less attainable.
Yes, British house prices did increase in the last year, but broadly in ways we would expect considering what happened to rents, emigration out of the major cities and the (probably persistent) trend of working remotely. Besides, two other developments undermine the idea that houses got more expensive in the last year: real interest rates and plenty of household savings. Those two trends mean that even though the sticker prices of many British homes are higher than they were before the pandemic, the ease with which the typical household could acquire them has improved.
The world is complicated, and we must look beyond single sticker prices to make sense of it – in housing as much as any other area.