Part 2: Are housing costs high?
The first post established that there doesn’t seem to be any evidence of a shortage of housing. But could spiralling costs of housing be suppressing household formation in any case? Because housing costs are spiralling, right? Well, no, it doesn’t appear so. This post looks at the evidence and shows why housing costs are not high by the standards of recent history, and have been falling on average.
The usually excellent Resolution Foundation has tried to shed light on what’s happening to housing costs in its Housing Headwind report from last year. In a key chart (below) they use the Family Resources Survey to establish that private renters’ and mortgaged home owners’ costs have been steadily rising relative to their incomes.
But there are a few problems with this approach to assessing whether housing costs are rising. First, it takes the housing costs of home owners to include mortgage capital repayment. But this should really be thought of as a form of saving, rather than a cost, since owners are accumulating an asset — the house — as they pay down the principal.
Second it excludes the opportunity cost of equity capital and the cost of depreciation. If I own a £200k house outright, living there isn’t ‘free’: if I didn’t have the capital tied up in the house I could get an income from it by investing it somewhere else. Missing out on that income is a real cost. Similarly the maintenance and depreciation costs associated with owning are very real.
Third the ‘private renters’ line (and indeed the others) constructed as it is, will move around based on how the composition of the rented sector changes over time. These compositional effects can cause real headaches for efforts to work out what’s happening to rents, as the ONS has found. For example, the proportion of families in the private rented sector (PRS) has tripled since 2003, and since families need more space it could be that they’re spending more of their income on housing.
Is there a better indicator of the cost of rent?
What we really need to understand the situation facing private renters is an index of rent on a like-for-like basis, that tracks changes in rent for a given type of house. This is what the ONS’s newish Index of Private Housing Rental Prices does. What it shows is that the cost of renting on a like-for-like basis actually fell in real terms from the start of the series, in January 2005, to the end of 2014. (Rents have been rising a bit in real terms since then but up to November 2016 they’re still roughly 4% lower than their 2008 peak).
What are the costs facing owner occupiers?
So that’s rent. What if we try and construct an accurate picture of the cost of housing for owner occupiers? Well, based on the average typical mortgage rate available at 75% LTV (applied to both the mortgage and equity portions of the average house price) and ONS estimates of depreciation rates for dwellings, combined with annualised versions of the relevant taxes, it looks like the light blue line in the chart below.
The true cost of owning a house — not the asset you accumulate by paying down the mortgage principal since, to repeat, this isn’t a cost — has been falling since prices and interest rates dropped after the financial crisis. Indeed we can see that the cost of owning has tended, with temporary divergences, to fluctuate around the cost of renting, which is exactly what we’d expect to see, according to simple asset pricing theory, when the housing market is in equilibrium.
So housing costs, in either tenure, don’t appear to be high by recent historical standards. And that’s consistent with the data suggesting the surplus of dwellings over households is the highest its ever been since decent records began. No quantity indication of an endemic shortage of housing, and no price indicator either, despite earnings growth having picked up in recent years.
All of this begs the question: if there’s no shortage and the cost of housing isn’t high, why are prices so high? The next post investigates.