Everyone talks about house prices – either rising or falling – as a
vital indicator of local and national economic health, and a range of indices
frequently make the headlines. Rents get less robust attention, largely due to
a scarcity of good timely information on the current state of the market. This
is clearly a problem, since now nearly 20% of households are private renters in
England, and nearly 30% in London, a figure that has nearly doubled from what
it was 10 years go (Survey of English Housing). It’s also a gap in our information
about the economy, because rents are likely to be more responsive than sale
prices to current conditions, local and national, and so a better barometer of
pressures in the market. Turnover in the sales market is much slower, since
people keep owner occupied homes for longer and properties can spend a long time
on the market. In general prices reflect people’s expectations about long-run
trends and will be sluggish to adjust to unanticipated shocks.
Last year I spent a bit of my time developing new rental indices
for HomeLet based
on their private rent data to try to address this omission. The index aims to
carefully adjust rents for changes in the types of properties being rented out
and their location, just like the leading house price indices. Fortune telling
based on price indices can be a futile exercise, but these new rental indices are
starting to reveal some fresh information and interesting patterns.
Figure 1 plots a range of different trends spanning June 2014 (the
start date for reliable rent data) to July 2017. The trend in blue is the publicly
available monthly Nationwide House Price Index for the UK. The red
line is a version of the new HomeLet index of private sector rents, based on
new rental agreements for the UK. At the bottom, in green, is the ONS ‘experimental’ rents index.
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| Figure 1: Rents and price indices for the UK |
There are some intriguing features here. Unsurprisingly, all the
indices agree rents and prices have risen in general over this period. Broadly
speaking rents for new agreements and house prices follow similar patterns, and,
up until June 2016 followed each other reasonable closely. These new rents exhibit
a marked cyclicality, rising over the spring up to July and then tailing off a
bit in the summer and autumn. The fall-off in rents in June 2016 looks dramatically
deeper at the end of 2016 and beginning of 2017 – more on which later.
The broad similarity of the patterns in rents and prices is quite
reassuring for people who like their economics simple, because the fundamentals
of housing should be similar for both renters and owners. To an approximation
we would expect prices to roughly reflect the value of the rents the property
could generate in the future (plus expected capital gains, less depreciation,
maintenance etc).
Even so, it is often said that prices are rising much faster than rents
in the UK, perhaps something to do with constraints on development making land
scarce and pushing up property prices in anticipation of future capital gains, or some
other form of speculative bubble or incentives that favoured buying, such as
“Help to Buy”. As it turns out from this - admittedly short - time series of data,
that wasn’t actually true nationally between mid-2014 and mid-2016 if we
compare new rents with prices.
One reason underlying the perception that prices rise faster than rents
might be that the main point of reference has been the ONS rental index – the green
line – which indeed suggests rents have climbed in a sluggish plod, showing a 7%
rise since June 2014. Prices, on the other hand, increased by over 12%. These
comparisons – if they represent the long run picture, rather than a short term
blip - would mean that renting a home is an ever-increasingly cheaper option than
buying, or else the expected percentage capital gain on housing sales is
ever-increasing. Neither of these possibilities seems very plausible.
But this comparison is misleading. The ONS index is based on valuation
data and reflects average rents in the stock of private rental accommodation. This
ONS index is based on data on rents for occupants of all lengths of tenure –
those that have just begun a rental agreement, and those that have lived in a
property for many years. This gives a poor indication of what a landlord can
ask and what a tenant can expect to pay when setting up a new rental agreement.
If new rents are rising. but landlords are less willing to raise rents for
existing long tenure tenants than new tenants, then the rent in the stock will
rise more slowly. Although this behaviour can be hard to rationalise, it is a
commonly observed feature of the rental market.
I we look at new tenancy agreements, as in the HomeLet data, things
look more in line with what simple theory would suggest. But something dramatic
seems to have happened in mid-2016. New rents fell sharply and stagnated right
up until May 2017, while prices continued to rise, with just a brief dip early
in 2017. What could have caused this drop in rents? While it is impossible to
attribute causality with a simple time series like this, some more insights
emerge if we split out London from the rest – see Figure 2.
The blue line is the Nationwide quarterly house price index for London
(unfortunately they do not publish a rest-of-UK index). The solid red line is
the HomeLet rental index for London. The dashed red line is the HomeLet rental
index for the rest of the UK. The green lines show the corresponding trends in
the ONS rental index.
Here it is clear that the trends in prices and rents in London departed
company some time back in 2015. But what is more striking is that London rents nose-dived
in mid-2016 falling about 4 % in the May-May year-on-year comparison. Indeed it
is this fall in London that explains the drop in the national index in Figure
1. The fall over the summer in the rest of the UK is not much different from
what it was in 2015. Rents have recovered in the last few months, but only to
about where they were this time last year.
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| Figure 2: Rents and price indices for London and Rest of UK |
House prices haven’t fallen (much, yet) in London – at least according
the Nationwide index. But they have flattened off a lot over the period when
rents started to tumble.
What can explain this sharp fall in rents in London and why haven’t
prices done the same? There are many candidate explanations, which surely have something
to do with a fall in demand relative to supply of rental accommodation.
The Brexit vote might seem like an obvious candidate. But it is a dubious
explanation on its own. Although there is some recent
evidence that net migration decreased over this period (mainly due to EU-8
emigration), there are still many more workers, both EU and non-EU, entering
the country than leaving (net migration between March 2016 and March 2017 was +246,000).
Based on recent years
of data, London accounts for about 40% of net international migration which
means an additional 100,000 foreign workers arrived in London between March
2016 and March 2017. By the way, if you wonder how these international workers are
accommodated, some relevant facts to consider are that net international
migration into London in 2015-16 was 126,000, net migration from London to
other UK regions was 93,000 and the number of new dwellings completed was
24,000.
The longer run economic outlook and exchange rate changes might be
relevant factors too, but would expect house prices to be more responsive than
rents if people were anticipating a future economic downturn or were concerned
about exchange rate risks to their investments.
So perhaps it is less to do with demand for living in London, and more
to do with supply of rental accommodation and incentives for ownership versus
renting. An associate of mine who is an expert in property valuation and knows
the London market intimately, believes this is at least part of the story. Non-resident
owners in London are letting their properties rather than selling, given the
low interest rates and the low cost of holding property, which is has been increasing
the supply of rental accommodation and pushing down rents.
Whatever the explanation turns out to be for these patterns, this new
index promises some unique insights into the rental market that have previously
been quite obscured by lack of timely data. Deeper analysis is obviously
required to properly understand the causes.
Declaration of
interest: I was given some remuneration for developing the code to estimate the
HomeLet index, but have no other interests in the company.
How the index works:
Simply looking at average rents in sample in new rental agreements is
potentially misleading if the composition of the sample – in terms of the
location, size, type and quality or properties being let – is changing over
time. For example, in recent years the share of homes that are privately rented
relative to owner occupied has increased but these changes are not evenly
spread geographically. So changes in average rents will reflect both changes in
the rent you can expect for letting a property in a given location, and changes
in the number of properties being let in different parts of the country or
different parts of a city. The changing patterns of rental locations and
changes in the type of property being let can lead to misleading long run
trends and to short run volatility in average rents.
The ONS rental price index addresses this problem by estimating rents
for a fixed ‘basket’ of properties – in much the same way as a retail price
index looks at a basket of consumer goods, or house price indices such as those
produced by the Nationwide and Halifax adjust for changes in the types of
houses being sold. These are called ‘hedonic’ house price indices. The
disadvantage of the ONS index for many users is that it estimates rents in the
stock, rather than the price of newly agreed rents.
The new HomeLet rental index combines elements of the ‘hedonic’
approach, with some ‘smoothing’ of the series over time. The source data
contains information on 20,000 new tenancy agreements each month, across the
UK. The index is estimated by looking at estimated changes in rents from one month
to the next for lets within the same small geographical area (e.g. postcode
sector). The method applies statistical techniques (regression) to adjust for
changes over time in the types of property being let (like the ONS and
Nationwide indices), but in addition smooths out short run volatility by using
information on trends in rents in recent months, rather than only a single
month (it uses local cubic polynomial smoothing). The index therefore offers a
big step forward by providing the first index of new rental prices that is
properly adjusted for changes over time in the characteristics of rental
properties.
