Tuesday, June 15, 2010

An Englishman's Home is His Retirement Policy

Last night's UK RICS Housing Survey pointing to further strong gains in UK House Prices (see below chart) has left Team Macro Man collectively scratching their heads and is certain it is not alone in wondering why the fortunes of the UK housing market ("it's aliiiiivee!!!") have been so different to those of the US (which looks a bit like this parrot). Now, Team Macro Man does not possess a uniform view on this and would like to invite readers to present their own views in the comments, but for the sake of actually writing something today, will make an attempt to explain why UK House Prices are bid and may not actually have been as bubble-like as those in the US...Obviously, this latest jump can be blamed on HIP replacements planned by the new government, but even after that the balance is still pretty high. The first place to start is home affordability - in this case, the House Price-to-Earnings ratio (see chart below, white line), which obviously hit pretty bubblesque levels of 4.8x earnings in late-2007 before plummeting a low of 3.55x in mid-2009, but seems unable to plumb the "undervalued" levels of the mid-90s. Perhaps the answer here is the currency, London and the Eurozone crisis? Team Macro Man has heard many reports of strong interest from Europe, the Middle East, Russia and even China. The orange line in the below chart shows the house price-earnings ratio scaled by the EUR/GBP FX rate in order to see the attractiveness in EUR terms to Giorgio & Giuseppe, and you can clearly see it got to the "undervalued" levels and still hovers around the long-run average. While that's there, the foreign money will come into the top end of the market and drag everything else up...

Team Macro Man was always taught never to underestimate the US Consumer, as they will always find some sort of bubble to finance their spending. The below chart shows Mortgage Equity Withdrawal (MEW - white line) and US Consumption growth (orange line): in the 1990s, consumption was first financed by the equity bubble, but from 2001 until 2008, in order to keep buying those Plasmas & Priuses, Joe Public took increasing amounts of equity out of his house, as can be seen by the correlation between the two series over that time period.

Now the Team has also been taught never to underestimate the stupidity of the UK Consumer, so they must've done the same, right? Err, no... guess there aren't as many hippies in Islington as there are in San Francisco. In the UK, while there was a similar amount of MEW (chart below, white line), it doesn't appear to have gone on consumption (orange line) at all, and there is very little relationship between the two series - in fact, consumption was actually quite a bit *lower* during the "bubble" than it was in the 1990s - until the economy fell off a cliff late-2008. So by definition this money must have gone into saving, and the only way to square that is inter-generational wealth transfer: young people taking on debt to buy their first houses and old people selling those houses to them, downsizing and booking the cash for their retirement. Now, that might not be a particularly socially cohesive situation to be in, but it doesn't imply that house prices are overvalued (once the government has taken its slice, that cash gets returned to the younger generation via inheritance).

For all the media talk of a buy-to-let-driven property market, the numbers still don't stack up. If that were the case, then you'd expect rental yields to have sharply fallen and though they have (chart below, rental yield index - white line), a quick comparison with 3yr Real Gilt yields (using trailing 1yr RPI, orange line) shows that this isn't really out of line with other assets. Perhaps the real answer is that real yields are plumbing 60yr lows... in which case, the answer to Bernanke's question about why Gold is going up is: "it's real yields, stupid!".

So given the persistence of UK inflation, perhaps Merv' is behind Joe Public's curve? Buy housing, sell Jun11 Short Sterling...

Talking about where property prices are going next is probably as contenious with our readers as mentioning Apple vs the rest of the world. But in this case, we really would like to hear the dichotomy of your views!


Nic said...

Pretty miserable for UK savers ...

Asset price inflation isn't growth though so if we melt down again and corporate profits don't match up to expectations are those foreign buyers of the high end properties enough to keep UK property a "safe haven" asset?

mod said...

Well, according to this unbiased paper not enough houses are built in the UK to meet demand. http://www.nuwireinvestor.com/articles/uk-residential-construction-continues-to-lag-behind-need-55247.aspx

msl22 said...


Great article, I was just wondering what ticker you typed in on Bloomberg to find that second graph. Thanks in advance.

cpmppi said...

Hi msl,


The chart is made up of two CIXs.

the white line is:

which is HBOS House Prices divdided by UK Average Earnings.

The orange line is:

which is the above scaled by EURGBP

VandalsStoleMyHandle said...

Long-run averages which include a megabubble naturally flatter valuations...standard equity analyst trick...

VandalsStoleMyHandle said...

...the above comment not meant to cast aspersions on today's esteemed scribe

Leftback said...

LOL. The Russian buyer will save the London housing market for Jeremy and Samantha Under-Water ... over here in New York it was the European buyers, now it's the bailout baby banker bonus buyers again, and up in Canada it's the Chinese buyer....

You really think a few landmark town houses in Knightsbridge being snapped up by Arab sheiks can support the bubble-inflated prices of semis in Croydon?

Two words: Spending cuts. Less foie gras and more fish and chips for Jeremy (soon to be known as Jez). Less Harrods and more Marks and Sparks for Sam. Austerity can be so chic, dahling.

Nic Barnes said...

a few years ago the BOE published a working paper and asserted that there was little evidence that mew had translated into higher consumption. Anecdotally that felt wrong then and still feels wrong now. i think the problem is that there is insufficient data on the distribution of mew. Much MEW (which you rightly point out is in the form of inheritances) went into acquisition of financial assets. However, those who are fortunate to be in that position probably have a low propensity to consume anyway. Those who undertook MEW for consumption were probably those with high propensities to consume (little data on distribution of consumption and housing wealth). So it is possibly the case (and we do not have data to make a convincing case) that lower house price growth will translate into lower consumption.

Your point on earnings is good (i hate seeing house affordability measured by interest payments - which is a temporary statistic that changes when rates change) - if we are in a western world of low nominal and real growth (even if inflation is the bulk of nominal growth) nominal house price growth could be flat for many years. Inflation will mean real growth is negative.

I also wonder about foreign immigrants. If i were a foreigner looking for work, the uk would not be the choice it once was - a weaker currency means my repatriation of earnings is lower and the job possibilities are less than 2 years ago. That will mean lower housing demand.

In London, the housing market has been boosted by the super-normal profits in the finance industry. Regulation is likely to curtail this.

Nationally house prices increased due to high leverage, re-building of banks balance sheets are likely to cap this.

Overall though, as you write, house prices rose due to a fall in real rates and property is a long duration asset. If you think real rates will rise, property is a sell.

Full disclosure: I rent


kjwilliams said...

US consumers consume private health care. If you factor out the increase in health care costs over the last decade, consumption has been a fairly stable % of US GDP. OECD data puts US health care costs at twice those of Canada and the UK. With US health care costs changing at twice the rate of inflation, the economic costs are almost as high as the social costs.

Nic said...

Uh oh, US healthcare.
Puts hard hat on ...

Leftback said...

Things That Make You Go... Hmmm:

T-Bill Yields to Go Negative

So the official explanation of demand for T-Bills is it is "Structural and Technical". Or perhaps it is because certain parties have been tipped off that there is going to be a Great Big Dump in Q3 ?

Gupta said...

There are a few things in favour of housing when compared to other assets.

Good hedge for inflation.

Real asset, that can generate a decent yield.

Shortage of supply in reasonable areas.

No dodgy accounting…4 rooms is 4 rooms

Compare this to other assets in the system…a system in which most people have lost faith. You got govies, equities, and corporate debt, currency wars, inflated commodities.... Gold, Brazilion emeralds.

All Joe bloggs on the street has is a sub par long only robot portfolio manager, he doesn’t understand GTAA let alone hedonics of the housing sector.

BTW I’d appreciate a piece on GB debt and credit rating going forward for the next 12 months

Polemic said...

Well that lit up a few message boards. Even rattled the cage of the perma-bears in the housepricecrash site. A fine site indeed but certainly as skewed in readership as the gold sites are with the GGUF crowd. If you want to see the bear trail check this

Being a housing simpleton I've always felt the ultimate measure of a housing shortage is the number of homeless on the street. There is an awful lot of "wishful thinking" in demand ( see how a load of it evaporated once people thought prices would fall further). Maybe we need to find out the ratio of population divided by the number of bedrooms available in the UK. If the number is less than 1 then there really isn't a housing shortage , shortage if its 2 then its just "friendly" but just needs someone to sort out the distribution ( no not by keys on the table) and if its more then yes, its getting a bit cramped. There is a price at which anyone would rent out there spare rooms. Or split their 7 bed house into flats ( like in the 80s).

So come on Halifax/Nationwide or whatever you are called now. Give us a Bedroom Index.

Leftback said...

Speaking of GGUF, gold has been going up as:

1) Fear trade.
2) Inflation hedge.
3) Deflation hedge.
4) Oil Spill hedge.
5) North Korean torpedo hedge.
6) England goalkeeper hedge.

With PPI and CPI likely to come in at the terrifying nose-bleed level of... zero, surely gold will make new highs this week.

(Note to US readers: Engage Irony Detector)

LUCA said...

Uk Nareit etf shows great inflows but overall all the equity markets are full of short calls players who are now obliged buyers, chasing benchmarks trying not to be underwighted. expect a top on friday....


MKGI said...

I have to agree that Giorgio & Giuseppe might boost the higher end of the South Ken market, but the RICS survey is a little wider than that. So the tranfer of Euros by Italian investment bankers working in London seems a litte too narrow to prop up the entire UK housing market.

It is interesting though that even after all the doom and gloom around housing, in GBP terms we are still a fair way from long run average earnings multiples. Perhaps housing in the UK will follow Germany and flatline in real terms for years?

oxon said...

In response to the previous comment, I (a German) do not believe that the UK housing market is going to behave like Japan's, Germany's, or Switzerland's housing markets, because from my own experience the cultural attitude to property is fundamentally different in the UK compared to Germany. In the UK (and the Anglo-Saxon world in general), people have regarded homes as a speculative investment for a long time. Just think about the way that property prices (or rather price movements) are dinner table conversation in the UK, or the media attention they get, and, to give this some historical perspective, think about the house price volatility that the UK has seen over the last decades, which has indelibly reinforced the 'speculation asset' idea in people's minds. In contrast, Germans view housing more as a consumption asset - when you start having a family, you typically build your family home, fund it with a long-term mortgage, and keep that home till you die. From my own experience, when Germans sell homes, the reason tends to be that grandma died and left too little assets for all her children to get some part without property having to be sold. Since house prices in Germany haven't really moved for a long time, they get near-zero media attention, and buying property with a view to make speculative gains wouldn't come across any German's mind I would say. So to conclude, as I stated in the beginning, these long-standing cultural differences in attitudes to home ownership which have been reinforced by the wildly different house price volatility in Germany and the UK make it extremely unlikely in my opinion that suddenly the English 'forget' about property and cease to entertain themselves by pondering where house prices will go next. In a way, I'd say that this post, and our comments, eo ipso give strong credence to my argument...

scepticus said...

Macroman, thankyou for this post - this paper from niesr about demographics, pensions and housing prices may be pertinent to this discussion:


It concludes:

"We find that the demand for owner occupied housing is sensitive to demographic change and to reform of the PAYGO pension system. If PAYGO pension replacement rates remain high as the population ages the level of owner occupation may rise only marginally over time. But if pension generosity is scaled back sharply, the rate of owner
occupation and directly held housing wealth may rise significantly faster. When the pension age is raised significantly the demand for housing rises most strongly and the demand for financial assets grows relatively less strongly. As a result there is a marked
change in the aggregate pattern of household wealth relative to other pension scenarios.

But one thing all our scenarios have in common is that the importance of owner occupied property in overall portfolios declines over time. This is despite the fact that owner occupation rates continue to rise as do real house prices. The links between the property market, demographic change and pension reform seem to be significant. The key policy conclusion from this paper is that the knock-on effect upon the housing market of demographic shifts and reform of the pension system is likely to be substantial."

james said...

Thank you for the information you have written

cpmppi said...

Thanks for all your comments.

Nic Barnes:

RE: MEW. I agree that, yes, some *must've* been used to finance consumption. This "feels" intuitive given anecdotal experience, but I think the data backs up the idea that it certainly was not the bulk of where this money went. I tend to think that some was used for retirement funds, but that some was recycled - either back into the housing market via buying 2nd homes, or by the Bank of Mum & Dad helping their kids buy their first home.

Alternatively, again anecdotal, some of the MEW may have been used to fund home improvements/renovation (c.f. the Property Ladder craze etc). However, this must have been recorded in the consumption data. It is, however, a form of investment that increases home value so, at least to some degree, this was not fully consumed.

Unfortunately I don't have the data to test the above, but it kind of "feels" plausible. As an aside, I'm unconvinced in general about whether there was actually a debt-financed consumption boom in the UK, but that's a post for another day...

Yes, the Nominal vs Real issue plus zero rates definitely will help a lot of balance sheets, especially those of buy-to-letters. When rates go up this is going to hurt, but Merv seems unable to see past the output gap (whatever that is...).

As far as foreigners go, this is less about "where do you want to work" and more about desirable property. London is pretty desirable. Contrast that with the apartment blocks in Leeds/Manchester etc, which have triggered write downs on bank balance sheets. Here, there was definitely a bubble, but in London, for example, I am not so sure it was irrational. Specifically, they ain't making any more Victorian stucco-fronted buildings. I tend to view these apartments as more like a consumable commodity... why would you buy a 5yr old one when they just built a new one down the road?

cpmppi said...


Thanks very much for that link. Have you read David Willetts' book "The Pinch"?.