Housing supply and rents: The issue of indicators

Over at the Rates Blog there has been a lot of talk about how we can’t have an under-supply of property – as rents are rising very slowly.

Now their are two issues I have with this claim.

1. The general idea is that their is the risk of an under-supply of property later in the year – because of rising net migration and a collapse in building. The claim isn’t that there is an under-supply right now.
2. Even if there was an under-supply relative to fundamentals, there are still reasons why rent growth may be slow.

Now the first statement is fairly self-evident. So let’s focus on the substance of the second statement and the idea of when under-supply matters.

Accidental landlords

A while back we mentioned the idea of “accidental landlords“. This has been the primary factor that economists have used to justify weak rent growth in the face of a tightening housing market. In this piece we gave four reasons why rent growth could be falling:

1. Accidental landlords are less interested in maximising profit – and so put downward pressure on the rental price,
2. Lower interest rates have lowered the cost to property owners. As property owners follow a “markup” rule of thumb this has reduced the rents they charge,
3. Rents are set on house prices (rule of thumb) which are falling,
4. The value of keeping a tenant during a recession is higher – leading to lower rents being charged.

Now only the first reason is the “accidental landlord” reason. The other three are behavioural reasons for lower rent growth.

One more reason I would like to add is this:

• A collapsing economy and rising unemployment is driving people to move in together, or stay with family. In this case when the economy recovers there will be a big increase in demand for property – implying that fundamentally there is “undersupply”.

This is by far the most compelling reason (in my mind) for why rental growth has eased, house prices have fallen (and will continue to) and why the build rate is too low.

Conclusion

Ultimately, living away from home or in a smaller household is a “normal good” as incomes go up people do more of this. Given that their has been a big shock to people’s lifetime incomes (and increased uncertainty) people are reducing the level of this “good” that they consume. However, once the economy recovers to normal there will be a huge boost to the housing and rental markets – leading to rising rents and prices. This is when the issue of under-supply will rear its ugly head.