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Dan Davies @dsquareddigest
, 10 tweets, 2 min read Read on Twitter
I think people might be being a bit complacent about house prices. "Crash" is the wrong word because housing markets don't trade like stock markets do. And housing isn't in a bubble. But interest rates are very low right now ...
BoE base rate is 0.75%. Standard variable rate mortgages are around 4%, Tracker mortgages are available at 3% and 5 year fixes at about the same. Ten year gilts are 1.5%. Rental yields are in the region 5%. That's the current weather.
OK, say interest rates go back up to 5%, which is close to a long term average and well within the stress test parameters. No reason why the rest of the term structure shouldn't move the same amount. So to preserve the relationship between interest rates and rental yields ...
... we would have to be looking at a rental yield of around 9%. What does that mean in price terms? Well, consider a £1000/month rent house and say it sells for £240,000 now - does that seem outlandish? I don't think it does. That's the 5% yield (1000 x 12 / 0.05 = 240,000)
Move that to a 9% rental yield without changing the rent and your new equilibrium valuation is 1000 x 12 / 0.09 = 133,333. That's a 44% drop. If I do the same calculation with an interest rate rise to 3%, I get 12,000/0.07= 171,428, a 29% drop
Say that the Bank would only do that to interest rates if there was some inflation, and inflation affects rents too. Even if we go to £1200/month rent, which is a lot of inflation for only a 2% rate rise, I'm at 1200 x 12 / 0.07 = 205,714, a 12% fall. 1200 x 12 / 0.09 = 160,000
And look - none of this is "a crash" or "a bubble". It's just the arithmetic of rental yields and the assumption that you can't structurally change the relationship between property rents and other income-producing assets
So people shouldn't be going wahhh and saying "that's unpossible" when looking at scenarios with big, very big house price drops in them. Those kind of numbers are unprecedented outside a bubble, but our current interest rate environment is also unprecedented.
Envoi: It also shouldn't matter as much. As a property investor trying to use housing as a form of retirement saving, I should be looking at the *real terms* value of the *£1000/month* rent. Caring whether it's a 5% yield on £240,000 or a 9% yield on £133,000 is money illusion.
It only matters to the extent that a) money illusion among property investors matters for a wealth shock to consumption, b) homeowners have mortgages and negative equity is also a wealth shock, and c) housebuilders behaviour depends on land values. How much is that? Don't know.
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