MacroScope is pleased to post the following from guest blogger Simon Ward. Simon is chief economist of Henderson Global Investors in London and previously worked for New Star Asset Management and Lombard Street Research. His own blog is Money Moves Markets.
UK house prices are no longer expensive relative to a measure of “fair value” based on rents. Prices fell significantly below fair value during the major house price busts in the 1970s and 1990s but a big undershoot is unlikely in the current downturn because low interest rates will limit forced selling.
The notion that housing is no longer overvalued is controversial because the house price to income ratio remains far above its average since 1965. This average, however, is unlikely to be a good guide to fair value because the ratio has trended higher over time, reflecting factors such as improving quality, the pressure of an expanding population on constrained supply and a high income elasticity of demand for housing.
An alternative approach is to use rents rather than income as the basis of comparison. Rents already incorporate fundamental influences on housing demand and supply. People need to live somewhere – the choice is between buying your own home or renting, not between spending money on housing or retaining income for other purposes.
An economy-wide rental yield can be calculated from national accounts data by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock. The yield averaged 3.6 percent between 1965 and 2007. This seems low but the measure includes subsidised social housing and takes account of vacant properties.