What Will Happen To Rents?

[padders]

The more I think about the UK and also see other countries situation the more I realise a major correction is inevitable for the UK economy. Unfortunatly I don't see this is just a pricing correction in the housing market but as something a lot more serious. As people's paper wealth evaporates they are going to stop spending very rapidly.

My worry until now has been inflation and the erosion of my savings but I wonder if we are in fact going to head for deflation in anything domestically produced and only suffer inflation on imports as our currency devalues. I am in Japan right now which has gone through about 10 years of deflation and wonder if that is what is instore for us. I can't really see any other option - if people suddenly realise all the wealth they thought they had is illusionary there are not going to continue to pay £40 for haircuts etc. This may not be a bad thing, in Japan the shops are very busy and people are spending - just at more sensible prices : in fact almost everythnig is cheaper in Tokyo and Japan generally than it is in London.

So this leads onto my next question, what happens to rents. We know that rents have not risen as fast as house prices so the assumption would be that they would not fall as far either. This is likely the case - but will they fall at all? A housing crash does not affect the supply of housing so assuming rich people don't buy up all the houses as 2nd homes, the supply of rental accomadation in a crash should rise with the increase in demand from those that have their houses repossessed or sell to rent because they can't afford repayments.

But I wonder if because of the general recession we will enter if house prices do crash that people are going to have less money to spend on renting - and as demand at certain prices fall rents have to come down again. What happened in the last housing crash to rents?

Anyway, just a few thoughts and what people think will happen to rents.

[non-FTBer]

Anyway, just a few thoughts and what people think will happen to rents.

I think it depends on the outcomes.

If there is (by some almost impossible miracle) an HPC without recessions/economic issues then rents would probably remain static.

The most likely event is that there will be significant economic problems at the same time as (or as a trigger for) an HPC. The rise in unemployment, and resulting restraint in wage inflation would put paid to increases in rent very quickly. I think a lot of people would also start to spend more sensibly and look to move to a rental that is better value in order to save more money (due to uncertainty). This could have a significant impact on rents.

Two things could drive rents down:

1) People do not have the money to spend (lower wage inflation, unemployment, higher living costs)

2) People choose not to spend so much (reigning in spending due to uncertain economic climate etc)

IMHO we will see both to some degree.

[padders]

If there is (by some almost impossible miracle) an HPC without recessions/economic issues then rents would probably remain static.

Yeah, I think this is the key point - I just can't see how we can have a house price correction without a recession. So much of current consumer spending is financed by debt, a large part of that debt being based on perceived housing wealth. It's not even a matter of people starting to pay back that debt instead of spending, if the don't continue to take out further debt then the growth in consumer spending stops. Without growth we head into recession.

That's even without anyone becoming unemployed ... add that factor in (as it seems to be now) and the situation could be dire.

I guess the best we can hope for is Japan. A long period of slow deflation. In this case maybe rents would remain somewhat static.

Out of interest, it's easy to rent a small one bed/bedsit flat in most major cities of Japan for around £300/month. There is absolutly no reason why prices won't fall to that sort of level in the UK as well.

[Time to raise the rents.]

Padders, you by telling us you're in Japan, you should be able to also tell us what happened to rents there. My guess is that they rose slowly, due to a lack of pressure to rise by Japan having such low interest rates.

My opinion has always been that higher interest rates force higher rents because landlords have to recover their costs. But lower interest rates (see the UK for the past 5 years) allow rents to stagnate as people concentrate on capital growth and the market draws in more investors while landlords banks accounts aren't suffering from allowing rents to stay where they are.

The time when less investors are drawn in may be nigh though. Higher rates are threatened, HMO licensing is a major issue barely getting the press it deserves, higher prices mean that less are willing to cover a shortfall in rent versus interest costs etc etc. As a natural number of investors sell up, the remaining investors are left with approximately the same number of renters chasing less rental stock. So we are left with the market forcing rents up.

The only way rents won't rise from here, is if rates are dropped enough to erase the cashflow problems of new BTLs and to encourage new investors into the market. If that happens you get HPI without rent rises.

As I said before, heads I win, tails you lose.

And please, Japan is a terrible example as they really were in a bubble. We're at high HP's with a relatively high base rate compared to what their situation was.

[The Masked Tulip]

I think it is going to be very bad in the next 5 years - probably the next decade. If you, for want of a better phrase, stuff yourself with cake there comes a time when you cannot only not eat any more cake but the mere thought of cake makes you feel ill.

The problem though is this - such a vast number of people now work in the Public Sector that I cannot see any major job redundancies amongst them. The Unions finance Labour and a Labour Government are not going to sack hundreds of thousands of Public Sector workers. We might have a recession where the Private Sector is devastated and the millions in the Public Sector are totally oblivious to any downturn. The only Public Sector workers who would have a problem, as far as I can make out, are FTBs as thouse already with homes will probably continue along quite happily, especially if they bought prior to 1999.

I think the issue of rents is an unknown though.

Perhaps rents in student areas will actually go up as the Government will encourage more teenagers to enter Uni in order to keep unemployment figures low - perhaps removing Uni fees would be the cheaper option than having the same number of young people claiming unemployment benefit?

Perhaps rents in places like Docklands and London will remain the same, even rise, as higher UK IRs/stronger Sterling brings investment into the City?

[padders]

Padders, you by telling us you're in Japan, you should be able to also tell us what happened to rents there. My guess is that they rose slowly, due to a lack of pressure to rise by Japan having such low interest rates.

No, the fell a lot - but then everything has fallen in prices. The Japanese are also not so keen to go into debt, in fact you can't really use credit cards in a lot of places - it's generally cash only. This is what worries me, they had a bubble for sure but one that wastn't even based on debt. What happens when you have both?

My opinion has always been that higher interest rates force higher rents because landlords have to recover their costs. But lower interest rates (see the UK for the past 5 years) allow rents to stagnate as people concentrate on capital growth and the market draws in more investors while landlords banks accounts aren't suffering from allowing rents to stay where they are.

That definitely makes sense but I wonder if it's really the principle cause of rental prices. Seems to me that the price of renting is based upon what people are prepared to pay as opposed to what suppliers want for it - and this partly goes back to the supply being inelastic in the short term. It's really based around sentiment, what people think a 2bedroom flat is worth to rent is all that matters - it could be that that sentiment decreases even as the costs to a landlord rise and there is nothing landlords can do about that. Housing is not like factory made widgets where you add 10% profit onto whatever it costs to make.

The time when less investors are drawn in may be nigh though. Higher rates are threatened, HMO licensing is a major issue barely getting the press it deserves, higher prices mean that less are willing to cover a shortfall in rent versus interest costs etc etc. As a natural number of investors sell up, the remaining investors are left with approximately the same number of renters chasing less rental stock. So we are left with the market forcing rents up.

That makes no sense. There are X people and Y houses. Unless one of those changes there is no increase or decrease in demand v supply of rental stock. It makes no difference on the supply/demand if there are 1 million renters and 1 million flats for rent or 5 million renters and 5 million flats. Only differences in either the supply or demand only matter - e.g. if rich people buy lots of houses to use as holiday homes thus reducing avaliable stock, if immigration falls thus reducing demand etc. People going from renting to owning or owning to renting makes no difference.

The only way rents won't rise from here, is if rates are dropped enough to erase the cashflow problems of new BTLs and to encourage new investors into the market. If that happens you get HPI without rent rises.

Not true at all? Tomorrow everyone in the country could decide that rents are too high and all demand a 10% drop in price. If they did, it would happen. There is no intrinsic value to renting it's simply based on sentiment because the only thing that renting value is linked to is house prices which are also just based on sentiment, nothing else.

And please, Japan is a terrible example as they really were in a bubble. We're at high HP's with a relatively high base rate compared to what their situation was.

If you don't think housing in the UK is a bubble (along with some other asset markets as well) then I think you may be living in one. There is still money to be made in housing now if you get the right thing but generally the market is one huge unsustanable bubble - the problem being it is all funded by debt - the Japanese bubble was a lot less severe in that sense.

The problem though is this - such a vast number of people now work in the Public Sector that I cannot see any major job redundancies amongst them. The Unions finance Labour and a Labour Government are not going to sack hundreds of thousands of Public Sector workers. We might have a recession where the Private Sector is devastated and the millions in the Public Sector are totally oblivious to any downturn. The only Public Sector workers who would have a problem, as far as I can make out, are FTBs as thouse already with homes will probably continue along quite happily, especially if they bought prior to 1999.

Maybe, but as tax revenues fall the government will either have to cut public spending or raise taxes. There is little room for any more stealh taxes and raising actual taxes will hand the conservatives the next election - so they may be forced to cut public sector jobs (or simply just not replace the natural churn).

Perhaps rents in student areas will actually go up as the Government will encourage more teenagers to enter Uni in order to keep unemployment figures low - perhaps removing Uni fees would be the cheaper option than having the same number of young people claiming unemployment benefit?

I think at this point anyone who wants to go to uni, already does.

Perhaps rents in places like Docklands and London will remain the same, even rise, as higher UK IRs/stronger Sterling brings investment into the City?

Sterling won't rise if we enter a recession, IMHO it's already very overvalued compared to most currencies (even including the $) whatever happens to interest rates.

[The Masked Tulip]

Well, the Japanese property bubble was created on debt and wasn't the major reason behind the decline of the Japanese economy was that for years the major banks and major corporates were in collusion and, for want of a better phrase, telling porkies about their profits and levels of debt?

[RobertPaulson]

My opinion has always been that higher interest rates force higher rents because landlords have to recover their costs.

A quick pop quiz:

Have you noticed what has happened to the UK manufacturing sector in the last 15 years?

Is it A:

Their costs have risen relative to the rest of the world (China in particular), but so has the price they are able to sell their goods at because, obviously, they have to recover those costs. Britain has a healthy trade surplus and a booming manufacturing sector which can charge 2x everyone else because they have higher costs to cover.

Or is it B:

Costs have risen, but in the face of cut throat competition from abroad prices have not. The most inefficient firms have been bankrupted, their best performing assets bought at a cheaper price/exported abroad/replaced by rivals who are then able to compete at or undercut exisiting price levels, adding further downward pressure on margins for the next most efficient tier of UK production. The high cost base in the UK has seen many sectors exit the country and the UK runs a growing structural trade deficit.

Rental prices are ultimately governed by how much the customer can afford to pay, not the cost base of the landlord. The globalised environment the UK now operate in means most companies cannot afford to increase their cost base (read salaries) and still remain competitive. Anticipated rises in interest rates are primarily an attempt to fight inflation caused by increasing energy/commodity costs and a weakening of the £ on the foreign exchange markets.

As the UK runs a structural trade deficit, a policy of either actual or relatively lower interest rates mean rising costs for imports, which must be taken on the chin without any domestic alternative to substitute with. Either we raise IRs, making the UK more attractive to foreign capital inflows - thus propping up the pound, or IRs are not raised and our currency falls causing inflation and a higher cost of living.

Unfortunately the effect of higher interest rates on both the domestic and export manufacturing sector is negative (a strong £ and our prices are uncompetitive abroad and imports are cheaper), eventually leading to a greater trade deficit as more domestic capacity is lost through global competition (i.e less jobs, is that a situation where wages increase?). Lower interest rates would import inflation leading to increased costs for manufacturers and the general public (but probably a short-term reprieve to exporters as their goods became relatively cheaper abroad).

Granted I've over simplified to get the point across and both are the extremes, but I don't see how general wages can rise in the UK and thus provide people with a greater ability to pay rent. It is more likely to produce darwinian pressure on landlords with sums that don't add up (i.e BTL is all about the yield).

[Sisyphus]

A quick pop quiz:

Have you noticed what has happened to the UK manufacturing sector in the last 15 years?

Is it A:

Their costs have risen relative to the rest of the world (China in particular), but so has the price they are able to sell their goods at because, obviously, they have to recover those costs. Britain has a healthy trade surplus and a booming manufacturing sector which can charge 2x everyone else because they have higher costs to cover.

Or is it B:

Costs have risen, but in the face of cut throat competition from abroad prices have not. The most inefficient firms have been bankrupted, their best performing assets bought at a cheaper price/exported abroad/replaced by rivals who are then able to compete at or undercut exisiting price levels, adding further downward pressure on margins for the next most efficient tier of UK production. The high cost base in the UK has seen many sectors exit the country and the UK runs a growing structural trade deficit.

Rental prices are ultimately governed by how much the customer can afford to pay, not the cost base of the landlord. The globalised environment the UK now operate in means most companies cannot afford to increase their cost base (read salaries) and still remain competitive. Anticipated rises in interest rates are primarily an attempt to fight inflation caused by increasing energy/commodity costs and a weakening of the £ on the foreign exchange markets.

As the UK runs a structural trade deficit, a policy of either actual or relatively lower interest rates mean rising costs for imports, which must be taken on the chin without any domestic alternative to substitute with. Either we raise IRs, making the UK more attractive to foreign capital inflows - thus propping up the pound, or IRs are not raised and our currency falls causing inflation and a higher cost of living.

Unfortunately the effect of higher interest rates on both the domestic and export manufacturing sector is negative (a strong £ and our prices are uncompetitive abroad and imports are cheaper), eventually leading to a greater trade deficit as more domestic capacity is lost through global competition (i.e less jobs, is that a situation where wages increase?). Lower interest rates would import inflation leading to increased costs for manufacturers and the general public (but probably a short-term reprieve to exporters as their goods became relatively cheaper abroad).

Granted I've over simplified to get the point across and both are the extremes, but I don't see how general wages can rise in the UK and thus provide people with a greater ability to pay rent. It is more likely to produce darwinian pressure on landlords with sums that don't add up (i.e BTL is all about the yield).

Economics made easy by Robert Paulson. I always enjoy your posts Robert.

[MarkG]

Remember, TTRTR has only been a landlord in a boom, not a bust: it's not surprising that he wouldn't understand the idea of rents having to go down because renters can't afford to pay them.

[CrashIsUnderWay]

My opinion has always been that higher interest rates force higher rents because landlords have to recover their costs.

what a moron

[MarkG]

It's also worth remembering that, like many people who bought houses years and years ago, my landlord's costs are... sod all. Electricity and other bills, occasional maintenance, that's about it... so he has plenty of room to cut rents, unlike some idiot BTL who bought a 350k 'executive apartment' and needs 1500+ a month just to break even.

[Ungeared]

It's also worth remembering that, like many people who bought houses years and years ago, my landlord's costs are... sod all. Electricity and other bills, occasional maintenance, that's about it... so he has plenty of room to cut rents, unlike some idiot BTL who bought a 350k 'executive apartment' and needs 1500+ a month just to break even.

Couldn't agree with you more Mark, having been a Landlord for 15 years now, apart from my small mortgage on my principal home, less than 80k i hasten to add, I have no real outgoings apart from the odd repair.

I've had all my rooms full now with the same tenants for over 3 years, I really don't think established landlords will suffer one bit from a decline in rental prices, whatever happens, because any landlord worth his salt would have a contingancy plan of some sort, if you're dunb enough to mortgage yourself to the hilt and have unsecured loans all over the place, don't blame anyone but yourselves when it goes tits up,

[sammysnake]

I totally agree with the OP

After visiting Japan It amazed me at the quality of goods and prices compared to the UK

Japan is reasonable, and your really dont mind paying reasonable in a safe consistant society

Then look at the UK, its a mess. High prices, poor service.

Japans approach is simplistic buts it works its about mass consumerism and they too have to compete with China...everything in the UK is short term and diabolically mismanaged

Japanese only buy products if they can afford it which creates real stabilty

I think renting incomes will continue to drop as the competition hots up even more in the near future

Many BTL landlords unable to cover the mortgages etc