In the comments to this post, L Fairfax put up a spirited rebuttal of my statement that:
Observation tells us that in the medium term, additional supply in high demand/high wage areas creates its additional own demand and the overall effect is to push up rents and prices, but his point stands.
The evidence he gave was as follows (I hope I have summarised correctly):
- The Spanish seem to have proved that if you build enough new flats on the outskirts of towns they become cheap
- my family in Spain live in a city of 228,000 people and mass house building has caused prices to go from EUR 100,000 to EUR 35,000 for starter flats
- £120pcm for the mortgage on a flat in parts of Spain.
- wages have fallen not that much
To which my reply is:
1. Perhaps I should have focussed on rental values rather than prices in my original statement. The agglomeration effect I referred to apply only if the population of the town increases in response to the additional supply; in which case added supply and added demand cancel each other out and we would expect no downward movement.
2. Golden rule: rents are the Maypole around which house prices dance. Rental values are a far better reflection of the absolute "location, location, location" value (average local wages minus time cost of travel to place of work etc) and, unless something in the real economy changes, are fairly stable.
3. House prices are rental values divided by the prevailing interest rate, plus or minus expectations of future price changes, so booms are busts are self-fulfilling. People who paid EUR 100,000 for a home which only has a rental value of EUR 2,000 a year must have been gambling on massive rent or price increases, this is completely irrational short term behavior which is difficult to factor into economic models.
4. Rational people will buy if the initial repayments on a mortgage are roughly the same as the rent, plus or minus a bit.
5. Flats cost EUR 35,000, so you'd expect the annual repayments on a mortgage to be around 5% of that = EUR 1,750 = EUR 150 cpm = £120 = looks about right.
6. So I would assume that local rents for a starter flat are about EUR 150 pcm, give or take a bit. It's not going to be much higher or else nobody would rent, they'd all buy instead.
7. So the missing bits of information here are:
- what has happened to rental values since the building boom started? If they have fallen by two-thirds, then that puts a hole in my theory, if they have remained stable, that supports my theory.
- what has happened to the population of that town since the building boom started? If it has increased by less than new supply, that puts a downward pressure on (average) rents and prices (supply exceeds demand and no agglomeration benefit).
Debate Magazine
