Are we destined to become a nation of tenants unable to bridge the gap between renting and buying?
The question was prompted by two recent headlines. One read; ‘Number of home owners drops to lowest levels in 25 years’. The other; ‘Over £400 a year cheaper to buy than rent in Scotland’.
But the idea that the recession has triggered a long term change in property tenure is not new and there are plenty of pundits who argue that many more of us will become lifetime tenants. If, as the headlines suggest, it is cheaper to buy than rent and home ownership is still falling, do they have a point?
Home ownership in Scotland
First, a few facts. It’s true that home ownership in Scotland has declined, but not as much as the headline might suggest. The Scottish Government calculates that home ownership declined from 62.5% in March 2007 to 60.7% by March 2011. That takes us back to levels of owner occupation last seen in 1997.
Over the same period, the number of homes in the private rented sector in Scotland (including second homes) has risen from roughly 12.5% to 15.5%.
So, is this a long term shift towards renting?
Probably not, for three reasons:
Firstly, it is perfectly normal for home ownership to decline in a recession as people either put off buying until the market shows signs of recovery or are obliged to sell as a result of redundancy. In the current market, a significant number have moved by letting out their current property and renting elsewhere so that they don’t have to sell in order to move. This group of reluctant landlords, however, really aspires to be owner occupiers and can be expected to revert to that status when market conditions allow them to sell their home. It’s true that we didn’t see a decline in home ownership in the last recession, but I suspect that that is because the effect was masked by Right to Buy (at very discounted prices) which was in full flow at the time.
Secondly, the rise in the private rented sector is broadly matched by a decline in the proportion of the housing stock owned (and let) by housing associations and local authorities. In 1999, the private rented sector represented 6.7% of the housing stock, while housing associations and local authorities accounted for 31% of the total. Today, the private sector makes up 15.5% of the market and public housing a little less than 24%. The overall increase in the number of homes in the rental sector is about 2% of the total stock. In other words, a lot of the growth in the private rented sector is no more than a straight transfer from the public sector.
Thirdly, and arguably most important, is the finding that it is now cheaper to buy than rent. The Bank of Scotland estimates that the average monthly cost of buying a three bedroom house in Scotland is now £524 compared with £558 to rent the same property. The difference, which seems to be widening, is £34 a month or just over £400 a year.
This is in marked contrast to 2008 when buying was almost 50% more expensive than renting. Since then, of course, rents have risen but the costs of buying have fallen. The Bank of Scotland estimates that the cost of buying in Scotland has fallen by 38% since 2008, partly due to lower house prices (now 12% below their peak) and lower mortgage rates.
The return of the buyer
Eventually, the economic advantage of buying relative to renting will trigger renewed demand to buy and a recovery in home ownership. That is likely to be true even if you discount the other attractions of home ownership such as tax free capital appreciation and improved access to credit.
In other words, people who are currently renting will decide to buy. But, with more properties in the private rented sector and good returns for landlords, will they succeed?
I suspect they will – because they attach a greater value to a property than a landlord will. For a landlord, the price of a property is set by the likely rental income. Ideally, a landlord will want a return on the purchase price of around 6%. If the price rises to the point at which the rent doesn’t represent an adequate return, the landlord will walk away from the purchase. An aspiring home owner won’t.
That presents an interesting conundrum for landlords. Demand for rental properties will fall, but at some point the value of their portfolio will rise as demand from owner occupiers increases. Landlords will then have to decide whether to cash in their investment or stick with it and compete with other landlords for tenants. If they go for the latter, they will have to decide whether capital growth is sufficient compensation for lower rental income.
Judging by past recessions, a recovery in demand starts when mortgage availability improves and incomes start rising faster than inflation.
In the last property market recession in the early 1990s, prices dipped slightly and then hardly changed until 1997. Over the same period, rising incomes made property affordable once again, so much so that first time buyers were moving in to two or three bedroom properties normally thought of as homes for ‘second steppers’.
There are at least some signs that mortgage conditions are improving. But, so far, incomes are just about keeping pace with inflation for some and may be falling in real terms for others.
The turning point will come when you see growth in real (i.e. inflation adjusted) incomes.