What would drive residential price growth?
If you were to ask me, that would be the wage growth in a country or a particular area. The second thing is the demand and supply dynamics.
If you wish to assess residential property is a good long, long term investment, it will be your mastery of this topic.
We often say that Singapore is a young country and our housing market going back to 1960, is probably 60 years old.
We have been through a period where the supply and demand dynamics have been in one direction and only until recently, some questions were asked about it.
As a person looking at data to shape my view about things, I am rather cognizant about how good is your conclusion depends on the data. If you have too little data, the conclusion based on the data, might not be as strong.
But how much is a lot or too little data?
Duncan Lamont from Schroders dug through 147 years of UK housing information and gives us a glimpse of UK Housing Affordability over the years.
I found his report interesting because if we conclude that it is dangerous to conclude the future residential growth from a historical period where the markets just went one direction (up), why not take a look at the evolution of housing affordability in a developed country that went through more than us?
It might give us a different perspective on the housing market.
UK Home Affordability Looks Expensive Now, But…
One of the ways we gauge residential home affordability is to use Price-to-Income ratio to determine.
In Duncan’s report that is what he used as well: House prices as a percentage of average earnings.
It gives us a reflection of how long it takes for us to pay off the home if we do not eat, drink and spend any of our income and there is no leverage interest on our debt.
As a lot of people know, London residential homes is not so cheap. But on average the house price as a percentage of average earnings ratio for the UK now is 8 times.
In Singapore, the 4-room HDB flat’s price to income ratio ranges between 3 to 8 times but averages around 3.8 times (read my detail 4-room HDB data article).
You can see the gulf in disparity in affordability.
This price affordability high has only been breached twice previously in the past 120 years:
- Prior to the start of the Great Financial Crisis (GFC)
- Once at the start of the 20th Century
120 years is a long time! And based on this, a simple conclusion could be that this kind of price to income unaffordability cannot be sustained.
However, if we extend back to 1845, then we will see some surprising data:
From the 1840s to 1900, the house price as a multiple of average earnings is very high!
It will take you a while to pay off your mortgage if you do not eat or spend. If you do, it will be even longer.
Schroder’s data also show that the disparity in regional home affordability is more of a recent phenomenon. London and the South tend to be more unaffordable but itis only the last 15 years that the gap grew wider and wider.
What Caused the Improvement in Housing Affordability from 1845 to 1915?
Something drove the improving trend of housing affordability from 1845 till the first world war.
Average house prices fell by 23% between 1845 and 1911 (-0.4% a year)
It can boil down to these factors:
- More houses were available. The stock of houses increased.
- Houses became smaller. House plot size went down from 913 sqm to 268 sqm on average.
- Income is higher. Earnings rose by 90% over the same period (+1.1% a year)
Actually, one thing to note is that while 90% growth in earnings looked big, on an annual basis, it does not look very impressive. Presenting numbers in different ways is interesting.
It feels very much like the Singapore situation where
- Housing prices per square foot is not cheap
- Developers justify that smaller family needs smaller homes and so the residential home size is dramatically reduced
- Smaller home’s PSF prices stayed higher but on a unit basis, they are more affordable and thus we can purchase them (A $1.2 mil 2BR now goes for $0.9 mil because the size is smaller)
The only difference is our home prices remain resilient, while in UK’s case, the prices went down.
More and smaller houses should increase supply and control prices while higher-income should increase prices. The fact that home affordability improved over this period feels to me that the greater supply outweigh the rising income well such that prices are still relatively controlled.
The chart above shows the UK housing completions over time. In terms of current levels, the home constructions were on the low side if you compare the period after the second world war.
However, in the period of 1850 to 1910, home completions were lower. We cannot discount that with better technology, home building may be much easier compared to in the past.
We can see the great pick up in home building from 1856 to 1900. The two periods where housing completions took a break was during the war.
The composition of who built the UK houses also shows the role of government in providing the need when the people needed homes the most and how eventually the private sector took over.
A Predominantly Renting Culture Probably Controlled the Price
I felt that given the same situation as Singapore, there would be periods where the supply could not keep up with the demand.
This would have caused some price appreciation.
I think that did not happen because even at the end in 1918, the UK has a higher percentage of people renting than owning a home, despite the improvement in residential affordability.
This gradually changed in the 2000s but the private renters started growing again due to the lower relative income to home prices today.
UK Property Performance Versus Equities Over 25 Years
Since Schroders is an asset management firm, they will always have an equity angle to their research.
Duncan’s research questions whether it is wise for Britons to put their faith in property over their equity pension.
The research shows that UK properties on average, 100,000 pounds in:
- UK Properties would be worth 416,000 pounds today
- London: 648,000 pounds
- Yorkshire: 356,000 pounds
This excludes maintenance, repairs, insurance or taxes, rental income (since this is your primary residence) and the impact of leverage/mortgage financing.
Global Equities would have grown to 787,000 pounds.
What was not factored in was the substantial tax savings that can be saved and the closing costs of buying and selling properties.
I think it is a strange comparison.
If we are talking about living in the property then we should not be compared to equities at all because the purpose is to have a roof over our heads more than the growth of our wealth.
I think property in the UK, like in Singapore, holds a big mindshare and people treat it as their retirement fund as well. If that is the case, then the closing costs of selling the property and the tax benefits of the pension will have to be factor into the equation.
The Global Equities have been impressive but I feel Schroders may be cherry-picking the numbers.
If you are UK person, there should be a home country bias. Your alternative should be to invest in UK equities. That should be a fairer comparison.
My data shows me that from 1994 to 2019, MSCI UK (net of dividends) grow 100,000 pounds to 463,000 pounds.
That is probably not as impressive as the home appreciation.
Duncan asked the question of whether UK homes could be more affordable.
If we draw from history, homes got more affordable when supply increases and wages increases.
This is very unlikely because:
- Homes today are already very small in UK
- The majority of homeowners are on mortgage, and if the prices slide, it would be a political suicide
- Wage growth has not been good
Affordability can be achieved if prices fall due to change in interest rate policies.
A Bank of England study shows that the rise in housing prices can be attributed to the fall in interest rates. An unexpected and persistent 1% rise in interest rate could ultimately generate a fall in real house prices (over a period of many years) of just under 20%.
You can read the paper here.
In Singapore, our HDB homes, relative to the median household income is about $9200 a month or $110,400. If we backed out the CPF SA and Medisave, that will be about $100,400 a year. The median resale price of our 4-room HDB flats is $400,000.
Thus the house price to average income ratio is about 4 times. This is pretty OK. I think the government has increased the supply such that there is no glut that would cause a price increase due to shortage of supply.
The demand for HDB is now more controlled as Singaporeans realize that as a leasehold, the eventual value is zero, and they have moderate their crazy expectations to bid up the prices.
The private sector:
- The homes are getting smaller
- There are a lot of supply still
- Wages of Singaporeans are rising
So in terms of affordability, things will get better. The prices would say in control and as wages go up affordability increases.
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