I was thinking leverage rather than yield. The decline in borrowing costs, holding rental constant, provides a significant increase in ability to pay. I appreciate that this is reated to the yield proposition, but commentators often neglect to consider that leverage provides, well leverage!

Hey other Neil!

I think we have to be a little careful here – yes a reduction in interest rates implies we do not need the same yield on property. Yes current house prices are likely to be related to future expected house prices for investors. And yes expectations of capital gains enter into an investors decision regarding whether to invest.

But the idea that expected capital gains replace rental increases for a “satisfying” investor goes a bit far for me – if there is an underlying shortage of “housing services” the price of housing services (rents) relative to income should be rising. If it is falling then the idea that an increasing shortage of property is driving an appreciation in house prices seems to be a stretch – unless we in turn talk about the way the market is segregated!

Ultimately, these issues are always a bit more complicated than the aggregates suggest. That is why the work laying all these things out by places like Motu is so useful 🙂

I do think there is a “cost of capital” argument playing into house prices too. The reduction in interest rates that has been experienced I think has played a big part in the valuation increase. Even allowing for flat rental payments the decline in interest cost means that the capital price can be bid up and still be cashflow neutral and the value leverage is significant. To the extent that people think there will be capital gain they may then place all of their return expectations into an expectation of future capital gain, rather than operating cash.

Adding to this are dimensions mentioned above such as replacement costs, consenting and zoning, but I also think standard budget constraints also result in the amount that can be extracted via rental being partially limited. So any shortage helps to reinforce the capital gain view. This in turn dampens the “need” for the investment to be net (of interest etc) cash positive. Of course if capital gain expectations are not met then this will create some problems.

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It is human nature – although I am sure policy analysts are quite careful, and if the “shortage” figure disappears they will no doubt give everything another look 😉

Thanks for the reply Matt – the old saw of “if all you have is a screwdriver then everything looks like a screw” applies to policy analysts as much as anyone I’m sure!

I’d note that the term “shortage” is being used in a bit of a cheeky way – it is just implying that housing is relatively scarce for some reason. Namely that it appears the price of existing houses are above their implied replacement cost for some reason!

The 20k figure simply that that, for a given occupancy rate (#people per house) the stock of housing would need to be X, but instead it is Y which is 20k lower. If it turns out that the stock is in line with the occupancy rate we instead need to ask why there is that price difference – consent laws and zoning restrictions will still be relevant even with 0 shortage, due to the fact they increase replacement costs for a given property!

Policy responses should be different though – having the govt just “building houses” would likely not be helpful, and would be pretty wasteful in this case. This is why the “numerical shortage” argument is very popular with policy makers – gives them an easy ‘solution’ 😉

Neuroscience won’t make behavioural economics more important than the rest – it will give it a way to be integrated. However, much of what neuroscience is finding is not policy relevant – a fact that seems to even be slipping by economists who are determined to make policy conclusions based on it. If anything, it is suggesting that it is time for a resurgence in welfare economics to meet our improvement in description due to neuroeconomics 😉