Renting could be more profitable – yet the chronic insecurity renters feel is pushing them to buy

The insecurity of tenants is likely to be forcing up the demand for home ownership in Britain and suppressing the demand for renting even if the latter may make more economic sense

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The Independent Online

How much does it cost to own your house? Not to buy it, but to own it.

It’s a question that we’re not accustomed to asking.

Many of us are more likely to ponder the costs of not owning a property. Consider that horrible feeling that comes from seeing the bottom rung of the property ladder disappearing skywards. Young prospective first-time-buyers know all about that particular cost.

And then there is the foregone capital gains cost, as house prices rise and you’re not on the ladder. As Andy Haldane, the Bank of England’s chief economist, recently pointed out, it’s an empirical fact that the best returns someone can get, historically at least, have come from putting money into property rather than a pension. Over the past 30 years average house prices have risen by an average of 6 per cent a year according to the Halifax, even including two serious busts in that time.

Yet of course there are tangible financial costs to home ownership as well. There’s the mortgage interest payments, presuming you didn’t buy the property with a giant pile of cash. There’s the maintenance costs. When damp destroys your living room wall, the price of the repair is coming out of your pocket, not some landlord’s.

There’s another, intangible, cost: the financial returns you could have earned if you’d put your money elsewhere.

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Imagine you buy a £200,000 house, paying a £50,000 cash deposit and borrowing the rest. What if you’d put that £50,000 in a bank account where you could have received 5 per cent interest in a year, or £2,500?

You won’t get £2,500 cash interest on your money when it’s tied up in bricks and mortar. So, from an economic perspective, one of the costs of owning a house is the income you could have got on your cash if you’d put it in the bank. Put all this together and we have what’s known as the “user cost of housing”.

Add up the mortgage payments, the maintenance costs, and the foregone interest on your equity and then subtract the expected capital gains from a year’s ownership and you have the true economic cost of owning a house.

So how high would the user cost of housing need to be before you decided that owning a house was too expensive and renting was preferable? Economic theory suggests that point arises when the user cost of housing rises above the annual cost of renting the same (or similar) house.

Then more people will choose to rent, bringing down house prices until rents and ownership costs are back in balance. Similarly, if rents rise above user costs more people will want to buy, pushing up house prices until equilibrium is regained.

This theory was laid out in the Labour Party-commissioned Redfern Review on housing last week, which also unveiled a new analytical model from Oxford Economics of the drivers of house prices and owner-occupation rates in the UK over the past two decades.

The same economic theory lies behind the decision, announced by the Office for National Statistics two weeks ago, to move to a new official inflation measure called CPIH, which is the same as the Consumer Price Index but includes owner-occupied housing costs.

The ONS will calculate these housing costs by estimating what homeowners would pay to rent a similar property, assuming that these rental costs will be roughly equal to the costs of owning a property.

The Redfern Review is valuable because it moves beyond the overly simplistic model used in political debate, whereby house prices are determined almost solely by new construction rates and by the number of new households being formed.

Instead, it includes other important drivers of the market including rents, household income growth and mortgage credit availability.

Yet how useful is the economic theory that house prices are tightly related to the user cost of housing? Do people really switch between renting and owning based on user costs relative to rents? Do people really think of their ownership costs in this way?

Only up to a point and there are pitfalls in taking the model as anything more than a very basic guide.

It’s certainly true that as interest rates fall, servicing a mortgage gets cheaper and most people, renters included, will probably notice that. If you could buy the house in which you live and pay less on your monthly mortgage bill than you are currently paying in rent that is a powerful incentive to buy.

But the idea that most people think of the foregone interest costs of their housing equity is quite a stretch. While they may notice that they don’t get much return on their cash savings when interest rates are very low, it’s hard to believe this will make a major difference to their preferences for owning a home.

Much more salient will be the capital gains from property. The saturation of the media with reports on monthly house price increases or falls ensures such mental calculations are almost inescapable.

The trouble here is that, over the long-term, house prices have tended to rise rapidly, sometimes by as much as 25 per cent in a single year in the UK. Throw in policies by cynical politicians to ensure house prices remain elevated – unjustifiably light taxation and various subsidies such as Help to Buy – and the capital-gain expectations element of the user cost of housing becomes very important.

Under the economic theory, this will tend to depress the user cost of housing in ways that are artificial but which can easily become self-reinforcing as house prices continue to rise because people are willing to pay more for houses etc. This is one way of describing a bubble, of course.

But there are also other factors that the basic model leaves out, such as the inherent insecurity involved in private renting in the UK (relative to other European countries) due to the design of “assured shorthold tenancy” rental contracts here. Thanks to the 1988 Housing Act a landlord is able to ask a tenant to leave with just two months’ notice once they are out of their normally brief fixed term.

This desire for security of tenure is likely to be forcing up the demand for home ownership in Britain – and suppressing the demand for renting regardless of relative user costs. It was certainly central to my own decision to stop renting and to buy a property last year. The greatest motivator was not, in fact, capital gains expectations but my fear of having to move my children out of their schools at short notice because my landlord might have wanted to sell.

“It’s not a house… it’s a home,” as Bob Dylan sang. That’s a powerful truth that economic models of the housing market need to take into account.