Is UK monetary policy driving private housing rents?

Daniel Albuquerque and Jamie Lenney

Lease costs have risen by 9% on common in England because the Financial institution of England’s Financial Coverage Committee (MPC) began elevating rates of interest in December 2021. Alongside this rise in costs has been a widening within the hole between reported provide and demand within the rental sector, with tenant demand persevering with to rise in 2023 amidst falling provide (RICS survey). Is financial coverage inflicting the rise in rents? On this submit, we offer proof that non permanent will increase in rates of interest are finally related to a lower in rental costs that follows an preliminary, however comparatively quick lived, improve in rental costs and tenant demand. These outcomes additionally maintain throughout areas in England.

Rising rents and financial coverage

The latest rise in rents will probably be of great concern to the 19% of households within the UK which can be non-public renters, for whom housing prices already take up 33% of their earnings on common. Even supposing rising rates of interest have been applied to cut back total value inflation, financial coverage has been cited as a doable reason behind rising rental costs principally via two channels. First, the ensuing improve in mortgage prices has penalties for each provide and demand within the rental market: it will possibly discourage new buy-to-let landlords, and maintain future householders as tenants for longer. Second, housing is an investable asset, and returns on different property are rising because of the improve in rates of interest. Thus, even non-mortgagor landlords are more likely to improve rents in response to rising rates of interest to match the anticipated return on different property.

Nevertheless, empirical proof is combined – within the US, for instance, economists on the San Francisco Fed discover that rents instantly decline in response to rising rates of interest, whereas different work has documented will increase in rental costs with no subsequent decline.

So is there any proof that financial coverage is pushing up rental costs within the UK?

Estimating the causal impact of financial coverage on the rental market

With the intention to reply this query we use a neighborhood projections framework with 12 lags of the variable of curiosity as controls. We depend on financial coverage surprises recognized within the 30-minute home windows round MPC bulletins to estimate the impact of financial coverage on rental costs, as described in additional element by Cesa-Bianchi et al (2020). We use surprising modifications (surprises) to establish the impact of financial coverage as a result of most rate of interest modifications are made in response to present and future financial circumstances. Merely utilizing all rate of interest modifications would combine up the impact of rates of interest on rental costs with the consequences of different shocks that rates of interest try to counteract.

For rental costs, we use knowledge from ONS’s Index of Personal Housing Rental Costs from 2005 to 2019, for England. We deal with England as a result of knowledge for the entire of the UK is out there from 2015 solely. We select to finish our knowledge pattern in 2019: we exclude the Covid pandemic interval, as a result of the connection between financial coverage and rental costs might have modified throughout this time; and we’ve got inadequate lags of information to make it worthwhile together with knowledge post-pandemic.

Chart 1 exhibits the estimated response of housing rents to a 1 proportion level rise in rates of interest. The response for England as an entire is the darkish blue line with the 1 normal deviation confidence interval shaded in blue. We additionally plot the purpose estimates for every English area in gray. The purpose estimates point out rental costs rise by round 1% over the 12 months following an increase in rates of interest. This result’s replicated in most areas in England excluding the East Midlands, the place the central estimate exhibits no rise in rents. Chart 1 additionally exhibits that after round 12 months this rise begins to dissipate, and by month 22 the purpose estimate is beneath zero in all areas.

Chart 1: The response of personal rental costs to a 1 proportion level rise in rates of interest

Observe: The blue shaded area is the 1 normal deviation confidence interval for England.

Does the response of rental costs make sense?

As famous above, since housing is an asset, when actual rates of interest rise the true return on housing ought to finally additionally rise according to different out there returns. This actual return may be achieved by both rising rents or falling home costs, or some mixture of the 2. Utilizing the identical native projections framework as in Chart 1, Panel A in Chart 2 exhibits that rental yields (lease divided by home value) do certainly rise in response to rising rates of interest. Panel B decomposes this response in rental yields for England between actions in rental costs and motion in home costs (the latter is calculated as a residual).

Chart 2: Response of rental yields to a 1 proportion level rise in rates of interest, and its decomposition between yield and home costs actions

Observe: The blue shaded area is the 1 normal deviation confidence interval for England.

As Chart 2B exhibits, rental costs improve initially, according to the rise in rental yields. Nevertheless, our estimates recommend that a lot of the adjustment is coming from falling home costs, although that adjustment is sluggish and takes nearly a full 12 months to materialise. As home costs are sluggish to regulate, this places stress on rents to rise at first to ensure that landlords to make enough returns relative to their exterior choice ie promoting and investing in different property like authorities bonds. On the identical time, we discover that housing transactions fall within the 12 months following the rate of interest rise (Chart 4A makes use of the native projections frameworks from earlier than on UK Land registry knowledge for housing transactions). This slowdown in housing transactions can assist clarify a discount within the provide of rental housing if promoting landlords take their property off the rental market however wrestle to seek out potential buy-to-let landlords who, discouraged by rising mortgage charges, want home costs to fall additional to make enough returns.

Utilizing survey knowledge on the residential market offered by RICS and family panel knowledge from Understanding Society we will additionally analyse the impact of financial coverage on tenant demand. Panel A in Chart 3 makes use of the same framework as utilized in Chart 1 to plot the response of the reported internet balances of modifications in tenant demand within the rental market within the RICS survey. It exhibits {that a} rise in rates of interest is initially related to an increase in tenant demand that then dissipates after round a 12 months. In Panel B, utilizing particular person panel knowledge, we present that the estimated chance of house possession falls for youthful cohorts within the 12 months following an increase in rates of interest. This helps to partially clarify the rise in tenant demand via a delay within the transition from renting to proudly owning.

Chart 3: Tenant demand after a 1 proportion level rise in rates of interest

Observe: The blue shaded areas are 1 normal deviation confidence intervals.

So initially rising rates of interest may effectively trigger pricing pressures within the rental market. Nevertheless, over time home costs fall on account of tighter financial coverage and allow new landlords to come back in and supply decrease rents. On the identical time, households are more likely to turn out to be more and more unwilling to simply accept and afford lease will increase because the impact of financial coverage on their actual earnings builds. This gradual transmission of financial coverage to broader financial exercise and incomes is illustrated in Panel B of Chart 4, which makes use of the same framework to that of Cesa-Bianchi et al (2020) to point out an estimate for the impact of a 1 proportion level rise in rates of interest on GDP. Panel B exhibits GDP falling steadily with the height affect occurring after round 12 months and persisting past that.

Chart 4: The gradual response of housing transactions and financial exercise to a 1 proportion level rise in rates of interest

Observe: The blue shaded area is the the 1 normal deviation confidence interval.

Rental costs in context at the moment

The causal impact of financial coverage in any given cycle is at all times troublesome to disentangle from different broader shocks. That is very true at the moment with the UK within the midst of a broader inflationary shock, and nonetheless recovering from the longer-run financial results of Covid that upended housing markets and migration flows. Additionally it is price noting that there have been modifications in rules affecting the rental market. These shocks are each instantly and not directly the underlying drivers of rising rents. Chart 5 plots the rise in non-public rents since December 2021 alongside the rise in common earnings and the extent of CPI companies. Each have tracked and certainly outgrown the rise in non-public rental costs, which means that the relative price of renting on common has not risen since rates of interest began to extend. In comparison with our outcomes that is considerably shocking, as our evaluation would recommend rents might be rising sooner than wages or different companies now. Nevertheless, different shocks to the UK’s labour market or price pressures in particular sectors make it troublesome to be definitive on this assertion. Total, via the lens of Chart 5, the pressures within the rental market appear to be per the broader provide constraints within the economic system. 

Chart 5: Rental costs relative to incomes and different costs

Observe: Costs are in ranges and normalised to 100 at December 2021. Earnings are common weekly labour earnings.

Summing up

This submit means that rate of interest rises lower rental costs in the long term, however that they might initially put stress on the rental market. In our evaluation, a brief rise in rates of interest results in non permanent will increase in rental yields, as occurs for returns on different property within the economic system. Tenant demand rises at first and landlord provide could also be dampened by rising mortgage prices and sluggish adjustment of home costs. Nevertheless, over time, our outcomes point out that the housing market ought to regulate, inflicting rental costs to say no.

Daniel Albuquerque and Jamie Lenney work within the Financial institution’s Financial Coverage and Outlook Division.

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