Houses are assets not goods: taking the theory to the UK data

From Bank Underground:

In yesterday’s post we argued that housing is an asset, whose value should be determined by the expected future value of rents, rather than a textbook demand and supply for physical dwellings. 

In this post we develop a simple asset-pricing model, and combine it with data for England and Wales. We find that the rise in real house prices since 2000 can be explained almost entirely by lower interest rates.

Increasing scarcity of housing, evidenced by real rental prices and their expected growth, has played a negligible role at the national level.

Includes lots of lovely charts, tables and calculations.

As I have said many a time, all you need to know is
(1) local wages in each area of the country, which tell you what local rents will be, and
(2) prevailing interest rates. You multiply local rents by the inverse of interest rates (or divide local rents by interest rates, same thing) and that tells you what house prices will be in each area to within a tolerable margin of error.

There is no need to factor in ‘scarcity’ to the equation, being impossible to measure once you have done the two-stage calculation.

This also explains why there is a larger variation in very local house prices within larger cities/conurbations, because there will also be a larger variation in wages in larger cities. Office cleaners earn the same everywhere, but the really high paid jobs are all in the larger cities/conurbations.