Burning down the house

The purpose of this post

Readers living in South West London may have seen the opposite poster featuring prominently in a real estate agency’s (Acquire Estate Agents not to mention any names) shop front. It was probably designed with the best intent, but this is actually a very bad promotional mechanism.

Let us dissect the proposal. At first sight, the offer seems appealing. The poster indeed advertises a “flat fee of £700” which “includes VAT, EPC, floorplans and pictures” for home owners willing to sell their property. With the average London house costing as much as £531,000, a £700 fee is equivalent to 0.1% of the average transaction value, whereas other major real estate agencies typically charge around 3% of the priceIn that case, why should the prospective seller think twice before walking into the lion’s den?

The reasoning is detailed in-depth and supported by empirical evidence in Levitt’s and Dubner’s Freakonomics  – a book I have already had the chance to write about – and relates to the role of incentives. In a nutshell, with a flat fee, especially a low one, the real estate agent is not incentivised to maximise the transaction value on behalf of the seller but to complete the transaction as quickly as possible, even if it means making sacrifices on price. Quantity prevails over quality.

For the seller, the ‘great offer’ may thus backfire and leave him worse-off overall after the transaction. He will save an average of £15,230 in agency fees (3% * £531,000 – £700), but this saving can be easily more than offset by performing a marginally higher number of visits or by spending a little bit more time negotiating the buyers’ offers – especially given the fever surrounding the London housing market.

A good alternative mechanism could have consisted in offering lower fees as a percentage of the transaction value, which would have maintained the agent’s incentive – albeit at a lower scale.

Daniel Kahneman

I have not been able to assess whether this marketing campaign ultimately proved successful for the agency or not. In any case, and to paraphrase Daniel Kahneman (2002 Nobel Memorial Prize in Economic Sciences) in Thinking: Fast and Slow, this is a perfect example of our ‘rational’ System 2 overriding the gut feels emitted by our ‘impulsive’ System 1.

P.S.: More on Kahneman and behavioural economics will be covered more in-depth in a later post.
P.S. 2: To finish with music…

Letter to FT – Housing prices are a threat to London’s standing

In an earlier post I mentioned the very interesting column Michael Skapinker published in the FT 3 weeks ago on the impact of house prices on London’s influence. I took the liberty of sending him my thoughts and a shortened version got published in the FT last week. You will find the full version below.


Dear Sir,

As regular reader of the Financial Times, I would like to thank you and congratulate you for your very wise column in yesterday’s paper entitled ‘House prices in London must fall if the city is still to be top’. I largely share your opinion and I am thus writing you to share some of my observations.

First, let me give you a bit of context. I am 29 years old and I arrived in London from France almost 7 years ago. I started my career as a strategy consultant and I am now working for a private equity fund – like tens of thousands of my compatriots here. I got married in 2012 and I am now the father of a 2-year old kid.

My friends who stayed in Paris told me that the first step on the rent or property ladder was usually the hardest: the Parisian housing market is narrow, landlords are asking for a ridiculous amount of guarantees when they are renting to young professionals and flatshares are often prohibited. The situation, nonetheless, seems to get simpler as they get older: higher salaries, more confident landlords and, for many, the possibility to get a foot on the property ladder when they are in their early 30s.

In London, my impression is that the situation is reversed. In one hand, it is indeed easy and flexible for a young talented professional with a job in London to find a room – albeit most often in a flatshare as you rightly pointed out. The situation remains largely unchanged after marriage – although ‘Double Income No Children’ couples can afford to rent their own studio rather than staying in a flatshare.

On the other hand, the situation gets increasingly complicated when you have a kid. The school system in London is either prohibitively expensive or prohibitively complex depending on the path you choose (public or private). Households relying on a single income (e.g. if the mother stays at home) or not working in the financial services sector financially struggle to rent a 2-bed flat while coping with the demands of the expensive ‘London way of life’.

Personally, I have come to London with many of my fellow students and I have since then witnessed two waves of departures: the first one took place 3-4 years ago, when some decided that a first experience in London of 2-3 years was enough and they decided to look for a stable family life in Paris. The second one is happening now, where I see married couples with young babies deciding to pack because they cannot make it work financially.

Root causes are multiple and have already been largely covered, including in your newspaper. I am convinced that London primarily suffers from a strong housing supply-demand imbalance and that the implementation of a bold housing construction programme would partly alleviate the tension. I also believe that the way London is organised and the high transportation costs play a role. London is a very vast city and, despite a tight bus network, the tube is certainly the safest way for Londoners to cut their commute time. As a consequence, the price of houses located near tube stations tends to soar. Similarly, tube fares are among the highest in the world and some Londoners are ready to pay more in their rent if this helps them save money on their transport budget – this drives the price of centrally-located houses up. Those two factors combined create a huge variance in house prices depending on their location. A couple of weeks ago, in an article entitled ‘London homeowners dig down as property prices shoot up’, the Financial Times mentioned that the average price of a home is 2.5 times higher in Chelsea than in Battersea, which is located just a few minutes away. As a matter of comparison, the ratio between the most expensive and the cheapest areas in Paris is no greater than 1.8 times – and we are talking about opposite sides of the city.

Last but not least, you mention in your article that sales of £1m-plus properties have fallen. Only time will tell whether this drop is the sign of a wider ‘market cooldown’ or just a pause until uncertainties surrounding the financial place of London (e.g. Brexit, stock market crisis) are dispelled.

I cannot agree more with your conclusion. London needs structural change to maintain its worldwide leadership. Time alone will only worsen the situation and could in the long term transform the city in a giant ‘gentlemen’s club’, where only those who invested early enough would be financially able to stay.

I would be delighted to continue the discussion if you wish – in the meantime, I thank you for your time and your consideration.

Best regards,

Quentin Toulemonde


Million Dollar Baby

Note: This post had been in my ‘draft’ basket for a while, but Michael Skapinker’s remarkable column in yesterday’s Financial Times put it back at the top of my pile.

Housing has become a real issue for British inhabitants in general, and Londoners in particular. LSE Professor Paul Cheshire has made a new contribution in this debate through a widely echoed report which concludes that one of four London homes will cost more than £1m by 2020, with the Financial Times concluding in the same article that “‘not just having a mum and dad who bought a house, but a grandparent too’ would be needed to get on the [property] ladder in the future”. So far, the latest data seem to prove him right.

The fact that owner occupiers and renters are not in the same boat is not news. The latest English Housing Survey supports that assertion in many respects. The share of overcrowded dwellings is almost four times higher in rented places (5-6% compared with 1-2%) and the gap is increasing. Conversely, the share of owned dwellings which are under-occupied has been soaring over the last two decades and now concerns more than 50% of the properties – partly due to the fact that almost all houses larger than 110 sq. m. are owned – compared with 9% and 13% for socially and privately rented dwellings, respectively. The share of non-decent homes has been decreasing across all types of occupations, but more than one out of four privately rented dwellings is still affected by ‘decency’ issues, primarily damp. For all those reasons, owner occupiers understandably report a higher satisfaction level than all types of renters (both social & private).

Share of non-decent homes, by tenure. Source: English Housing Survey 2014-15.
Share of non-decent homes, by tenure.
Source: English Housing Survey 2014-15.

Although the benefit of home ownership in terms of life satisfaction is indisputable, and despite the low interest rates and the numerous government schemes aimed at favouring ‘prime ownership’, UK inhabitants remain negative about their chances to ever get on the property ladder. Only 60% of private renters expect to buy one day, although the age for first time buyers has been continuously rising. For the youngest (25 to 34 years old), the mirage of ownership is vanishing at fast pace.

Split of households with a HRP aged 25-34, by tenure. Source: English Housing Survey 2014-15.
Split of households with a HRP aged 25-34, by tenure.
Source: English Housing Survey 2014-15.

In his report, Prof. Cheshire adds to the pessimism. Analysing the historical evolution of house prices in the UK, Prof. Cheshire concludes that “the key variables we have found have influenced house prices are real incomes, changes in population and house construction and interest rates”, with the former being “by far the most influential”. That being said, the relationship is clearly not 1:1, since real incomes have gone up by a factor of more than 3 since the early 1950s and the price of houses in London has been multiplied by 10 in half the time according to the Halifax House Price Index.

Quarterly evolution of house prices in London. Indexed at 100 for the average of 1983 prices. Source: Halifax House Price Index.

Government schemes or massive foreign capital inflows are not part of the list. In one hand, this is reassuring, as this means that house prices are directly linked to the income UK workers receive. On the other hand, this also means that an increase in inequalities between the richest and the poorest will leave more and more people on the side of the property ladder.

Source: http://thecrownblogspot.blogspot.co.uk/.
Source: http://thecrownblogspot.blogspot.co.uk/.

Prof. Cheshire’s quantitative forecast adds further colour. His econometric model, calibrated using historical data, forecasts an average house price increase of 23% by 2020 and 97% by 2030, with significant disparities between areas. London will be most heavily hit, with 25% of houses being priced at £1m or more by 2030 and the price of a house in the lowest quartile of all prices representing 17 times the income of a person earning the lowest quartile wage at that time, compared with 11.5 times today.

House Prices Observed and Predicted 1961 to 2030 – in logs. Source: Future Britain: Housing Millionaires and housing paupers.
House Prices Observed and Predicted 1961 to 2030 – in logs.
Source: Future Britain: Housing Millionaires and housing paupers.

Experts agree to say that the price surge we have been witnessing is also due to an imbalance between supply and demand. On that front, the Financial Times recently highlighted that new house building was still apathetic, leading the government’s ‘1m homes built by 2020’ target to be considered as increasingly unrealistic. The root causes of this supply shortage are subject to debate, but the UK regulatory and planning systems surrounding the building industry are often pointed out as major roadblocks – at least this is an area where the British and the French converge. There is however an urgent need for action: as rightly pointed out by Skapinker, at that pace, London will become unaffordable for the next wave of young talents it used to attract.