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Thank Fathom It’s Friday – The everlasting bank of mum and dad

Around 2 million students are studying at UK universities in the hope of developing their knowledge, gaining life experience and broadening their horizons, while, perhaps, partaking of one or two alcoholic beverages along the way. Many parents wish this for their children, the idea being that if they invest in their child’s future now, there will be substantial gains in the longer term. The majority of parents, depending on their income threshold, have to support their children financially throughout these years, some by helping them with accommodation costs that a maintenance loan may not cover or, for the fortunate few who think the 6% interest rate on a student loan is not the most favourable option, paying the fees up front. All in all, the university route can be very costly for many families.

However, never fear: there will be a return on that investment. It’s commonly accepted that graduates on average earn more than their non-graduate counterparts. Your child will (hopefully) work hard, (unlikely) avoid the clubs on a Friday night and opt for the library instead and (hopefully) end up with a first-class degree. The end goal is for them to land themselves a graduate job, with which they can then financially support themselves. Finally, the bank of mum and dad is officially closed.

That is, of course, until they decide that they’d like to fly the nest and live on their own. Then there is a grand re-opening ceremony.

As many of us at Fathom are economics graduates (or, in this author’s case, an economics student on a placement year at Fathom), let’s talk about the ability of an average economics student to buy their first house. The financial industry towards which economics graduates generally gravitate is relatively limited in terms of location. The big financial hub is London, and that’s where many of us end up. Fantastic news! The average price of a property in London fell by 0.6% in June of this year. Does that make it affordable for an economics graduate to purchase their first home in London? Do pigs fly?

A property in London will cost you on average just over £480,000, with a flat on average costing you just under £430,000. In 2013, the average starting salary for a UK economics graduate was £25,000; average house prices in London were an eye-watering 18.8 times this starting salary. Recent graduates are really feeling the sting of just how expensive houses are, but it’s not just the recently graduated, everyone is reeling from the effects of absurdly high prices. In 2017 Q2 average house prices in London were a staggering ten times average earnings. Let us hope that lottery ticket comes in this week!

The reality is that we have a generation that’s falling behind its parents and grandparents in terms of net wealth. If the bank of mum and dad is available, then maybe the transfer of wealth between generations may help bridge the gap between incomes and house prices, so to speak. After all, the over-55s are sitting on a vast amount of wealth and capital, having been helped along by the very factor that keeps the younger generation off the housing ladder – the long house-price boom in recent decades.

This inter-generational effect notwithstanding, increasingly unaffordable house prices could lead to a larger divergence in home ownership rates between those from poorer and wealthier backgrounds, as not everyone has a bank of mum and dad to fall back on. A consequence of this could be that in the future we see a spike in the rental market, boosted by those from low-income backgrounds who are unable to get on the housing ladder. The UK could take inspiration from some of its European counterparts, for example Germany, which has one of the lowest rates of home ownership in Europe. The chart below suggests that this movement towards the rental market has already begun. Since 2010, home ownership in the UK has been falling steadily.

House price inflation in the UK has been a major driver of consumer spending, which accounts for 66% of GDP. The rise in house prices, combined with low interest rates encouraged consumers to borrow money against the real value of their house at low rates, significantly increasing consumer spending along the way. It is worth noting that there has been no net wealth effect in aggregate except to the (limited) extent that new houses have been built; but there has been a boost in consumer spending due to the collateral effects of higher house prices – the fact that home-owners with positive equity in their home can borrow more cheaply than others.

If Germany is any example, the share of consumer spending in GDP might drop substantially if the UK were to move to a more rent-based housing market. In Germany consumer spending accounts only for 53.6% of GDP. From a long-term, macro perspective, this would represent a welcome rebalancing.

Increased renting could impact GDP, but is renting even affordable? The average monthly rent paid for new lettings in Greater London was £1,564 a month in July. After deducting tax on a £35,000 salary, which is the average salary for London workers, the take home pay per month would be £2,256 — and this is without student loan repayments. That would mean that at least 69% of the income of new graduates would be used to pay rent, which by most standards would define renting in London for the average worker as unaffordable.

However, many recent graduates would not be looking to rent an apartment on their own, often favouring a cheaper shared-occupancy property. The average price of a single room comes out at around £609 a month, which would be 27% of an average London worker’s salary and 36% of that of a recent graduate. It is very expensive for economics graduates to rent in London, but it is not ‘unaffordable’, if you don’t mind a flatmate.

We find that the fall in the cost of owning and maintaining a property, brought about by exceptionally low real rates of interest, accounts for most of the jump in house prices relative to incomes since 2013. Additionally, the demand for housing has been turbocharged by Chancellor Osborne’s Help-to-Buy policy and the search for yield — which has resulted in the accumulation of housing wealth as an investment alternative for low-yielding financial assets. Indeed, the rental yield in London is around 3.2% — well above the current yield on a ten-year government bond. Conversely, an increase in the interest rate, if substantial enough, would change the balance between the affordability of renting and of buying a home.

However, for the moment with the current interest rate, if recent graduates ever want to move out and own their own home in London, then the best option seems to be to stay at home for now, save money and hope there is an everlasting bank of mum and dad. Or else to encourage mum and dad to move into rented accommodation themselves…

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