Earlier this year, the government published a white paper called 'Fixing our broken housing market'. It was all about building more homes, with the implication that builders such as Persimmon (PSN), Barratt (BDEV), Taylor Wimpey (TW.), Bellway (BWY) and the like are letting the side down. But are they?
If the market is broken, could it be due to its rules of engagement? Here are 10 examples of misguided beliefs and perverse incentives that could almost have been designed to promote housing shortages:
1. Treat housing like any other market investment
Everyone needs somewhere to live – shelter and security are a basic human need. Many people think of their homes as investments too – a source of resentment amongst those forced to rent. Unlike other types of investment, property also defines local characteristics and carries social consequences.
2. Treat housing as a global asset, open to all
UK housing is seen as a safe investment in a turbulent world. And foreign investment aids the economy – but it also adds to demand. If homes are left empty as a result, supply for domestic purchasers is removed. This helps to push up prices. Telford Homes, which builds in London but markets its flats abroad, claims that most of their properties are rented – where properties are kept empty, they say, they tend to cost £1m or more. Since there are no reliable statistics on how many properties are left vacant at any one time, this might be more widespread than is generally realised.
3. Expect the housing market to self-balance by following the normal laws of demand, supply and price
Intuitively, you would expect increased supply to lower prices as demand is satisfied. But often new-builds increase the prices of existing homes in the surrounding area, suggesting that housing acts more like a Veblen good – higher prices increase demand. When prices rise, buyers are supposed to hold back until prices fall again.
But with Veblen goods, the sellers hold back, expecting prices to rise even more. Potential buyers step in to buy for the same reason. This pushes prices higher. And that increases demand. The opposite happens when prices flatten – if prices fall, demand drops off, sellers and developers resist reducing prices for as long as possible. This downward Veblen effect was seen in the 1991 recession. When sellers eventually capitulated, prices fell by about a fifth, and relative supply began to increase.
So the belief that the housing market is self-balancing and that building enough homes will stabilise prices can itself be counter-productive. When demand exceeds supply, prices rise – but these rising prices in themselves stimulate further demand.
4. Engineer low interest rates.
The Bank of England’s Term Funding Scheme encourages investment in the economy through rock-bottom interest rates. Commercial banks no longer need deposits from the public – it’s cheaper to borrow from the Bank. This makes mortgages cheap, but it also propels savers towards buy-to-let in pursuit of higher returns. But as the economist John Kay and others have observed, this influx of investment helps to push up prices. Squeezed-out first-time buyers then rent instead, and this pushes up rents. A greater demand for rental properties in turn pushes up prices and so on.
Buy-to-rent and build-to-rent both provide homes, but low interest rates limit home ownership because they reduce (or fail to increase) the number of homes available for purchase. For owners, buy-to-let backed by relatively cheap lending rates has been a no-brainer. Those squeezed out and forced to rent see it in a different light. For them, low interest rates have promoted a vicious circle that denies them places to buy and makes them pay higher rents.
5. Rely on market forces
The lower end of the residential property market used to be determined by what first-time buyers could afford. That became overtaken by how much those buying-to-let were prepared to pay. They outbid many first-time buyers, so keeping them in the rental market. That helps drive up rents to the point that renters can comfortably bear, or even beyond. Even if first-time buyers do get a foothold, when their homes go up in value they will end up beyond the means of the next generation of first-time buyers.
For too long, there was a reliance on the private sector to build sufficient affordable homes to make a dent in the housing shortage. This reliance only served to prolong it.
6. Distort the market with different tax breaks for landlords versus owner-occupiers
Buy-to-let was originally encouraged to generate more rental properties. And it worked. That was in response to the 1991 recession. The paradox of a lower tax for letting property and a higher one for living in it has persisted – owner occupiers lost tax relief on mortgage interest long ago; but if they let out their home, until recently they could still offset it against their rental income. This is now being phased out for individuals who buy-to-let, but not for limited companies. The uneven playing field has shifted. It can pay individuals to move their investments into their own limited companies.
Some argue that capital gains tax applies an opposite bias. Home owners are exempt (on their main residence). The tax applies to others – but only when they realise the gain, so the incentive is not to sell. This keeps homes in the rental market that might otherwise have been returned to owner-occupation.
A mixed bag, then. The uneven playing field that initially brought more rental properties on to the market has gone on to hamper their return to owner-occupation.
7. Distort the market by separating annual property taxes from property values
This is a major factor. As long as the annual tax on housing bears little correlation to the current property value, there will be little financial incentive to downsize and little imperative to rent out parts of larger properties. If second homes are not taxed at a premium, holiday homes are encouraged. Houses sub-divided into flats (that together might house a dozen people) are taxed higher than similar homes in which just one or two people live. What this all encourages is the under-use of property – the housing stock is there, but it does not reach the market.
The highest rate of council tax is only three times that of the lowest rate and there are many exemptions. Prices of more expensive properties are buttressed by these relatively low annual overheads. If annual property taxes were linked to current property values, more property would come up for sale.
Whisper reform if you dare. Council tax is highly emotive. But dodging reform only helps to depress supply.
8. Apply a blanket pressure to build
The property market is fragmented, with significant local differences. People cluster where the jobs are. They want to live in attractive areas. Popular locations are where housing shortages, particularly of affordable housing, occur. In other places, there can be surplus housing. The market is a dynamic too – people movements, demographic shifts and changing investment patterns can all cause housing pressures to change over time.
Building without focus can too easily result in the wrong sort of housing in the wrong place – hardly a cure for where the housing shortages are.
9. Relax planning controls
The government sells unwanted land to a developer. The developer doubles its value by acquiring planning consent that includes a significant proportion of low-cost homes. A new developer buys the site and disputes that affordable homes are financially viable. Few get built. This is an actual example of the disconnect between intention and practice and it is not uncommon.
Inappropriate development is another. The housing shortage has a produced a presumption to develop land, but if luxury homes are built where affordable ones are needed, it does little to reduce housing shortages.
Builders lobby for fast-track planning consents on the grounds that bureaucracy delays building-starts. But planning controls and enforcement are intended to prevent inappropriate housing – the weaker they become, the less likely it is that the right sort of housing will be built.
10. Focus on supply rather than demand
Many assume that simply building more will eventually outpace the demand for housing. The counter-argument is that increasing supply in itself can stimulate further demand. What if supply can never catch up? The focus would need to shift to other solutions.
Reality bites
So, a broken housing market? If building companies have to work within a framework that bakes in an institutional housing shortage, they can hardly be held wholly responsible for it.
For investors in housing developers, the question is whether the landscape is shifting. In the June election, all political parties recognised the need for social housing and to provide more affordable homes. There is already an increased focus on the rental market. Build-to-rent is one outcome. Rent controls are lurking in the wings. Grainger (GRI) and Mountview Estates (MTVW) are still managing “regulated” (sitting) tenancies from the last time controls were in vogue. The German rental model has been mentioned. Phoenix Spree Deutschland (PSDL) knows all about that.
Pinning the blame on the builders deflects attention from the underlying issues – and notably the need to address the causes of demand as well as supply. Demand arises for various reasons, some of them complex. The housing shortage would be threatened by a tax system that changed behaviour and, perversely, by stronger and more selective planning controls.
The apparent myopia among many politicians is because they know that the property market drives much of the economy. Upset it and a recession becomes more likely. Their reluctance to be too candid is also because homeowners tend to vote for those that increase the value of their properties - and there are still twice as many homeowners as renters. As the number of renters increases, this might change, but for the time being the institutional housing shortage is likely to continue. In the absence of a recession, that might be good news for investors; but it is bad news for those left out in the cold.
