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House prices aren't wealth

The housing market is cooling off a little: the Halifax reports that annual inflation has fallen from 9.6 per cent in May to 7.6 per cent last month. For most of, us, though, this does not matter because house prices are not really wealth.

Former Bank Governor Mervyn King pointed this out back in 1998. A rise in house prices is, he said, another way of saying that the cost of housing has risen. This is obviously a bad thing for buyers. And because we owner-occupiers are in effect buying housing services from ourselves, higher prices are neutral for us: we benefit as sellers but lose as buyers.  

Let’s put this another way. If the price of your house rises, how can you benefit? One possibility is to trade down. But this means consuming less housing. You’re better off – but only in the same way that you’d be better off if you consume less food or electricity too. You could use equity release, but this only means your descendants will consume less housing as they’ll get a lower bequest.

Here’s another perspective. Bank of England economists say: “the rise in real house prices since 2000 can be explained almost entirely by lower interest rates.” This is basic asset pricing. As interest rates fall, people are willing to pay more for future income streams; the present value of them rises. But why are people willing to pay more? It’s because it’s harder to get such an income from bank deposits or bonds, and so other forms of income such as rent becomes relatively more attractive. But this is just another way of saying that as interest rates fall so too do the consumption possibilities of savers. Rising house prices are then just the flipside of the lower savings and annuity rates that make us worse off.

This point applies to landlords. They only profit from higher house prices when they cash out. But where do they put their money? Either back into housing, for which they must pay more. Or into cash and bonds where interest rates and hence future incomes are lower. Either way, the benefits of higher house prices are dissipated.

For many of us, then, housing is not net wealth, as former MPC member Willem Buiter has pointed out. If you doubt this, imagine half the houses in the UK were to be demolished and so the prices of the remaining ones soar. Would we as a nation be better off? Obviously not.

Now, there are caveats to this. Higher house prices do benefit those who get houses as a bequest. And they allow home-owners to borrow more, which can enrich the nation if they do so to invest in new businesses. And there are some types of rises in house prices that do represent increased wealth: if prices rise because expected future incomes rise we are genuinely better off.

For many of us though – and for the country as a whole – higher house prices don’t make us richer. In fact, they can make us poorer by depressing productivity (especially of commuters) or increasing economic instability. We would be better off as a nation if we could kill off our obsession with house prices.