Britain’s banks are lending £1.4 trillion in mortgages to households. This is more than three times as much as they are lending to all non-financial companies put together, and 28 times as much as they are lending to manufacturing industry. Banks are, says Josh Ryan-Collins at University College London, “primarily real estate lenders”.
This is only one measure of just how central property is to the UK economy. The Office for National Statistics (ONS) estimates that land accounts for over half of the UK’s total wealth of £10.2 trillion, whereas in Germany it accounts for only half that proportion. It also estimates that households’ property is worth £4.5 trillion – over 60 per cent of all wealth held outside pensions. This reflects not just massive house price inflation over the years – the Nationwide estimates that the average house price has risen from under £2,000 in the early 1950s to over £212,000 today – but also increased home ownership. More than half of households now own their own home, compared with just over 30 per cent in 1961.
So, the UK economy is dominated by property. Many economists, though, think this is a bad thing.
Willem Buiter, chief economist at Citigroup, has denied that the £4.5 trillion of housing wealth is in fact national wealth at all. Of course, your house is wealth for you and increases in its price makes you richer. But such rises are bad for prospective buyers who’ll have to shell out more for it, and bad too for renters, whose rents increase over time as house prices do. Just as rising prices of goods and services reduce our purchasing power, so too do rising house prices reduce the purchasing power of those who would like to buy a house. It is for this reason that Charles Goodhart, a former member of the Bank of England’s monetary policy committee, has recommended that the Bank’s inflation target should include house prices.
What’s more, there are many ways in which our obsession with property hurts the economy. Andrew Oswald at the University of Warwick and Dartmouth College’s Danny Blanchflower say that high rates of home ownership make it harder for people to move to better jobs, and depress investment by fuelling nimbyism – hostility to development in one’s neighbourhood.
There’s also evidence that mortgage lending can crowd out lending to business. A team of US economists has found that banks that raise mortgage lending a lot in strong housing markets tend to cut lending to companies: why go to the difficult job of appraising a business’s prospects when you can lend against the collateral of a high house price? In this way, house price inflation can depress growth in capital spending and productivity. In a similar way, expectations of rising house prices can divert would-be entrepreneurs towards “property development” and away from more productive businesses.
High house prices have other costs. One is that they mean high rents: the Resolution Foundation estimates that private renters now pay almost two-fifths of their income in rent, compared with just 10 per cent in the 1960s. This means they have less than they would otherwise have to spend on the goods and services produced by potentially more dynamic businesses. This problem is magnified by the obvious fact that when housing is unaffordable housing transactions dry up – the ONS reports that just under 100,000 homes changed hands in April, which is 30 per cent fewer than at the pre-crisis peak in 2006. This means less demand for housing-related items such as furniture and carpets. In this sense, the unaffordability of housing and the troubles of many retailers are related. Nicola Borri and Pietro Reichlin at Luiss Guido Carli University in Rome show that there is a “housing cost disease” whereby rising house prices reduce productivity growth.
Yet another cost – especially in London – is that high house prices compel people to live further away from where they work. That means longer commuting times, which add to stress, unhappiness and absenteeism.
And then there are dangers in the high debt caused by high house prices. In a study of 30 countries since 1960 Princeton University’s Atif Mian and colleagues show that rises in household debt relative to gross domestic product (GDP) tend to reduce economic growth in the following years.
There are also now political consequences to high house prices. If you want to know why Jeremy Corbyn is so popular with young people, just look in an estate agent’s window. Young people are being priced out of the market: the IFS estimates that only a quarter of 27-year-olds now own their own home, compared with 43 per cent in the early 2000s. And if people don’t own property they are less likely to vote for the traditional party of property owners. A recent Yougov poll found that only 8 per cent of 25-49-year-olds plan to vote Conservative – in 1987, by contrast, the Tories were the most popular party among such people. Those of you who are worried by the prospect of a Labour government should blame the housing market for your concern.
Our dependence on property is not wholly a bad thing, though. Home ownership and high house prices give people plenty of collateral with which they can borrow to finance new businesses. Nevertheless, it’s likely that – on balance – our obsession with property is bad for the economy.
How did we get into this state?
It’s tempting to think that a love of bricks and mortar is hardwired into the Anglo-Saxon psyche: an Englishman’s home is his castle. But this is not true. In 1918 only a quarter of households owned their own homes and even in the 1960s less than a third did so.
Nor are ever-rising house prices normal. The University of Bonn’s Moritz Schularick and colleagues show that house prices actually fell in real terms in the first half of the 20th century – as they did in many developed countries.
So what changed? One thing was inflation. As this increased in the late 1960s and 1970s people looked to property as a safe store of value. And then in the 1980s came the deregulation of the mortgage market and sale of council houses. Thanks to these, the proportion of households owning their own home rose from 41.8 per cent in 1981 to over 55 per cent by the mid-1990s. Mr Ryan-Collins says this generated a positive feedback loop, in which rising prices encouraged more mortgage lending which in turn pushed prices even higher.
In recent years, though, these forces for higher prices have been replaced by another one: falling real interest rates. As real long-term interest rates began to fall in the 1990s, so house prices have risen relative to wages. Since 1986 the correlation between the 10-year index-linked gilt yield and the ratio of house prices to earnings for first-time buyers has been a whopping -0.82.
One reason for this is that low long-term real interest rates are a sign that people expect mortgage rates to stay low, which emboldens them to take on more debt. Also, house prices are an asset (to their owner!) like any other, so when real interest rates fall future benefits from them are discounted less heavily, with the result that prices rise.
Given the high level of house prices, and the damage they do, there is increasing interest in policies that might reduce them. You might think the answer is obvious – to simply build more of them. Not so. Ian Mulheirn at the Tony Blair Institute says even a massive increase in housebuilding “will do very little” to depress prices. Spanish and Irish experience confirms this. Both countries saw huge construction booms in the decade before 2007, and yet house prices still soared.
There’s a simple reason for this. New building would add little to the housing stock. Last year the UK built just over 192,000 homes, which is just over 0.8 per cent of the total housing stock. Even a doubling of housebuilding would therefore add less than 2 per cent to the stock.
In this sense, houses are like bonds and equities – prices aren’t much affected by new supply. A swathe of new issues didn’t depress shares in the late 1990s, and big issuances of government bonds after 2008 didn’t depress their prices either. In all three cases the reason is the same. Asset prices depend on the supply and demand for the stock of assets, and new supply is only a small fraction of this.
If more housebuilding won’t much depress prices, what might? Economists such as Mr Ryan-Collins have revived interest in an old idea: taxing increases in the unimproved value of land, so landowners no longer benefit from rising prices caused by factors they don’t control. Although such an idea seems radical, it has some old and illustrious supporters. Winston Churchill backed the idea in 1909, arguing that rising land prices were “positively detrimental to the general public”.
Another idea, proposed in a report by Grace Blakeley for the IPPR thinktank, is for the Bank of England to directly target house prices. She’s advocated a target of no price rises at all for five years, followed by an annual rise of 2 per cent, with the Bank limiting the availability of mortgages if prices look as though they are rising faster than this.
Yet more ideas have been suggested by a recent report commissioned by the Labour party and edited by environmental campaigner George Monbiot. He recommends capping rent increases, restricting buy-to-let mortgages and nationalising some land.
The mere threat of policies such as these would deter property speculation and so tend to reduce land prices – with, Mr Ryan-Collins says, the additional benefit of diverting investors towards more productive assets such as equities or small businesses.
All this means that property carries a new risk. On top of the longstanding dangers that prices will be hit by recessions or overvaluations, and that liquidity will disappear in bad times, the property market now faces political risk. Perhaps Britain’s long love affair with bricks and mortar is coming to an end.
Over the next two parts in this series we will explore in greater depth the effect government policies such as Help to Buy have had on the profitability of UK property groups and what shape future housing stimulus could take. Historically low interest rates have made borrowing more affordable, but increased competition among lenders has also driven up loan-to-value (LTV) ratios – how will they fare in a rising rate environment or in an economic downturn? We will also explore how developers are tapping into demand for rental property alongside the regulatory changes that have raised costs for buy-to-let landlords.
