Are house prices too high? Hardly an original question. But it will hang over many owners and buyers as the economy opens up. “Affordability” in the property market is determined not only by the headline price of homes, but by the buyer’s level of earnings – required to service a mortgage – and the interest rate – the cost of borrowing.
Until prices took off at the turn of the century, people on average looked to buy somewhere costing a maximum of 3.5 times their annual earnings, though there were variations over time and around the country. At that price to earnings ratio building societies and banks could provide a mortgage to the family breadwinner on an average income for an averagely priced house.
In consequence, owner-occupation seemed a reasonable aspiration for most families. Then, prices took off in the 1990s in the run up to the financial crisis. The illusion of affordability was kept alive then, and after, by the emergence of the two-earner family, if both partners were willing to postpone or sacrifice having children or had good, cheap, childcare arrangements. Also interest rates fell to a historic low after the financial crisis, making it at least possible to keep up interest payments on a very large mortgage.
To sustain the notion of affordability, the coalition government introduced the so-called Help to Buy scheme making it easier to purchase a home with a minimal deposit. Unfortunately, rising demand pumped up prices so that, while some took a step onto the ladder, others were pushed off it. I made myself very unpopular with Conservative colleagues in the government by calling out the dishonesty of the scheme.
Demand is now strong again despite the pandemic and the average price to earnings ratio is now around 8.5, making house purchase unaffordable at anything like average earnings. Of course, there are big regional variations. In some northern towns, houses can be dirt cheap but there are few job opportunities. In the hotspots of London, Oxford, Cambridge and much of the southeast, the price to earnings ratio can be double the average. But that is where people want to be and where the jobs are.
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The numbers of households in private rented accommodation has doubled in two decades to over 20 per cent and is now around 5 million. Many are there not by choice but because ownership is unaffordable. Meanwhile, the house prices and rent levels are linked, albeit indirectly, through the residential property market. Property booms drive rents up too. Low income tenants then find themselves pushed into increasingly poor quality and insecure tenancies and into reliance on housing benefit which often locks them into a poverty trap, dependent on benefits.
Now that the pandemic seems to be easing, with mass vaccination, the problem of affordable housing is being revealed as worse than ever. Despite the headwinds, UK house prices rose 8 per cent on average last year, as part of a global property boom in which prices rose 11 per cent in the USA and 9 per cent in Germany.
Everywhere, the availability of cheap loans at rock-bottom interest rates has pushed up the price of assets including property. But the problem is most acute in the UK, where our property market starts this boom from a higher base. In the USA, house prices are now back to the levels of 2005 having crashed after the financial crisis, while Germany has seen only 25 per cent property inflation over 20 years. In the UK prices have risen 100 per cent over those two decades.
So what can be done? There are two different approaches. The first is to treat house prices as one aspect of inflation, to be tackled through monetary policy. In New Zealand, the central bank has been told to look at house prices when setting interest rates. But this is not without problems. Central banks would be distracted from their central concern which is general inflation.
An increase in interest rates, now, would not merely cause serious problems for those with high levels of debt but could choke off economic recovery from lockdown. An alternative would be to restrict lending to mortgage borrowers. That is the right economic response but would cause serious rage amongst those encouraged to believe that they should try to move into home ownership.
There is another approach which seems obvious: build more homes. Increase supply. However, the laws of supply and demand work in mysterious ways in the housing market. Even when builders are working flat out – building around 300,000 new homes a year – they are increasing the overall stock by only 1 per cent. It would take years of developers building flat out to make a discernible impact on supply and therefore prices. In any event, production is below that level – around 240,000 in the pre-pandemic year 2018-9 – despite that being the best for 30 years. Post-pandemic building will probably fall because of labour shortages as Brexit takes its toll on the previously vibrant supply of young, east European skilled workers choosing to come to Britain for a relatively short time.
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Also, market demand is not the same as need. Developers, understandably, build where the profits are largest and this may be, for example, for small flats rather than family-sized houses. And in London, especially, a share of sales goes to overseas investors whose business is seeking assets to acquire rather than homes to live in. And there is always a temptation to hold back development, even with planning approval, since rising prices mean that there are bigger margins from building and selling later.
A large part of need, as opposed to demand, is for homes for low and middle earners who will never be able to buy at market prices and can only afford “social” rents well below market levels. But this government has shown little interest in supporting new, subsidised, social house building by councils or housing associations, or even retaining the existing stock which is being sold off under the “right to buy” policy of the 1980s with ever growing discounts.
The lack of supply also drives a stigma around social housing as the preserve of the undeserving poor who breed too many noisy, unwanted, children persists. The Conservative press ought to look at a real model of enterprise and social discipline – Singapore – before it makes such judgements. There, 80 per cent of the population live in public housing. But, sadly, there is no sign of a change of heart here.
Beyond a massive council house building programme, the key to achieving affordability in the market is addressing the cost of land which underlies the cost of new build properties.
The price of land is heavily distorted by the planning system which allows landowners to make large windfall gains if they can get hold of land cheaply which is designated for agricultural or industrial use and then get planning permission to use the land for housing which massively increases its value.
These distortions could be sorted out by repealing the 1959 legislation which ensured landowners keep all the gains from such changes in use. To revert to the earlier regime – which catalysed the massive expansion of both owner occupation and social housing in the 1930s and 1950s – would create anguished screams of “confiscation” from wealthy landowners, who regard housing inflation as a right.
Taking them on, and at the same time permitting public bodies to acquire agricultural and industrial land cheaply through compulsory purchase,then obtaining planning permission for housing and building at cost for sale or rent could make a transformative difference. The cost of new homes would fall dramatically even taking account of quality improvements like zero-carbon construction and a contributions to local infrastructure.
The government should become a serious developer itself (commissioning private builders), but it has to change the law around land values before it can start laying bricks.