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What’s missing from the house price debate

11 August 2015

Richard Blyth

It’s supply, stupid

For a long time now successive UK governments have argued that pretty much the only problem with the housing market is inadequate supply. I maintain that this exclusive focus on supply is not only misguided, but has also meant that attempts to solve the growing housing crisis have not worked.

Economics 101

My own economics experience doesn’t extend beyond A-Level. But I did learn that price is determined by the intersection of supply and demand curves, and that therefore demand can never “exceed” supply. Yet I hear this phrase all the time, even from experts. I think they are referring to what happens when the demand curve moves upwards but the supply curve doesn’t move rightwards. The consequence is higher prices, not demand “exceeding” supply. So it would be really worth looking at demand as well as supply if we are genuinely concerned with house prices. 

Housing is a peculiar product and to treat it like any other (except perhaps gold) is unhelpful. Homes have several characteristics which render them exceptional. Among other things, houses are:

  • Durable
  • Essential
  • Inseparable from neighbourhoods
  • Lightly taxed
  • Safer investments than many
  • Immobile.

Let's briefly note some of these characteristics.

Rock solid

Homes are generally well-built, and if a small amount is spent on them they can last a century. This makes housing suitable for investment and means that to compare homes to weekly shopping (as Shelter has) is misleading. Like land, there is little incentive to part with it because it doesn’t (much) decay, and some owners even find it quite okay to hold houses and not let them out to anyone.

Roof over your head

We all need somewhere to live. However, the way we choose the tenure of where we live is distorted (see below). Moreover the alternatives to home purchase have become increasingly rare and unsatisfactory. This all fuels demand for home ownership.

Des res

Another reason why housing cannot helpfully be compared to a weekly shopping basket is that when you buy a house you are buying a lot more than just a house. You are buying (if you’re lucky) access to:

  • Good schools
  • Good public transport
  • Interesting local shops
  • Good road access
  • Personal and property safety (and lower insurance costs)
  • A nice view out the front and out the back
  • Nice neighbours
  • Proximity to your friends

And sometimes:

  • Peer-group esteem
  • Expression of aspiration and identity

So, a lot more than a weekly shopping basket!

The various neighbourhood things you “get” when you buy a house are amazingly difficult to provide. The reason why homes in Winchester or Hampstead are expensive is that reproducing any of these places is incredibly difficult. However, we can work hard to ensure that additional homes are provided in a way which maximises the chances of the many of these neighbourhood benefits being provided. Dismantling urban planning might result in sprawls of homes everywhere – I doubt there would be many new Hampsteads among them.

So when you next hear that we should “deregulate” (i.e. “do less”) urban planning to enable house prices to fall, just remember that all the demand-side issues should be brought into the frame.

Death and (no) taxes

Property is lightly taxed in the UK, especially if you own a lot of it. This is very clear in contrast to some other jurisdictions (a Manhattan flat can face an annual tax of $40 per $1,000 value), but also in contrast to our own recent past. For example, if domestic rates had been retained in central London rather than being abolished in 1991, Band H homes would be attracting rates of three times the current Council Tax (at 2014 prices).

Owner occupiers live in homes without, obviously, paying rent. So their assets are providing housing services to them which is untaxed. This is called “imputed rent” and until 1963 this was taxed in the UK.

The profit on the sale of your own home is not only not subject to any taxation whatsoever, but this applies whether you own a modest terraced house in Yorkshire worth under £100,000 or a Mayfair flat worth £10,000,000. The aggregate value of this tax relief is strongly skewed to the owners of high value homes and strongly skewed to certain parts of the country, yet all taxpayers everywhere subsidise it.

Safe as houses

It is not just the nature of homes as assets which features in the housing crisis. It is the relative performance of homes as opposed to other investments. We have already seen how housing receives prior treatment in tax terms, but it gets worse. Other investments in the UK have been performing poorly, or more particularly have been recently perceived to be performing poorly. For example, the FT100 index has barely risen since 2000 whilst at the same time homes are easily twice the price. And whilst the post-war generation could count on final salary pensions in both private and public sectors, these have been increasingly whittled away. Now people are being told “save for your retirement”.

Further, the gearing on these savings at a time of low interest rates is extraordinary. To receive an income of say £20,000 in retirement, a person would have to have a pension pot of £400,000 when leaving their last job. Not surprisingly, over the last 20 years when shares have performed poorly (and also increasingly erratically) those with some money to spare have looked at the housing market and decided it is a good bet: it offers security, long term capital gain and an income stream (this does not only apply to buy-to-let but can be argument for people buying larger homes than they need – all free of CGT).

You can’t take it with you

A little-debated question of housing is its immobility. This is sometimes taken as a good thing. “Real” estate originated as a term referring to things which couldn’t be removed and which therefore were safe bets. However, it can be a curse if the home is in a place of declining economic performance or a place which is becoming increasingly ugly or unsafe. The economic changes which have coursed through the UK in the last 40 years have led to a much enhanced prosperity on average. However, this has been quite unevenly spread among different social groups and ages, and most unevenly spread among places.

There has been a long political discussion about housing supply in London and the surrounding prosperous counties. Opponents of increasing housing supply often argue that “there is room in the North”. There is indeed possibly room in some localities, but slow job growth or even absolute job decline has meant that housing land supply is often in the wrong part of the country.

It’s demand, stupid?

All this adds up to a perfect storm of excessive demand. Imagine a share certificate from which the dividends you receive are exempt from tax, the value is almost certain to rise, which you can sell with no tax on the profit, which you can shelter under, and whose ownership will cause you increased esteem from your peers and gratified looks from your family. I think that share price would tend to rise!

So when you next hear that we should “deregulate” (i.e. “do less”) urban planning to enable house prices to fall, just remember that all the demand-side issues should be brought into the frame. House prices are high due to excessive demand as well as limited supply. Single-issue answers do not work.

Richard Blyth is the Head of Policy and Research at the RTPI.