F4 National Institute Economic Review No.

235 February 2016

COMMENTARY: UK HOUSING MARKET: PROBLEMS AND

Housing is at the top of our political agenda. This is in 2013. But there may be problems on the horizon. The
appropriate given that housing is a necessity as it is ONS estimates that the number of new households is
essential for the security and well-being of our families. projected to increase by 250,000 per year over the next
Article 25 (1) of the United Nations Declaration of decade while the number of net new houses completed
Human Rights recognises housing as part of citizens’ over the past decade averaged 175,000 per year.
right to a “standard of living adequate for the health
and well-being of himself and his family.” The share of households who are owner occupiers has
fallen from 69 per cent to 63 per cent over the past
There is mounting evidence that we are failing to deliver decade. This headline figure masks interesting and
decent housing, especially for the younger generation. divergent trends. Ownership among people under 34 has
First, more and more houses are being bought for fallen by around 20 per cent, while ownership by those
investment purposes which raises the cost of housing. over 75 has actually increased. The decline in the owner
Second, older generations appear to be ‘under occupying’ occupation rate matches the rise in households in the
and even hoarding houses while younger generations private rented sector and coincides with a steep rise in
are struggling to move into homes. Third, the number the number of households who own additional homes.
of new homes continues to fall below the number of
new families. Fourth, the re-reclassification of housing A new trend in home life is the rise in the number of
associations may leave this essential source of housing households with shared families. For example, children
for lower income families less able to access long-term staying at home with their partners at their parents’
stable funding. home. This trend was relatively steady until 2006 but
has since started to rise by around 7 per cent per year.
This Commentary looks at the problems in the UK The sudden change in trend suggests this has more to do
housing market and considers fundamental reforms to with affordability than preferences.
housing taxation and housing finance.
Overcrowding is almost exclusively found in rented
Home ownership trends homes rather than owner occupied. At the same time a
Housing policy is complicated because houses perform remarkable phenomenon called ‘under occupied’ housing
several functions at once. First and foremost, houses is on the rise. An ‘under occupied’ home is defined as
provide shelter. An obvious measure of a well performing having two or more spare bedrooms. According to the
housing market is if there are enough houses for everyone. English Housing Survey, 61 per cent of those who own
The Office for National Statistics (ONS) estimates that their house outright are said to ‘under occupy’, compared
there were roughly 27.5 million dwellings (excluding to 39 per cent of mortgage holders and only 15 per cent
long-term vacant houses) and 26.5 million households of private renters.

*National Institute of Economic and Social Research and Centre for Macroeconomics. E-mail: [email protected]. This commentary is based on a
written submission to the House of Lords Economic Affairs Committee for their inquiry into ‘the economics of the UK housing market’.
 Armstrong Commentary: uk housing market: problems and policies F5

This evidence suggests some degree of hoarding housing courts that uphold property rights. According to Property
consistent with housing being a store of wealth. Owners Week, the annual amount of overseas investment has
are happy to ‘under occupy’, many households are risen from around £6bn per year a decade ago to £32bn
buying second properties and the older generation are in 2014.
not releasing equity by leaving owned property towards
the end of their life. The market is clearing through Indeed, UK housing has been a sound bet for decades.
higher house prices which prevents those in the early Over the past twenty years the price of an average house
years of adulthood, who have most housing cost risk, has risen by 7.3 per cent per year, higher than a 6.3 per
from becoming owners.1 This suggests that the market cent total return (dividends reinvested) in the FTSE100
is becoming less efficient in allocating housing on a basis stock index. However, assuming a very modest rental
of needs. yield net of depreciation and repairs of 2 per cent takes
the return on housing significantly higher than other
Investment returns assets and much less volatility.
Housing is also the most important asset we own.
Households have more wealth invested in housing than The difference is even greater when considering the after
any other asset including pensions. In 2014 the value of tax return. Home owners pay council tax and stamp duty
households’ and non-profit institutions’ dwellings was when they move (1 per cent on the average home) which
£4.43tn (ONS data). This is 58 per cent of the entire net are small relative to overall housing costs. Wealth in
wealth of the UK. Figure 1 shows ONS data for personal housing is also sheltered for means testing, which becomes
sector housing and net financial wealth as a share of especially important when faced with uncertain late in life
disposable income. The rise of housing wealth reflects health costs, and increasingly sheltered from inheritance
higher owner occupation and house prices. According to tax. By comparison, owners of financial assets pay income
Savills, landlords with mortgages now have more housing and capital gain taxes. Therefore, the after-tax and risk-
market equity than owner occupiers with mortgages.2 adjusted rate of return on housing has been far in excess
of other investment options.
It is not only British households that invest. In a world
where secure assets with a positive yield are scarce, UK Intergenerational fairness
property is popular with overseas investors. A popular There is surprisingly little, if any, credible economic
private sector buy-to-let index suggests that annual gross evidence that owner occupation leads to better economic
returns have been above 10 per cent since the start of outcomes, such as better education, health, fewer social
2014.3 UK property has all the essential attributes of a problems, to mention a few.4 Owner occupiers are likely
secure asset, such as complete records of ownership and to be wealthier and have better outcomes, but there is no
evidence this is caused by housing tenure. The evidence
that ownership limits labour mobility is also not very
Figure 1. Personal sector wealth as as share of disposable conclusive.
income
Ownership can adversely affect other citizens through
9
intergenerational fairness. The 50 per cent rise in house
8 prices over the past decade benefits the existing owners
7 at the cost of those wanting to become owners. The
younger generation, perhaps simply not old enough to
6
own in 2004, now have to save 50 per cent more, or
5 £93,000, from after-tax income just to afford an average
4 UK home. This explains the divergent owner occupation
trends noted earlier.
3
2 There are parallels between the government debt and
1 house prices. The burden of servicing and repaying
the public debt and paying more for housing falls on
0 everyone in future generations. Even those who rent
1950 1960 1970 1980 1990 2000 2010
are not exempt; house prices and rents move roughly
Net financial wealth Housing wealth together. Yet there is a marked contrast in the desire to
Source: ONS. repay government debt but support housing demand
F6 National Institute Economic Review No. 235 February 2016

and house prices. Over the past decade the increase in as the government chooses not to build council houses,
public debt was £1 trillion and the increase in the value supply depends mostly on choices made by private sector
of dwellings was £1.3 trillion. agents who respond to their own incentives. For all the
effort of successive governments to increase supply, the
Economic cycles and growth outcome has been disappointing. In 2013, the last year of
A second way rapidly rising house prices can impose data, the number of new houses completed was 138,000.
costs on others is through economic and financial This is well below the 177,000 average over the past
instability. A simple approach to valuing home decade, and the projected 250,000 new households each
ownership is the user cost of capital. This adds up the year over the next decade.
cost of borrowing, essentially the interest charge, plus
the cost of wear and tear on upkeep and minus the The real question is why supply continues to fall below
expected rise or fall in price. If the user cost is less than target. Perhaps the most compelling answer is the
the cost of renting, then it makes sense to own. When planning system. The current government intends to
house prices are expected to rise strongly the user cost decentralise planning by giving more power to local
can fall to zero or even negative. councils and prioritising the development of so-called
‘brownfield’ sites.9 While all governments seek to
According to the IMF, housing cycles in the UK have overhaul the system, with so much wealth in the housing
the greatest amplitude of OECD countries.5 This stock there are strong interests of owners or ‘insiders’ to
matters because aggregate demand is highly correlated proceed with caution.10
to house price cycles. A recent Bank of England blog
has discussed the correlation between house prices Even if housing supply targets are met this would not
and job losses.6 The Bank also suggests a link between solve some the amplitude of cycles. Houses last for
household debt and the sensitivity of spending.7 There around fifty years, so the market is dominated by stock
are disputes about the cause, but no doubt about the rather than flow of new supply. Assuming supply targets
correlation. If households are required to take larger are met, the flow of new houses is less than 1 per cent
mortgages this may increase the amplitude of economic of the stock. Indeed, if the construction industry were
cycles further. The consequences for financial and also more procyclical, expanding when house prices are
economic stability are at the heart of the UK’s boom rising, this may even make economic cycles bigger. The
and bust history. US is a cautionary tale of how a more elastic supply of
new homes does not ensure lower amplitude of house
Another reason for concern about rising house prices is price cycles.
the consequences for long-term income. Feldstein (1982),
using a growth model with different productivity for Sub-market housing
the housing stock and businesses capital stock, shows Some families cannot afford to participate in the private
that spending on housing may be consistent with slower housing market. Housing Associations (HAs) are not-
productivity and lower long-term income.8 If a greater for-profit private organisations that provide rental
share of savings is being invested in property, less may accommodation at sub-market rates and carry out
be available to support the nation’s more productive property development. They fund development from
capital stock. Less investment over the long term results retained earnings and a grant from central government
in diminished supply and income potential. to the tune of around £1bn per year. HAs are the third
largest source of housing providing homes to 10 per cent
One option is to borrow from abroad to invest in our of the population and 20 per cent of new housing supply.
capital stock. But overseas borrowing needs to be serviced The government has extended its ‘Right-to-Buy’ to HA
which can ultimately reduce our income. Assuming we tenants in the hope that they will replace homes sold
do not borrow from overseas, our national savings rate with new developments.
last year of 12.5 per cent and capital to output ratio of
2.2 and a depreciation rate of 4 per cent, implies long- In October 2015, the ONS reclassified HAs as public
term income growth of 1.7 per cent. Rising house prices sector corporations. This meant that the government
can crowd out productive investment. became the country’s largest landlord with over 2.8
million families as new tenants and inherited £60bn
Planning and supply of new public sector debt. The proximate cause for the
Over the long term we clearly need more housing supply reclassification was probably the government’s decision
as household formation exceeds new supply. Yet as long to extend ‘Right to Buy’, which meant that HAs could
 Armstrong Commentary: uk housing market: problems and policies F7

sub-prime debacle in the US). HAs may be boring, but

60 The lesson of the re-reclassification of Further Education

40
step much further back than simply dropping ‘Right to
30 Buy’ plans. The risk is that the government may have to
step so far back from control of HAs that they are no
20 longer able to rely on long-term private funding. This
will lead to an even greater share of our housing market
10 being funded by short-term finance.

0 Housing taxation
2001 2003 2005 2007 2009 2011 2013 2015 A first priority must be to improve the taxation of housing.
Private Enterprise At present our taxation of housing is possibly the worst
Housing Associations of all worlds. We tax the purchase of houses by stamp
duty, which limits the efficient allocation of housing
Source: Department of Communities and Local Government, Live Tables
and labour mobility. Council tax has no connection to
21.
existing property values. Unlike other assets the income
no longer ‘fly under the radar’ as de facto public bodies and capital gains on primary residences are untaxed. No
since the Housing and Regeneration Act of 2008. attempt is made to tax the excess returns on housing
which accrue because of its relatively fixed supply.
But this is unlikely to be the end of the story. The
government has said it will take whatever actions An efficient tax system would be consistent across assets
necessary to reverse the reclassification decision. There and leave the decision about how much to consume
is a precedent for re-reclassification: Further Education today versus save and consume tomorrow unaffected.
Colleges were reclassified in 2010 then re-reclassified This is difficult for owner occupiers as the ‘dividend’ or
in 2012. Convincing the ONS will require significant income from their investment is the housing services the
change in the governance of HAs. The problem is that household consumes. This suggests a tax on the value
these changes may undermine the funding of HAs and of housing services consumed. Further, because of the
therefore limit the possibility of developing new homes relatively fixed supply there is a strong case that housing
to replace the existing stock. earns an ‘excess return’. An efficient tax system would
tax this element, or more likely create an allowance
The HA funding model was surprisingly sound. They based on a ‘normal return’ and tax any additional
receive a steady income stream of social rents and because capital gains.
the government’s claim via its grant is subordinate to
private creditor claims this gives investors comfort that If a capital gains tax were introduced, this would reduce
their credit risk is limited. Therefore, HAs can aggregate the gains in an upturn and losses in a downturn, so
their borrowing and tap domestic long-term investors dampening house price cycles. This may also reduce the
such as pension funds and insurance companies. As a resistance to planning, reduce ‘under occupancy’ and even
result, unlike private developers HAs have little reliance increase the flow of savings in productive investment. To
on short-term debt. make such a tax manageable, investment in properties
would be exempt and the gains would be paid on final
Figure 2 compares housing supply from private sale or even death. This would avoid any incidence on
developers and HAs. Private developers’ completions fell ‘cash poor’ home owners. The revenue raised could be
by 45 per cent in the crisis period while HA completions offset by scrapping the stamp duty transactions tax.
rose steadily, providing counter-cyclical support to
the economy and the construction sector. This is quite These ideas are unfortunately in the opposite direction
a success for a section of the housing market that is to recent policies. Recent changes to inheritance tax
notoriously difficult to fund (consider for example the limits allow couples to transfer even more wealth in
F8 National Institute Economic Review No. 235 February 2016

housing to descendants free of tax. This creates another Interest rates influence the user cost of capital (discussed
tax advantage to home owing. Previous governments above) through mortgage costs and expectations of
removed the tax relief on mortgages (MIRAS) without price appreciation. Mortgages are priced on short-term
lasting electoral damage. This shows that changing the interest rates which are more volatile than longer-term
taxation of housing for the better is possible. rates. It is no surprise that our house price cycles coincide
with the fortunes of the banking sector. Every downturn
Housing finance system in the property markets coincides with serious stresses
A second priority for a better housing market is an on the banking system.
effective housing finance system. Housing finance is
simple in theory, but difficult in practice. In theory, young As Goodhart and Perotti (2015) make clear, a more stable
households want a long-term loan to fund the purchase housing market will require less maturity mismatch and
of a long-term asset. Middle-age and older households leverage in housing finance.11 Mortgage supply would
are looking for safe long-term assets to invest in for their be more efficient if funded by long-term sources of
retirement. The ideal contract between generations is finance. Most other countries manage this. It requires
fixed in real terms, and second best is fixed in nominal leadership in the design of the financial system to meet
terms. Short-term floating rate mortgage debt is third the economic objectives of the citizens who underwrite
best for both sides. the system.12 The Treasury and Bank of England have
the capacity to develop a housing finance system that
In practice this is hard to achieve. When the young delivers stable funding and less financial vulnerability.
move house, or when interest rates fall, they pay off
the existing mortgage which shortens the duration of NOTES
pension savings and introduces refinancing risk. Long- 1 See Sinai and Souleles (2005).
term investors have to price non-stationary credit risk 2 Reported in the Financial Times, 15 January, 2016.
3 LSL Buy-to-let index (2015).
(risk falls as the mortgage is repaid) which interacts with 4 O’Sullivan and Gibb (2012).
refinancing risk. This is all possible, but expensive. 5 IMF (2014).
6 http://bankunderground.co.uk/2015/12/11/house-prices-and-
No country in the world has found a satisfactory solution job-losses.
without state involvement. In the US Fannie and Freddie 7 Bank of England (2104).
8 Feldstein (1982).
removed residual credit risk (before President Clinton’s 9 Brownfield is land previously used for commercial purposes.
housing reforms in the 1990s), meaning that investors 10 Some studies note the increase in the planning and appeals
only had to manage prepayment risk. In Canada the process just as policymakers are trying to shorten it.
residual credit risk is managed through insurance, where 11 Goodhart and Perotti (2015).
the ultimate insurer of last resort is the state. In Germany 12 Armstrong (2013).
the state implicitly supports Pfandbriefe (covered bonds)
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