UK Housing

“An Englishman’s home is his castle”

-Popular phrase

The UK in general has a strong attachment to its housing market. The apparent resilience of house prices in the UK since the financial crisis has been a source of much comment and analysis but I wanted to reconsider the broader issues in the market and look at potential remedies.

Clearly one of the key supports for house prices have been interest rates set by the Bank of England at just 0.5%. In the UK a large number of mortgages are indexed to the base rate plus or minus a number of basis points. Therefore for many homeowners interest payments on their mortgages are negligible. This has helped cushion the blow of rising unemployment and falling real incomes from driving a wave of repossessions. In fact the primary reason for the UK housing market remaining at such elevated levels is the distinct lack of repossessions.

The UK housing market has shown a distinctly different pattern from the US market where some areas have seen falls of more than 50% from their peak. I would suggest four primary reasons for this.

(i)                 More UK mortgages benefit from the extremely low BOE base rate. Many US subprime mortgages had punitively high fixed rates after the 2 year teaser rate expired. Most of UK mortgages are inherently more affordable.

(ii)               UK home loans are recourse loans. If you default on your mortgage the lender can pursue you for the difference between the outstanding balance and the realised price of the home. In many US states a mortgage is a non recourse loan. If your lender has recourse to chase you for your debt you are less likely to bail on the loan.

(iii)             Unemployment has risen more slowly and less drastically in the UK meaning more people can afford their mortgage payments by virtue of having an income. In the UK more workers found ways to move to part time or took a pay cut whereas it would appear in the US more workers simply were fired.

(iv)             Britons tend to have a greater psychological attachment to housing due to various historical and cultural factors. This is indicated by the composition of assets. People in the UK seldom own shares or other financial assets aside from funds held in pension plans as they have tended to view their homes as their primary asset leveraging up to buy the best home they can afford. Some of this makes sense as the UK has a scarcity of housing and tough laws on new development alongside a rising population. In the US far more families own equities and other financial assets so their personal wealth is more diversified.

A new factor is also starting to weigh on the market. A popular trend during the last decade was for a number of homeowners to acquire a second or third property as a buy-to-let investment. Often this was on the basis of potential capital gains i.e the tenant effectively finances the mortgage and the capital gains from rising house prices provide the owner with future investment gains. During the crisis buy-to-let homes saw a greater pickup in delinquencies as tenants lost their jobs and landlords looked to exit the properties having lost the hope of speculative capital gains. However this quickly abated. Now with rising rental yields, due to the shut down of mortgage finance to first time buyers meaning they are forced to rent, combined with potentially very low mortgage rates for landlords the rental yield now provides a spectacular income stream. This means that for both buy-to-let investors and forced mover home owners (those with a job offer abroad for instance) they no longer need to accept a potentially lower offer for their home than they paid for it – they can let it out instead. Market forces suggest over time the market will find equilibrium due to new supply of rental property coming to market but in the short term those renting are paying more.

I would say that in many ways buy-to-let has been very damaging to the UK economy and the housing market. In the past decade it drove up the price of housing across the board due to additional demand aside from normal household formation. Now buy-to-let is damaging the economy because it is creating a rentier class of private landlords. The charging of rent by what is generally an affluent older segment of the society against what is generally a younger generation who do not yet own homes is damaging to a consumer economy. This is because rising rents are another squeeze on real income. Further young people tend to spend more driving the economy by virtue of having young families and generating more activity. What we are seeing therefore is an accumulation of assets in the hands of one segment of society to the detriment of the wider society. Now I am not arguing that home ownership is a right for young people or a better alternative to renting. What I am saying is that this process is making society less equal and not from an equality of opportunity perspective. By this I mean even those with good jobs who have worked hard are finding the cost of accomodation in general prohibitive if they dont already own property whilst a number of older people are sitting on valuable assets, assets which they could not afford to buy again. This disincentivises productive employment and incentivises asset accumulation which is bad for economic growth.

Nepotism is on the rise and to my mind this is damaging for society. The so called ‘bank of mum and dad’ has become the primary option for young people today to stick up a deposit on a home or to buy one outright. So what we see is those families who are more affluent, who likely also hold more housing assets already, are able to buy or subsidise homes for their children. This is hardly the way one wants to see wealth being distributed in an economically liberal society. This is ironically in many ways a function of the economically liberal post-war society because it was probably those productive workers of the previous generation who were best able to afford housing and accumulate assets and who are now passing these down to their children. Any parent would want to provide for their children so this is understandable.

What troubles me most about the UK housing market is popular attitudes that I find when engaging people on the subject. For one thing the ‘recency effect’ means that people view ‘bricks and mortar’ as unequivocally the best investment they can make. This is because for a generation over the past 15-20 years house prices have risen steadily. I find it frankly absurd that young people are expressing anger that they are not being granted sufficient leverage to get on the housing ‘ladder.’ People should be considering why they should need such leverage in the first place. Government policy on this matter is highly contradictory with various shared ownership schemes designed to support the housing market by splitting said leverage between the first time buyer and government or local authorities. Surely the point is the housing is unaffordable? Why don’t people question why housing is unaffordable?

Further to this point I might add that George Osborne’s plan to sell up to 2 million social houses to tenants at up to a 50% discount is frankly *insane.* He claims the proceeds would be reinvested in new social housing but surely selling 2 social houses to build 1 more amounts to a massive depletion of social housing at a time when it is more in demand than ever. It is also a ridiculous gift of a discount to those lucky enough to have received social housing. But such a policy has a strong appeal to the British psyche and this highlights the strength of point (iv) above.

There is nothing wrong with renting per se however I should highlight the primary frustration of renters are two fold;

(i)                Rental protections in the UK are poor. Landlords can often evict tenants with as little as one to two months notice. Further tenants often cannot even paint the walls without the landlords say so. The issue is you cannot make you rented accommodation your home in the same fashion as you can if you buy it.

(ii)               The perception that renting is throwing money away paying someone else’s mortgage. This has some truth to it. With an amortising mortgage over time the payments become more capital and less interest and in the end one pays no more for their home. This especially makes sense when prices are rising as capital gains accrue to the borrower. However if prices are flat or falling then arguably the difference between renting and buying narrows (assuming payments are roughly equal). This is because when one rents a home one doesn’t pay for the maintenance, the new boiler, the new kitchen etc. All of these incidental costs add up over the tenure of a 25 year mortgage and beyond.

So this is the problem for the UK housing market. But what can be done?

(None of these ideas are my own in any sense, rather they are different arguments I have seen presented in various forums.)

A radical solution suggested would be a land tax of some form. In many ways this is actually a very intelligent idea. By shifting more of the tax base from income tax to asset taxes one can improve the utilisation of scarce assets and encourage more velocity of asset exchange. However I would argue that said tax should be levied on all property rather than being an obvious punitive ploy to play on resentment of the rich such as the Liberal Democrats' ‘mansion tax policy.’

If taxes were levied on housing and land based on size, value etc it would encourage more efficient use of housing. There would be a strong incentive for older people to downsize from large homes as their income from productivity reduces in retirement freeing up housing stock for larger, growing families. Similarly by reducing the tax burden on income one encourages greater productivity from workers and incentivises production and activity rather than asset hoarding and rent seeking behaviour. A limited version of this would be to raise marginal tax rates on rental income to disincentivise rent seeking.

 However I fear such a fundamental shift in the tax base as an asset tax would be highly unpopular. It would be highly unpopular because human nature suggests we would all like to accumulate enough assets to retire and seek rents from everybody else. Removing that option from people would make society fairer but I am not sure people want it to be fair – or rather they would probably rather have the chance to become a rentier than the certainty of living in a fairer society in aggregate.

At a more microeconomic level what the UK certainly needs is more housing stock. The lack of supply is one factor which has elevated prices and keeps them elevated. Strong incentives could be made through taxation/subsidy to encourage new developments of housing perhaps specifically for letting but built to a high standard. With many institutional investors (pension funds) looking to diversify away from financial assets due to high volatility, perceived counterparty risks and systematic risks investment into these kind of real assets could be attractive. This would have the added benefit of supporting the future pensions and pensionable income of those with defined contribution pensions or annuities by bringing stable cash flows to investors. This would have the added societal benefit of bringing rental income within a more regulated environment than private tenancies increasing social protections for tenants and income protections for landlords. Further institutional management would lower frictional costs through economies of scale.

People often present Germany as an excellent example of a society where people tend to rent as often as buy property. I would concur with this view but there are key structural differences in terms of rental protections for Germans vis-à-vis those available in the UK. In Germany one often rents a mere shell of a dwelling and brings all sorts of furniture and fittings to the home including the kitchen. This would be highly unusual in Britain where most rental properties are at least part furnished and it means that Germans can better customize their home to their preferences. It has some of the benefits of ownership with some of the benefits of renting. In addition German tenancies are usually longer (as you would expect when you just unpacked and fitted your kitchen) and better protected in terms of rights against eviction and intrusion. The UK would need a variety of structural reforms to move to this model.

What may change in the near term for UK housing?

A recession.

With the Eurozone slipping into one now and no end in sight to the austerity race to the bottom its hard to see the UK escaping a similar fate since the EU is our largest trading partner. With further rises in unemployment we may well see substantially lower costs of housing and renting in the UK. This could finally flush out much of the leverage in the system. But be careful what you wish for because such a scenario would likely bust the banks and sink the economy. It’s a sorry state I’m afraid and we are all in it together.