Market Housing

Issues, Problems and Solutions

Stephen Nickell

Chair of the National Housing and Planning Advice Unit

Presentation at the Cabinet Office, 19th May, 2008.

Stephen Nickell is Warden of Nuffield College

Market Housing

• What has been happening?

House prices, house-building, households, incomes.

• The private rented sector. Buy-to-let.

• Do all the recent changes matter?

• Prospects:

House prices, house-building plans, households.

• Policies:

Command and control, incentives.

What determines house prices?Basically, the “price” of houses is fixed at the level at which the

demand for houses today is equal to the fixed stock available today.

In the recent past, demand has been shifting to the right more rapidly than the stock (which moves to the right by around 3/4% per annum).

Stockt

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So house price inflation depends on how fast demand rises relative to the available stock.

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• Over the short term, house price inflation is dominated by the speed of the demand shift. Over twenty years, however, the rise in the stock is “big enough” to make a significant difference to the overall rise in house prices over this period, and hence to the average rate of house price inflation.

• What are the implications of all this?

• Typically, the price of houses exceeds, often substantially, their replacement costs (ie. the costs of rebuilding). The difference is the value of the land.

• This means that house prices and house price inflation are, currently, more or less unaffected by construction costs. Note, current construction costs impact neither on the demand for houses nor on the existing stock.

• If construction costs go up while house prices remain unchanged, land prices (ie. the price of land with planning permission) will fall.

• The same argument applies to tariffs or an infrastructure levy.

House Price Inflation in the Medium-Term

• Over the medium term, the key to house price inflation is the rate at which demand (the demand side) increases relative to the rate at which the stock increases (the supply side).

The Supply Side• The rate at which the stock increases is determined essentially

by the planning regime and the capacity of the house building sector.

• The more restrictive and directive is the planning regime, the lower the rate at which the housing stock rises and the higher will be the rate of house price inflation.

• Example.

• Suppose the planning regime forces builders to raise the proportion of “cheap” (small) homes. This will have two effects.

• First, the rise in planning restrictions will slow the rate at which the housing stock increases, raising the overall rate of house price inflation in the medium term.

• Second, reducing the supply of “expensive” (large) houses will raise their price, forcing better-off households into the “small home” sector where they will compete with less well-off households. This may well drive up the price of “small” homes despite the increase in supply.

• Overall this policy is quite likely to reduce the housing prospects of the less well off.

• What about the policy of cutting stamp duty to first time buyers (FTBs)?

• The key point to recognise is that this can only help FTBs if the supply of FTB type houses is higher than it otherwise would be.

• Initially the demand for FTB type houses rises and with constant supply, their price rises by the amount of the tax cut. So the tax cut goes straight to the existing owners of FTB houses.

• This price will bring forth increased supply only if keen landowners/house builders can persuade planners to release more building land. Unlikely. So aside from some, probably tiny, composition effects, no other changes will ensue.

What Determines Demand and Prices?

• Real incomes and the number of households relative to the number of houses determines the trend.

• Note income elasticity of demand > price elasticity. So cet. par., as incomes rise, prices tend to rise faster than incomes.

• Other factors include ease of borrowing, long-term real interest rates.

The Recent Past• From 1997 to 2006, real house prices have more than doubled. Real

earnings have increased by around 15%.

• The ratio of (lower quartile) house prices to (lower quartile) earnings has risen from around 4 in 2000 to over 7 today.

• From 1996 to 2001, housebuilding was at a rate of around 135K per annum, households increased at around 159K per annum.

• From 2001 to 2006, housebuilding was at a rate of 146K per annum, households increased at around 199K per annum. Incidentally, this rate of housebuilding adds around 1% of England to urban areas every 20-50 years depending on use of brownfield/density.

• Households are now rising at over 210K. Net migration represents around one third. Increasing life expectancy and behavioural changes continue to lower household size.

Indexes of real house prices, earnings and GDP, United Kingdom (1997 to 2006)

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Housebuilding: permanent dwellings completed, by tenure, England

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Household estimates and household projections, by household type, England only

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Does it Matter?• As affordability worsens, more people are pushed into private renting, forcing

up rents.

• More people are driven into the already hard-pressed social renting sector and queues lengthen.

• Deprivation increases and the situation worsens in already deprived areas.

• This affects us all. The economy suffers from the consequent impediments to labour mobility.

• Key workers are unable to find somewhere to live near where they work.

• Increasing quantities of taxpayers money are required to address these problems.

• Housing wealth has risen enormously. Can the country really be wealthier because we collectively restrict the supply of building land?

The Private Rented Sector (PRS)• Overall, the PRS in England represents around 2.7 million

dwellings which is around 13% of the overall housing stock.

• At the low point, in the late 1980s, the PRS was just over 2 million dwellings, around 10% of the stock. Buy-to-let (BTL) mortgages were introduced in 1996. In 1988 and 1993, there were changes in legislation which made the PRS more attractive to investors.

• Interestingly, the size of the PRS rose at least as rapidly from the late 1980s to 1996 (when it represented around 2.4 million dwellings) as it did from 1996 to the mid 2000s.

Figure 1.1 Number of dwelling in the private rental sector (thousands)

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Private rental without BTL mortgage Private rental with BTL mortgage

The Impact of BTL (I)• The introduction of BTL mortgages had two effects. First, it

raised the supply of rented property and hence lowered rents (below the level they would have reached otherwise).

• Second, it raised the overall level of demand for residential property (demand by those who want property to rent out plus demand by owner-occupiers).

• Note, however, that the fall in rents will have reduced the demand for residential property by owner-occupiers. Nevertheless, it is plausible that the overall demand for residential property rose despite this offsetting effect.

• The upshot would have been that the rise in BTL mortgages contributed to the rise in residential property prices.

The Impact of BTL (II)

• The fundamental question is: to what extent can the dramatic rise in house prices over the last decade be attributed to the BTL phenomenon?

• Our estimates suggest that the contribution of BTL is small. From the mid 1990s, the real price of houses has risen by around 150%, which is around 8.6% per annum. If BTL mortgages had not been introduced, we estimate that the rise in real house prices would have been a little over 130%, which is around 7.9% per annum. So BTL has added an estimated 0.7% per annum to the inflation rate of real house prices.

What do Affordability Prospects Look Like? І

• Household projections suggest that the number of households in England will grow by an average of around 223K per annum over the next 20 years. This rate is significantly higher than in the recent past. Furthermore, projected growth up to 2020 is even faster at an average of around 230K per annum.

• 168K new homes were completed in 2006-7.

• The fact that the rate of completion of new homes has been well below the rate of formation of new households means there is a large build-up of unsatisfied demand.

• The evidence suggests that over the long-term, a 1 per cent rise in real incomes raises house prices by 2 per cent if the housing stock remains unchanged.

What do Affordability Prospects Look Like? П

• If the housebuilding plans currently embodied in the draft RSS plans (around 200K p.a.) are fulfilled, house price to earnings ratios are likely to rise from around 7 to around 10 over the next twenty years.

• If Green Paper plans (reaching 240K p.a. by 2016, 3m. new homes by 2020) are fulfilled, house price to earnings ratios are likely to rise to around 9.5 over the next twenty years. This may be reduced significantly by biasing new homes towards more expensive regions and even further by some bias towards larger family homes which are in shortest supply.

• NHPAU projections indicate that a plan to reach 270K new homes p.a. by 2016 would come close to stabilising affordability in the long run.

Policies I

• It is plain that the problem is housing supply and, in the market sector, the binding constraint lies with local authorities (LAs) and the planning system.

• Fundamentally, LAs have had no incentives to encouraging housebuilding:

i. The majority of their constituents are against.

ii. The financial incentives to encouraging housebuilding are very low, maybe negative.

• Note, more or less every other rich country builds at a faster rate than England, sometimes dramatically so.

Policies II• Two types of policy to encourage housing supply:

Command and control (CC)

Financial Incentives (FI)

• In practice, CC typically includes elements of FI.

• Basic system:

Regional spatial strategies, local development frameworks, LA land supply (PPS 3).

• Add-ons:

Thames Gateway, growth areas, growth points, eco-towns.

•These involve continuous interaction between LAs, Regional Assemblies, CLG with some flows of money.

•This involves huge expenditure of time and energy.

Policies IIIFinancial Incentives

• Section 106 payments. These are made by developers to LAs as a condition of planning permission. The idea is for the LA to negotiate some community benefit such as infrastructure, open space (including a proportion of low cost homes in the development). These have high transaction costs and as a proportion of the “planning gain”, they are trivial, generating no serious financial incentive for development.

• Housing and Planning Delivery Grant (HPDG). This is a reward payment to LAs for delivering land for development and delivering housebuilding relative to plans. Overall, the amounts are small and are not likely to generate strong incentives.

Policies IV

• Community Infrastructure Levy (CIL). This is proposed and out for consultation. Could replace Section 106 but that is not proposed. This allows LAs to apply a levy (per roof or per square metre) on all new developments. This is to provide for infrastructure, widely defined. So LA assesses infrastructure requirements and, after consultation, publishes a charging scheme, the levy being paid at the outset of development. The incidence of this tax is on the landowner. It should differ between greenfield/brownfield and across areas. Cannot be used for general LA expenditure, nor to remedy existing infrastructure deficiencies, unless aggravated by new development.

Policy Changes IPossibilities include:

• Reduce extent and detail of the command and control framework.

• Cut Section 106 and HPDG.

• Use a CIL type system to provide strong incentives. The planning rules about housing mix can be incorporated.

• An alternative to the CIL system is the Leunig system - LA buys undeveloped land, auctions it with permission, uses profit to benefit locality.

Policy Changes II

More controversial:

• Allow CIL incentives to work. CIL rates can be much higher in areas where the difference between the value of land with permission and its alternative use value is much higher. These high value areas are around certain towns in SE/E, eg. Oxford, Cambridge. The green belt is important here.

• Remove brownfield and density targets. Note urban back gardens are brownfield sites! People like living in houses with gardens, indeed in urban sprawl!