On cutting house prices

Ian Mulheirn, echoing Kate Barker, writes:

It is very unlikely that the perennial wish of housing commentators to simply ‘build more houses’ will make any meaningful dent in prices.

Many people think this is counter-intuitive, so I’ll try to explain why it’s not.

It’s because flows of supply are too small relative to the stock of housing to much affect prices. There are 23.7 million homes in England. In the 12 months to June, only 153,330 were completed. This means that even if annual housebuilding were to treble, we’d see a less than 2% annual increase in the housing stock.

There’s an analogy here with government bonds. Even before QE, government borrowing did not much affect bond prices. This was simply because the new supply of bonds was generally small relative to the existing stock.

It’s the same with houses. Houses are an asset, and the price of an asset depends upon the willingness and ability of people to hold the stock of it. Changes to the flow of the asset are generally too small to have much effect. For this reason, many economists have traditionally modeled house prices as if only demand matters; see for example this (pdf) or this (pdf).

This isn’t to say that increasing housing supply is a bad idea. It’s not at all. It’s just that it isn’t a magic bullet for solving the problem of affordability.

If supply doesn’t affect prices, what does? Lots of things: demographics (pdf), incomes, debt levels, expected incomes and the availability of credit. My chart shows another influence: real interest rates. The lower these are, the cheaper is the cost of credit and hence the higher are house prices. (Or if you want to be fancier, lower interest rates mean a higher net present value of future housing services and hence a higher house price.)

All this raises a puzzle: if high house prices are due to high demand, and if they are a problem (as I think they are on balance), what can be done to help young people buy them?

Obviously, some possibilities would do more overall harm than good. A recession would cut house prices, but it’s a lousy idea. I suspect the same would be true of tougher immigration controls. And other policies to help buyers would do no good because they’d be offset by price increases. Help to Buy, for example, seems to have pushed up prices. And I’d expect cuts to stamp duty to have a similar effect; yes, there’s a strong case for reforming property taxation but we shouldn’t hope it’ll much help first-time buyers.

That said, there are some demand-side policies that might reduce house prices, such as restrictions on owning second homes or housing as investments – in short, reversing the financialization of housing. Instinctively, I’m not over-keen on these; they would be abridgements of freedom. As ways of reducing house prices, however, they might be worth considering.  

Comments

[MJW]

@Blissex

The point about people sitting in subsidised council houses too large for them is that they continue to receive an ongoing subsidy from the state to maintain the inefficient use of stock.

People sitting in private stock that is too large for them may not be efficient use of resource. But it's not subsidised in the same way (I don't accept low interest rates are a subsidy in the same way as state provision at below market rates). Besides, the state will make attempts to claw back some of that wealth in the event they need social care in later life.

As for politics of Lunts' presentation, it was supposed to represent some of the current thinking going into Sadiq Khan's housing strategy. I'm just writing what I can remember weeks later, I know there was other stuff on 'affordable housing' and demographic changes i.e. more demand from single occupiers which is relevant to changes in population relative actual stock, and various attitudinal studies and related transport/investment stuff...

I'm convinced from reading more astute commentators that we need to get away from obsessing over unrealistic levels of new build and instead focus on actual stock capacity and utilization. Seems obvious really that much focus has been diverted away from the problem of how to meet demand for housing, towards a focus on adding new housing which is only one part of solution. There was an interesting chart in Lunts' presentation showing historic building levels in London and aside from a few specific periods like after WWII, London has rarely built the huge numbers of new dwellings we're told are needed. With hindsight what would have been useful is if he'd have focused on actual levels of stock, in dwellings and in bedrooms.

[rogerh]

I reckon there are a couple of extra factors to consider.

Firstly whilst the number of houses/home may be fairly accurate (there are good systems and incentives to make it so), the population numbers may not be so accurate. In particular estimates from supermarkets and others suggest the numbers are rather higher, up to 70 millions already. Now aiming off a bit for hype we still have an even bigger shortfall. But we can also see that HMG has no real incentive to measure this number accurately, the lower the better suits the government narrative. But we are left with an even bigger shortfall in available houses. Brexit may reduce the population a little but with wages headed south affordability is not likely to improve at all.

Secondly those who earn their wages in think tanks, journalism and academe have an incentive to produce 'helpful' narratives if they want to keep getting paid and get noticed. Better for them to help out HMG and the housebuilders and the right wing press (it pays better). We live in a wicked world.

[Blissex]

«Building more houses is what breaks the bubble»

That's one way to start it, if done right in the right places, but in itself it means little. as our blogger says, financialization is more important.

But what really matter is political will, then there are many ways. Unfortunatley a large chunk of voters are well described by this commenter on "The Guardian" (not the "Daily Mail"):

“To be fair the house owning majority will never vote for it either. Any solution that improves the housing situation for those who don't own them will screw those who already do.
I will put it bluntly I don't want to see my home lose £100 000 in value just so someone else can afford to have a home and neither will most other people if they are honest with themselves”

But eventually a coalition of renters and northern owners will likely get a majority in parliament.

And then the best way to get cheap housing is simply to stop subsidizing with enormous sums job creation and house prices in the south and encourage modern service jobs in the north, relieving congestion of both housing and infrastructure in the south, and enabling people to take advantage of the large availability of cheap housing in the north.

[Blissex]

«The point about people sitting in subsidised council houses too large for them is that they continue to receive an ongoing subsidy from the state to maintain the inefficient use of stock.»

But they don't receive any subsidy: the cost of council housing is lower than the rent council housing tenants pay.
Council housing is *profitable* for local councils. It may be less profitable than renting at full market price, but that's a completely different argument: that local councils are collecting the benefits of the huge subsidy the government of the past 35 years have made available to landowners in the south.

«People sitting in private stock that is too large for them may not be efficient use of resource. But it's not subsidised in the same way»

But colossal land prices are indeed subsidised by the provision of below-cost credit, and by bail-outs of city lenders:

«(I don't accept low interest rates are a subsidy in the same way as state provision at below market rates).»

You don't accept it, but that position is ridiculous: a subsidy happens when something is provided below cost, and providing council housing at below market rates but above cost is not subsidy; while clearly spending hundreds of billions on the City to bail-out insolvent mortgage lenders is a direct subsidy, and lending hundred of billions more to them at 0% by the BoE is also a direct subsidy, because it is ridiculously below the risk of that lending.

Never mind schemes like "Help To Buy" that are a direct subsidy to land owners again by lending at rates well below the cost of risk.

[MJW]

@ Blissex

You don't seem to understand the concept of subsidy. The difference between the cost the social renter pays and the market rent is the subsidy. Cost includes opportunity cost, and there is very much an opportunity cost to the rents they forgo, basically the things that the social housing provider, such as the local council, could do with that money if wasn't using it as a subsidy to social renters. The opportunity cost of the subsidy could be the houses that don't get built, the social care that doesn't get given, the potholes that don't get filled, or simply the things the tax paying resident would have spent the money on if their tax was lower. (In practice housing revenue accounts are often ring-fenced from general accounts, but the principle remains).