6 May 2015
IT’S NOT ABOUT HOMES, IT’S ABOUT HOUSE PRICES
Politicians, journalists and sundry do-gooders seem, against the odds, to have discovered one fact on which they all agree. It seems that Britain has a housing shortage and, to paraphrase the late Vivian Nicholson, we must build, build, build. Whenever an opinion, no matter how compellingly simple, is presented as a fact with which no one could disagree it is wise and even compulsory to question it.
I bought a dead tree copy of the Times last week (28 April 2015) and there was an opinion piece about housing that contained this sentence: “It’s reckoned that we need about 250,000 new homes a year”. It didn’t add who reckons that or why. But once you start googling “250000 new homes” you quickly light upon a report written in 2003 by Kate Barker, a one-time stalwart of the Bank of England Monetary Policy Committee. It is reckoned, as they say, that this report demanded 250,000 new homes a year and eleven years on that has not been achieved once. It would appear that the nation has accumulated a bit of a backlog: to be more precise, a backlog of 845,000, that being the difference between the actual number of completions and 2.750,000 (11x 250,000).
So what did the esteemed Kate (now Dame) Barker actually say in her report? Did she really demand that 250,000 new homes should be built every year? (Spoiler: no).
The first line of the report is this:
“The UK has experienced a long-term upward trend in real house prices.”
And there’s a clue. I think it is fair to say that the primary motivation of this report is to make housing more affordable by increasing the supply in order to restrain prices. Here is the section that deals directly with the question of how many new houses are desirable:
“Looked at purely from the perspective of the UK economy, more housing would be beneficial. Different approaches to measuring the shortfall, produce a range of estimates:
• projections of population growth and changing patterns of household formation (a proxy for future demand), compared to current build rates implies there is a current shortfall of 39,000 homes in England per annum, of which 8,000 are private sector and 31,000 are affordable homes. In addition there is a backlog of around 450,000 households without self contained dwellings;
• keeping affordability for new households in line with that in the 1980s would imply a current shortfall of between 93,000 and 146,000 homes per annum in England, of which, 20,000 to 45,000 are owner occupied private sector homes and 73,000 to 101,000 are affordable; and
• reducing the long-term trend in house prices to zero real growth would imply an additional 240,000 homes per annum across the UK. To lower real trend price to 1.1 per cent, 145,000 more houses per annum might be needed, about double the current private sector housing output of 150,000 units.”
So let me summarise. The first bullet point deals with how many extra houses were needed for our housing needs. That was 39,000 (of which only 8,000 were private sector) on top of the 180,000 gross new builds that were the typical annual totals at the time. That suggests 220,000 new homes per year.
The second and third bullet points are purely concerned with intervening in the housing market for the express purpose of manipulating prices (downwards, obviously).
I’m not sure where that round number of 250,000 comes from. None of her estimates reach that total but what is absolutely clear but scarcely ever mentioned is that this number, to which everyone in public life appears to subscribe, is the result of an ambition to game the housing market.
So what happened? In 2003, housing completions ticked up to 190,000 and then continued to rise each year to 203,000, 210,000, 213,000 and then 226,000 – above Dame Barker’s estimate for housing needs! – in 2007.
So what else happened? In the four years 2004-7 average house prices rose by 35%. Dame Barker would probably say that this was because the country was building only enough homes to live in. Houses were becoming increasingly unaffordable, having risen from c.8x average earnings in 2003 to nearly 10x in 2007.
You might conclude that we should have built more. Here is a quote from the Taylor Wimpey 2007 annual report:
“The UK housing market continues to exhibit a structural undersupply of new housing against Government projections of household formation, providing support to the market in the long term.”
What could possibly go wrong? Readers of this website can find part of the answer here. Suffice it to say that Taylor Wimpey’s share price hit a high of around 5 pounds in 2007 and a low of around 5 pence in 2008. The company, along with almost everyone else, believed passionately in the “structural undersupply” of new housing and found that it had extended itself to the edge of destruction when the financial crisis hit.
There is a neatly symmetrical narrative to this continuing story. After five years of housing completions below 150,000 the sector is back in some sort of health and since 2011 a revived Taylor Wimpey has had a new non-executive director by the name of Dame Kate Barker.
SO WHERE ARE WE NOW?
Average house prices are now again 10x average earnings. This fact puts politicians in serious difficulty. They find it hard to reconcile two widely held views: that property owners expect their houses to behave like investments and that those not on the “housing ladder” rightfully wish to take a first step. It is obvious that the interests of these two groups are potentially at odds.
Every political party is in favour of building more houses, even the Greens (500,000 and absolutely no rabbit hutches). I wonder if they have really thought this through. Those who own houses and want to see their value rise will not necessarily favour new supply, especially if it is local. Those who are waiting to get on the housing ladder might well think that they are being enticed into buying new homes at the top of the market.
The 250,000 annual target is a fudge. It is a way of trying to cool house prices without saying that you want them to fall. It ignores recent history in which universal belief in “structural undersupply” nearly wrecked the UK housebuilding industry.
HOW OVERCROWDED ARE WE?
Political fudging aside, what evidence is there of a critical shortage of housing in the UK?
There are 28 million dwellings in the UK (government stats for 2013) of which 17.7 million or 63% are owner occupied. 19% are privately rented and 18% are rented from housing associations or local authorities.
In England, 37% of dwellings have more than one spare bedroom. 34% have one spare bedroom. 7.6 million people live alone and on average have just over two bedrooms each.
The big picture is that there are 65 million of us and on average two and a third of us live in each dwelling. Perhaps two’s company but two and a third’s a crowd?
4.5% of households in England and Wales are officially “overcrowded”. This is a technical term calculated on the basis of assigning bedroom needs to children depending on the age and gender and requiring two rooms that are not bedrooms. So overcrowding, where it occurs, is an official fact, not an opinion.
It comes as no surprise to learn that the national average for overcrowding is dominated by London where 11.3% of households are overcrowded. What is somewhat ironic is that some of the new building that we see all around us in London is of flats that will be overcrowded by definition. Down the road from where I live there is Deptford in which one can acquire a new studio flat consisting of a living/kitchen area with a bedspace and a bathroom: that’s two rooms in total and is probably offered with couples in mind. According to the official definition of overcrowding, even “a one-person household requires three rooms in total”. In case you’re wondering, these pre-overcrowded studio flats cost around £320,000.
By contrast, more than 50% of households in Rutland have at least two spare bedrooms. Rutland is not crowded, it is two hours from London and it is infinitely more beautiful than Deptford. I would suggest that many people living in London in overcrowded accommodation are choosing to sacrifice home comforts for work and other urban amenities. This may not be the best of all possible worlds but it is not a crisis.
If we have a problem it is first, that people do not want to live where accommodation is relatively plentiful, secondly that too many of us live alone and thirdly that the elderly tend to be “bedroom blockers” by lingering in family properties from which the children have moved on.
Before we start wagging our fingers let us remember that in theory people should be able to live where they want, with whom they want and in whatever type of property they want. It is usually financial considerations that thwart the fulfilment of our accommodation dreams.
HOW MANY NEW HOMES WILL WE ACTUALLY NEED?
Regardless of who owns all these homes, how is demand likely to develop over the next five, ten or twenty years?
Let us first look at the big numbers. The Office for National Statistics (ONS) expects the population to rise by 2.6 million (including migration) by 2020. We already know that we use one dwelling for every two and a third people. 2.6 million divided by 2.33 is 1.12 million new homes over six years. That’s 186,000 new homes needed per annum.
What sort of homes will we need?
It is fair to say that young and old people are better suited to smaller properties or apartments and middle-aged people to larger family homes. Due to demographic numbers we have a pretty good idea of how this is going to play out. Let us assume that the age group with the strongest demand for family homes is 30-59.
In the early 1970s this age group was 35% of the population. It peaked at just below 42% in 2003. In 2015 it is just below 40%. According to the ONS, it will be 39% in 2020 and 37% in 2030. (These estimates include “medium” assumptions about immigration).
Incorporating the ONS’s total population forecasts, our 30-59 age group represents 25.8 million people now, 26.2 million in 2020 and 26 million in 2030. Assuming that most of these will live as a couple, that’s a requirement of 12.9 million family homes rising to 13.1 million in 2020, an extra 200,000 or 40,000 a year.
40,000 a year is peanuts. There were 38,000 new detached houses registered in the UK last year and 145,000 new homes in all.
A different question is whether the UK is preparing for the forthcoming flood of downsizing oldies. Over-75s are 8.2% of the population now: they will be 11.5% in 2030. In headcount terms, that’s an increase of >50% or 2.85 million extra greyheads. Assuming that, given the demographics of their generation, 70% of those 2.85 million people are owner occupiers there could be quite a number of family homes coming onto the market.
The mathematics suggests that there could be 1 million homes coming back onto the market over the next 15 years. I get this number by taking 70% of 2.85 million and assuming that one family home becomes available for every two owner occupiers who downsize. Over 15 years (2015-2030) that’s around 65,000 a year on average. I have already calculated that with no extra supply we will need only 40,000 new family homes a year.
Demand for homes is all about demographics. And we have peaked. Here’s a thing that hasn’t peaked but will in fact climb inexorably for longer than any of us is likely to live: unfunded pension liabilities. That’s those pesky greyheads again. This topic is better deserving of the word “crisis” and consequently not a topic of choice for a politician standing for election in 2015.
WHY ARE PROPERTY PRICES SO HIGH NOW?
Given my claim that our housing stock is basically sound and that there are doubts about the long-term demand for new housing based on demographics you might reasonably ask me to explain why property prices are so high.
I am afraid that the answer once again leads back to QE.
Average house prices are back at their high, relative to average wages.
Most of us remember a time when the main reason for buying property was in order to have somewhere to live. Mortgage providers would lend according to their view of our ability to service the interest and ultimately repay the principle.
In the 1970s average UK house prices rose by 474% which, at the time, was considered quite a boom. As it was also a decade of explosive wage inflation, house prices largely stayed with a band of 5-7x average earnings. Mortgage lenders would typically cough up loans of 3-4x earnings (to men, rarely to women) implying that buyers would need to find deposits of at least 20% of the purchase price.
The key mortgage lending decisions in the 1970s, ‘80s and ‘90s were driven by the income of the borrower on the basis that this was the soundest indication of his or (after the ‘70s) her ability to repay.
This condition was undermined in the 21st century with particularly notorious results in the USA where mortgages were not even secured on the property. During the first years of the 21st century US housing starts rose from around 1.7 million a year in 2000 to 2.2 million a year in 2006. Home ownership, cheered on by politicians, obviously, became speculative – people bought houses hoping to flip them for a capital gain – and the world of finance securitised the toxic assets that many of these mortgages were and had great sport stuffing each other with them.
Kate Barker would probably have approved, though she might have seen the impending collapse of global financial markets as a high price to pay. The US built far more homes than it needed and median real estate prices fell by nearly 20%. Such was the scale of the oversupply that housing starts fell by 75% and stayed there for a few years. (They are now about 50% below the 2006 peak).
We avoided such extremes in the UK. New housing completions fell by 40% at worst and prices by 15%. Most importantly, mortgages in the UK are secured against the property meaning that neither the creditor nor the debtor had a strong incentive to effect a default (in the US some people who could afford to service their mortgages would simply choose not to and hand over the keys of the house if they were making a notional capital loss). UK banks began to allow borrowers to refinance at low short-term fixed rates, encouraged by the Bank of England cutting its Bank Rate to 0.5% in March 2009, at which level it has just celebrated its sixth birthday.
Low mortgage rates have become normal and recently offers have become bolder. HSBC has a 5 year mortgage fixed at 1.99%. It is true that these are teaser rates that tend to jump or incur serious penalties at the end of the period. It is also true that teaser rates didn’t work out so well for the US housing market. But it seems that the banks now trust the Bank of England to protect them by keeping rates down sine die.
In the most recent Bank of England minutes it noted the position it had stated in February 2014:
“…given the likely persistence of headwinds weighing on the economy, when Bank Rate did begin to rise, it was expected to do so more gradually than in previous cycles. Moreover, the persistence of those headwinds, together with the legacy of the financial crisis, meant that Bank Rate was expected to remain below average historical levels for some time to come.”
This remains the status quo and Governor Carney is being taken at his word.
Cheap mortgages undoubtedly help make apparently expensive properties affordable and they have, for the time being, effectively cut the anchor that used to tether house prices to incomes. This doesn’t matter for as long as we remain in this era of unprecedented low interest rates. But it would matter very much if interest rates went up and house prices fell at the same time. Cue an outbreak of defaults and forced sales into a messy market.
A large number of people appear to believe that this can never happen.
My own view is that interest rates will continue to stay low for longer than most of us can imagine. That should at least reduce the possibility of the double whammy of higher rates and falling house prices.
But house prices are vulnerable for the following reasons.
THEY HAVE BEEN BID UP BY Q.E.
Although distressingly illiquid, houses are treated as investible assets and as such their prices have been inflated by QE which has bid up the prices of potentially competing investments. Bonds and equities may look high but you can liquidate your positions in them in minutes. To avoid a crash in house prices you will need to see six months into the future. Nobody knows when the magic dust of QE will dissipate.
NEXT GENERATION BUYERS WILL BE POORER
This summer, the first year of graduates burdened with penal interest rates on their student loans will start to enter the careers market. They will be materially worse risks as first time buyers and indeed second time buyers and should find that their access to mortgages is negatively affected. Note this is not down to the size of the loans (despite this predictably being the only point of interest to politicians) but to the scandalous repayment terms.
HOUSE BUILDING POLICIES ARE DESIGNED TO DEPRESS PRICES
Every political party is claiming to being committed to enticing or commanding more house building. They may not realise it but they are subscribing to a policy designed to curb house prices.
DEMOGRAPHICS
Finally, the demographics tell us what is going to happen. We will need relatively fewer family homes and relatively more retirement accommodation. Many of the people planning to downsize are relying on selling houses whose prices have risen four or fivefold in real terms since they bought them. Who is going to buy those houses?