Our housing market needs renovation

Monday, May 21, 2018

Like most young people who want to own their own home one day, I worry about our dysfunctional housing market. In London, the house price/earnings ratio has risen to 12.2, which, given that most banks will only lend five times a borrower's salary, puts housing out of reach for the vast majority of the population. According to the Resolution Foundation, it now takes over 10 years to save for a deposit, up from less than 2 years in the 1980s. This is both inefficient on the macro-level, as it prevents labour from moving to where it is most efficient, but it also causes equity concerns. The broken housing market is causing knock-on effects in the rental market, where private renters spend 36.3% of their income on housing costs, as opposed to 12.1% for those who own mortgages. It will also have large implications on voting behaviour. Typically, the act of buying a home and obtaining capital would be the turning point that correlated with people starting to vote Conservative. With fewer people owning houses, the Conservatives might see their voter base die off.


There are two broad problems with the status quo. The first are policies such as Help to Buy (HTB) which have stimulated the demand side of the economy, without having a corresponding impact on the supply side. HTB allowed some homes to be purchased with only a 5% deposit, aided by low-interest government equity loan worth up to 20% of the purchase price. However, this meant that on the simplest level, there was now more money chasing the same number of housing stock, pushing up the price of housing. Indeed, Sir Stephen Nickell, a senior official from the Office of Budget Responsibility noted that "Is it just going to drive up house prices? By and large, in the short run, yes." Furthermore, he went on to mention that the "historical evidence suggests" that the increased house prices won't have a large effect on house building. This is because the housing market has a very low price elasticity of supply. An increase in the price of housing has a less than proportional effect on the supply of that housing. This is because of long delays in being able to obtain planning permission, and the high barriers to entry involved in starting a build.


The second problem within the housing market is that there are structural faults with how builders operate. In 1960, the 10 biggest house builders only produced 9% of all new homes; by 2015, the top 10 accounted for 47% of all new-builds. This market concentration has led to sector being described as having "all the characteristics of an oligopoly" according to a recent inquiry by the House of Lords. Crucially, it is these SMEs who tend to be the most efficient in converting planning permission into homes, in order to sustain cash flow, but by 2011 SMEs comprised only 11% of new builds.


Builders face perverse incentives. The first is to undertake land banking. The Ministry of Housing, Communities and Local Government estimates that 40% of permissions granted are allowed to lapse. This is because builders have an incentive to wait until house prices rise even further before deciding whether to build. By holding on to this land, larger companies prevent smaller builders from building houses where there is strong demand in order to retain upward pressure on house prices. The second incentive that builders have is to increase the amount of time taken to build houses. In 2013, it took on average 1.7 years for developers to start and complete building. By 2017, this had risen to "at least 4 years on average"; a 2.4-fold increase over just 4 years. This is again because of how developers prefer to sit on the houses that they have built, and slowly release them onto the market in order to keep prices high.


If we are to solve rocketing house prices, then the solution seems fairly simply. The answer is more nuanced than simply building more houses – it is to interrogate the structural flaws within the housing market and to remove them.

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