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.
Price

Pt
Demandt

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

Price

Pt+1
Demandt+1
Pt

Demandt

Stockt Stockt+1 Houses

• 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)

250

Real GDP
Real House prices
Real Earnings
200

150
Index (1997=100)

100

50

0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
 Housing affordability: ratio of lower quartile house prices to earnings

10

9 LONDON
SOUTH EAST
SOUTH WEST
8
EAST
ENGLAND
7 WEST MIDLANDS
EAST MIDLANDS
6 YORKSHIRE AND THE HUMBER
NORTH WEST
Ratio

5 NORTH EAST

0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
 Housebuilding: permanent dwellings completed, by tenure, England

400000
350000
300000
Private enterprise
Number of completeddwellings

250000
RSLs
200000
Local Authorities
150000
All dwellings
100000
50000
0
1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006
 Household estimates and household projections, by household type, England only

30000

25000

20000
Number of households (000s)

one person
other multi-person
15000 lone parent
cohabiting couple
married couple

10000

5000

0
1981 1986 1991 1996 2001 2006 2011 2016 2021 2026
 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)
Thousands
3,000

2,500

2,000

1,500

1,000

500

0
1990 1992 1994 1996 1998 2000 2002 2004 2006
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 III
Financial 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 I
Possibilities 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!