Commentary: House price worries
One of the major adverse developments affecting the United Kingdom economy over the last twenty years has been the rise in house prices. The Nationwide House Price index shows the average price is 4.3 times its value in the first quarter of 1987, an average rate of increase of 7.6% p.a. Over the same period the Retail Price Index excluding mortgage interest has risen by 3.4% p.a. giving a real rate of return of 4% p.a. over and above the benefits to owner occupiers of being able to live in houses that they own without paying rent. Making the modest assumption that the rental yield is 3% p.a. after allowing for maintenance costs, the total return on housing over this long period has been 7% p.a. in real terms. Comparing this with the return on equities a more reasonable but still high rate of return would have been 5% p.a., with a rental rate of 3% p.a. and capital gains of 2% p.a. Had this happened, house prices would have risen in money terms by 2.92 times since 1987, as compared to the 4.3 times observed. Thus house prices are 47% higher than they would have been if housing had earned a normal return.
Implications of Rising House Prices
Rising house prices are frequently, and correctly credited with maintaining a high level of demand in the economy, which is seen as a contribution to its steady economic growth, at least after the recession of the early 1990s. But rising house prices crowd out saving.
Suppose that people save for their retirement. A high rate of return on housing means that house-owners do not need to save as much, at least provided they are willing to trade down once they retire, or to release their housing equity in some other way. What has seemed to them like manna from heaven is in fact financed by the younger people to whom they sell their houses. Working through the chain, the capital gains of the house-owners are transfers from first-time buyers. It is not the retired people who are disappointed by their circumstances, but the first-time buyers whose capacity to spend on things other than housing is limited by the size of their mortgage payments. The political appeal of this situation is easy to grasp. The burden of rising house prices falls on current and future first-time buyers. Many of these are too young to vote and many more have not been born yet. Thus rising house prices are a transfer largely from people who cannot vote to those who can. This makes it politically very difficult to address the redistribution of wealth to which rising house prices give rise.
Housing Values and Government Debt
There is rather a close analogy between the effects of rising house prices and the effects of government debt. The latter, like the former, imposes a burden on future generations while providing resources to those currently active. Rising house prices reduce the need for people to save to finance their retirement. Low taxes reduce the amount of consumption that they have to give up to finance their retirement, so the effect is similar. Both have the effect of depressing saving which either reduces the economy's stock of productive capital (crowding out) or results in investment being financed from abroad, with a similar effect. In the first case there is a mortgage burden on future generations. In the second case there is a burden of debt interest to be paid. The only significant difference is that the government has to collect taxes in order to pay debt interest, and these taxes have a distortionary impact on the economy resulting in an excess burden. By contrast there is no excess burden associated with rising house prices.
The average value of housing as a multiple of GDP over the period is 2.2 times. With an excess rise in house prices of 1.9% p.a., the average increase in the housing burden has amounted to 4.3% of GDP. Even if we once again allow for the fact that £ for £, extra government debt is more of a burden on the economy than is rising house prices and correct for the assumed value of the excess burden of taxation, this is similar to a deficit on the government current account of close to 4% of GDP.
It is not a very profound comment to observe that increased housing supply is likely to reduce the rate of growth of house prices. Superficially the government seems to have recognized this with a commitment to a target of raising net additions to the housing stock from 180,000 housing units per annum achieved in 2006 to 200,000 by 2016 (Budget 2007, p. 69.) after earlier denying that it had a target for housebuilding. Very old readers will remember that the Conservative government of 1951 adopted a target of 300,000 houses a year (gross of demolitions) which it reached in 1953, taking only two years to raise the output by 100,000 instead of the current Government's ten years to raise it by 20,000. Less old readers may remember Labour's 1960's target of 500,000 houses a year gross in the 1960s which was not achieved, with output peaking at 425,000 in 1968. Compared to what was delivered in the 1950s and 1960s it is difficult to conclude that the Government is seriously concerned about the consequences of the failure to expand housing supply.
As with budget deficits, so too housing booms have an immediate appeal. Their long-term effects are also similar in terms of their capacity to impose burdens on future generations. Given the magnitude of the burden imposed by rising house prices, which is broadly equivalent to a government current account deficit of 4.4% of GDP or around £50bn p.a. one might reasonably wonder whether the fiscal rules which the Government adopted in 1997 have missed the point.
1. Yvette Cooper MP on Newsnight 25th May 2005.