The illogical pricing of property

The illogical pricing of property

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The dream of property ownership has been fostered by Government in the UK for a very long time. Perhaps not as long as in the US, where FDR's New Deal in the 1930s promoted the goal of every American owning their own home: but certainly for over 50 years. Owning a house has become the principal icon of membership of the middle class. 

Yet owning a house is becoming ever more difficult as house price rises outstrip wages. In the US, this tendency was interrupted by the 2007/8 crash, though house prices are now rising again. But in the UK, house prices have risen to the point where in much of the country only the very well-paid can afford property on a single income, and in parts of London and the South East even well-paid couples struggle to afford a family home:


The age at which people buy their first house is rising well beyond the age at which they have their first child, and an increasing number of young people are opting either to live with parents or rent instead of buying. The dream that everyone can own their own home is fast dissolving into the reality of unaffordable and unsustainable house prices. 

In both the US and the UK, people expect property to appreciate. A rise in house prices is greeted with relief, while falling house prices are a cause of worry. But actually this is pretty illogical. Leaving aside the question of the price of land (to which I shall return shortly), there is absolutely no fundamental reason why house prices should rise, either short-term or long term. 

Left to itself, property decays. A house that has been left empty does not remain in the condition that it was when its occupants left: gradually, over time, ivy comes through the walls, rain comes through the roof, and even if vandals don't trash it rats do. If it is neglected for long enough, rot sets in, and eventually it becomes a ruin. The natural course of property value, therefore, is downwards. The effect of people living in property is to arrest that downward trend, because people maintain the houses they live in - which costs money. Maintaining a house at its original value requires additional money to be spent on it. 

 If we assume that the majority of people maintain their houses at the standard at which they bought them, a minority allow them to deteriorate and another minority actually improve them, the housing market should be flat over time. If we further assume, as we do with cars and computers, that new builds have technological improvements such as greater energy efficiency that older houses don't have, we would expect the value of even well-maintained houses to fall over time. But this doesn't happen. Instead of declining in value gradually as they age, houses tend to INCREASE in value. 

This can be indicative of only one thing - a shortage of supply relative to demand. Demand for housing is deliberately increased by Governments promoting the dream of home ownership, encouraging people at ever lower income levels to buy houses and introducing all manner of schemes to help people buy houses they can't really afford, from mortgage guarantees to tax breaks and even outright subsidies. The result, as we might expect, is a tendency to demand-pull inflation in house prices. But for some reason we have come to believe that inflation in house prices is a good thing.  I shall discuss shortly what that reason might be. 

The valuation of land is slightly different. Land is a scarce asset: you can't create more of it except by doing expensive reclamation projects or going to war with your neighbours. The latter is not recommended, but in the not too distant past it was the preferred way for nations to obtain more "living room" (yes, I chose that phrase deliberately). And unlike property, land is not a depreciating asset. It is actually neutral: it is possible to "improve" land, which increases its value, but if you do nothing with land it doesn't deteriorate. The value of unimproved land, therefore, should remain constant. So as with housing, appreciation in the price of land is a consequence of demand exceeding supply. It is, once again, inflation. 

Assuming that we aren't going to waste a lot of lives and even more money trying to capture a few more square miles of land, land scarcity is a brake on housing development. Though not much of one, really - even in the UK, which is often considered "crowded", only about 9% of the land surface is actually built upon. A much bigger obstacle to development of land for housing is planning restrictions, usually put in place by well-meaning governments concerned about the effect on the value of EXISTING housing if lots of new houses are built in nice places. They may also be concerned about the effect on the environment, but that's a lesser consideration really: it's amazing how ways can be found round environmental objections, but not round the objections of existing residents. I suppose that is understandable: there are far more homeowners than environmentalists, and votes matter. But it does mean that trying to get approval to build houses anywhere near a pretty village full of Conservative voters is a minefield.  Farming, too, can seriously restrict the land available for development - though plenty of farmers, suffering from poor returns in farming and attracted by the high price of development land, have circumvented planning restrictions that prevent their land being used for development and sold extensive plots for ribbon development. 

So on an asset that has constant value - land - we build assets that naturally depreciate. Yet we expect both the land and the property built on it to appreciate in value, and we deliberately restrict supply and talk up demand to ensure that prices do indeed rise. Why?

A friend of mine has a beautiful house in the little village of Hartlip, near Sittingbourne. I have no idea how much that house is worth, but it is probably seven figures. Anyway, when I visited him recently I complimented him on his lovely house. And in three words, he explained the reason for the illogical pricing of property. "It's my pension", he said.

That, in a nutshell, is the reason why house prices must always increase. We have come to see houses not as a home to live in, but as an investment - a safe haven for our savings. And the investment is long-term. Most people buy houses with mortgages that are 25 years or more, and during the period of the mortgage the mortgage owner has a claim on part of the value of the house. But when they pay off the mortgage, they have a valuable asset. Now, if that asset had depreciated as it should, they would receive a negative return on 25 years' worth of savings. Oh dear. We can't have that, can we? 

The need to ensure that people don't save diligently for 25 years and end up with an asset worth less than the (principal) amount they paid for it is a sufficient explanation for all manner of apparently illogical and even dangerous behaviour on the part of governments, homeowners, housebuilders, lenders and real estate valuers. Housebuilders, for example, will hoard land, restricting its supply, in order to drive up the price. Some property owners do the same with property, leaving it empty in the expectation that the value will increase even if the property itself deteriorates. Governments prop up overvalued housing markets and pressurise lenders into higher-risk lending. And lenders relax credit criteria, lending more and more to people at higher and higher risk, in the expectation that the rising value of property will always compensate them even if borrowers default. Does this sound familiar? Yes, it's exactly what happened in the run-up to the 2007/8 financial crisis. There is no doubt that expectation of ever-rising house prices encourages excessive risk-taking in mortgage lending, leading to periodic property market collapses and financial crises: Charles Goodhart observed that of four banking crises in his lifetime, three were caused by property market collapses. 

If inflation in house prices is to be not only tolerated but encouraged, it must be countered by stricter regulation of lending standards to avoid unacceptable risks to financial stability. Politically, though, this is not popular. Enforcing lending standards that make it even more difficult for people to buy into an overvalued property market is a certain vote loser. No wonder Governments come up with all sorts of dodges to make it possible for people to buy houses they can't really afford. 

The latest crackpot scheme for helping people to buy ridiculously overvalued property is the UK Government's Help to Buy scheme. The first version of this scheme was effectively a subsidy to housebuilders, since it guaranteed part of the mortgage on new build houses only. Not surprisingly, housebuilders loved it and almost everyone else hated it. It was panned by the Chancellor's own department, and the IMF and the OECD both expressed concern about its possible effect on an already overblown housing market. So of course the Government is now extending it - to buyers of existing houses and remortgages. 

This looks like complete madness. But actually, there is a sort of warped logic to it. Let's start from the premise that the primary purpose of house purchase is not to provide a home to live in, but to acquire an appreciating asset. There is actually a desperate shortage of safe assets for ordinary people to invest in: savings banks disappeared long ago, the Cyprus disaster showed that lending banks and building societies are not safe places for large amounts of money, and the Government is trying to reduce issuance of gilts ("We have to get the deficit under control"). I don't know if Reinhart & Rogoff realise what damage they did when they invented their 90% threshold for government debt becoming "unsafe", but by creating the myth that a high level of government debt is always a drag on growth they made it virtually impossible for governments to provide safe savings vehicles for ordinary citizens. No wonder government has started to rely on property as a substitute safe asset for ordinary people. No wonder it is hell-bent on persuading as many people as possible to buy houses. No wonder it is determined not to allow property prices to fall, as they naturally should. And no wonder it is resorting to mortgage guarantees (Help to Buy) and outright subsidies (the Right to Buy is a subsidy) to tempt people to buy. The only other choice it has is to issue far more government debt, and hope that future growth will be sufficient to keep returns above inflation - or, of course, invest the proceeds of that debt issuance productively to generate that future growth.

Not all Western countries use property as a savings vehicle. Germany, for example, does not. In Germany people save with savings banks (Sparkassen) which invest those savings in businesses. There are hundreds of these savings banks, most of them are publicly owned and all are in effect backed by Government. It's all a question of where you put your Government guarantees - do you guarantee property investment, or do you guarantee business investment? There have been calls for the UK to develop a similar network of small savings banks, but I fear this is a non-starter. For the UK to release the savings needed to fund such a network, it must end its love affair with property. And I don't think that is likely to happen any time soon.

What bothers me the most about the UK's property addiction, though, is the effect on growth. Ever since the war, the UK's economic performance has been less than spectacular. And I think it is the property addiction that is largely the cause of the UK's tendency to stagnation. Consider this: if people see buying a house as their top priority, they will cut other spending in order to pay the mortgage. Property prices have risen enormously in the last 15 years, far faster than wages:


If property prices continually rise faster than wages, then the amount of spending that is taken out of the economy and diverted into payments to lenders constitutes a serious reduction in demand. Admittedly, in the 2000s we compensated for that demand drop by ramping up consumer credit, but that gave us a mammoth hangover from which we have not yet recovered. And of course our obliging Chinese friends have produced goods at much lower prices for us to buy, so we haven't noticed the reduction in our spending power quite so much - but we have noticed a fall in manufacturing and the growth of a considerable trade deficit. We have also, in the last five years, had very low interest rates, which at least makes mortgages vaguely affordable (mortgage payments at over 50% of income, as they were in 2007, is not remotely sustainable): 


Does anyone REALLY think interest rates will return to the levels of the past while house prices are so high? 

It is a fallacy to suggest, as some do, that lenders recycle mortgage interest payments back into the economy in the form of productive investment. They are much more likely to "recycle" them into more mortgages, other economically unproductive investments, shareholder dividends and bonus payments to executives. Indeed, if the effect of house price rises outstripping wages is to depress consumer demand, I would expect that over the longer-term, a rising property market would correlate with poor business investment. When they can't see future sales, businesses won't invest....

If I am right, then the use of mortgaged property as a form of long-term saving is toxic for the economy if it results in ever-rising house prices. But there is one other factor that is even more damaging - and that is the political power of retired, debt-free homeowners. These people own valuable assets that continue to appreciate. I don't see any sign of elderly homeowners selling their assets and living on the proceeds, as we might expect if - like my friend - they really viewed their houses as their pensions. No, they don't. They expect to keep their assets and be supported by the State. And they lobby politicians to ensure that, for example, the cost of their care when they are too frail to care for themselves is largely borne by taxpayers. If politicians agree to this - and because of the size of the grey lobby, failing to do so looks like electoral suicide - the result must be yet more depression of demand in the economy, as younger working people pay ever more for houses while also supporting asset-rich elderly people through their taxes. I can't see how this is remotely sustainable. At some point, there must be a reckoning: either the elderly must sell their assets, causing a significant fall in property prices, or they will have to be taxed on those assets to subsidise younger people's purchase of property that is priced out of their reach. 

It's not difficult to see which direction we are heading in at  the moment. Help to Buy is the start of Government subsidy of house purchase; the so-called "mansion tax" (currently shelved) would be the start of asset taxation. But I'm not convinced this is the right direction.

Either houses are homes to live in, or they are investments. If the latter, then house prices must continue to rise - in which case we will inevitably have to support house purchase with Government guarantees, tax breaks and subsidies, so that demand doesn't fall through the floor due to people spending ever more of their income on houses. This does make some sort of sense: people need to save for their old age, and since Government has tied itself into a straitjacket that prevents it using public debt for its real purpose - to provide safe savings vehicles for citizens - property is a reasonable substitute. But don't then provide pensions, health care and social care to the asset-rich elderly from the taxes of the young who are also trying to buy houses at far higher prices than the elderly ever paid. Let the elderly sell their assets and live on the proceeds. After all, that's what savings are for. 

But we don't have to do this. We can restore housing to its real purpose, which is to be homes for people to live in. We can build or renovate enough properties to ensure that supply matches demand, so that house prices are not constantly driven upwards by supply shortages. We can tax away unearned profits on unimproved land, and we can tax away profits from speculative investment in property. We can allow government debt to become the preferred savings vehicle for ordinary people, issuing as much of it as people want to buy and using the proceeds to upgrade our national infrastructure and support domestic enterprise. And we can stop draining our economy to support a bloated property market.  

Related reading:

UK Housing Market Stats and Graphs - Economics Help

The illusory housing recovery - Coppola Comment

Government debt isn't what you think it is - Coppola Comment


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Frances, thank you for a thought provoking article. I would be interested in your views on the commercial property market. Do you see parallels with the domestic property market? If commercial property is also viewed primarily as an investment rather than a place where businesses can start up and grow, do you think that is likely to further depress business investment?

Dear Frances,
As your graph shows, prices more than doubled under New Labour and a had a brief spike after one of Lawson's underlings typed "August" instead of "April" in his budget speech. So there is not a single long-term trend. There is a not-quite-exponential trend under New Labour preceded by various moves over the previous two thousand year which raised the level to a bit under half that in 2010.
So, while I agree with some of your analysis I feel that the causation goes the other way in a few cases. e.g. house prices will not stay so high if interest rates return to normal levels.
The devotion to home ownership is partly due to the desire to be certain that you could still have somewhere to live after retiring, partly to it being the only assert class where Gordon Brown would not tax you on the imaginary profit resulting from his systematic debasement of the currency. This predates any impact of Reinhart & Rogoff in the UK.
The key factor in the shortage of supply is government regulations: the Attlee government did not think about multi-storey blocks of flats so every time there is rebuilding in London more people are forced out into commuterland. I think that you are misjudging housebuilders - naturally they will hoard land if the rise in land prices exceeds the return on capital that they can earn from building houses but that assumes an economic disaster scenario to start with.
Speaking as a member of the grey vote (I am older than you and going grey at the edges but far less elegantly) I can state that not all of us object to paying our bills. Our commitment to providing for our kids extend to my working well beyond NRD (albeit my wife expects me to retire by the time she reaches 65) but not to leeching off others. Why should our house not be sold to pay for care bills for the last survivor who will no longer need it to live in?

Excellent article. However, you did not touch on the reason for this obsession with home ownership as a necessary objective of public policy. It is not much different from indentured servitude. People in debt are much easier to control. If you risk losing your home because you can't make your loan payment, or you are liable to losing health service with your job, then you won't organize or take up any role in society that will conflict with protecting these "assets".

(For some reason part of my comment disappeared!)

I'm not sure there is anything inherently wrong in acquiring a house as security for your old age - as long as it is intended to ensure you have a roof over your head. If it is treated as a /financial/ asset, it is no less crazy than investing your life savings in gold bullion.

You suggest "property prices" should "naturally fall". I am not so sure. If you only look at the building, this is true, of course, but if you include the land then the price will be determined by supply (e.g. planning permission) and demand (e.g. Help to Buy).

It is also not clear whether, overall, deflation of property prices would be better than modest rises, if only for the effect continually falling prices might have on the population's behaviour. Just like a little bit of inflation in the rest of the economy, both for prices and wages, is on the whole a good thing, a little bit of property price inflation might be preferable over deflation.

Given the overwhelming role of (building) land price, I do wonder whether the ownership structure of land is an important factor in the peculiar UK property price situation. In my country of origin (Belgium), most building is done by households on individual plots of land, and only a small fraction is done by developers. When a large amount of land is made available for building, it is generally parcelled out and sold as individual lots.

I am not sure what the effect of a more individualized market, with households as key players rather than large building companies, would be on the obsession with property prices in the UK. It is not quite as extreme in Belgium as in the UK, but that may have other reasons for this (not least the high cost of acquiring property, which means most people stay put once they own a house).

By the way, in the last 10 years the average number of new dwelling starts has been between 40,000 and 50,000 (about 45% houses, 55% apartments) - in a country with less than 5 million households. Compare this with the UK's 26 million households, and you have an instant illustration of why the problems with UK housing is by and large on the supply side...

Long article, but I don't think such a comprehensive analysis could be squeezed in anything shorter - it really gets to the very core.

You make a point that apparently remains elusive to far too many people: there is a distinction to be made between a house of bricks and mortar and the land on which it sits. House prices are really land prices.

As if to illustrate how easy it is to fail to make this distinction, having illustrated this distinction so clearly, you then readopt the common inaccurate phrase: "That is the reason why house prices must always increase". The real asset people consider to be their pension isn't the house any more than the wallpaper against its walls- it really is just the land (and of course the fact that it has permission for a house to be on it).

As this doesn't really detract from the strength of your argument, this may come across as a somewhat pedantic point. However, I think it is important to be clear that it's not *house* prices but *land* prices that are the problem. Remember John Prescott's "£60,000 house" challenge, which implied that affordable housing was a matter of the construction cost of the bricks and mortar, rather than the price of the land.

There remains almost universal cultural acceptance of the concept of house price inflation as a desirable and effective means to increasing personal wealth. It is depressing that this continues to be so when high house prices have reduced standards of living for the majority and not created meaningful wealth. Housing is not an asset that can be arbitrarily disposed of, being required to serve its primary purpose of providing accommodation.

The impact on the economy has been equally destructive. High house prices have decreased UK competitiveness through increased living costs and wage demands, as well as channelling investment away from wealth creating activities. The damage caused to the UK economy from such unproductive activity will be long term.

The premise that house price inflation arises through encouraging investment (really speculation) on property is absolutely the right one. However, please, please do not continue to repeat the mantra that house price inflation arises from a lack of supply. The supply of housing cannot fluctuate as a typical commodity and supply can never increase sufficiently to influence price levels. This is evidenced in Ireland and Spain where relative oversupply did nothing to limit house price inflation in a speculative based market. A lack, or perceived lack of supply creates the conditions for house price inflation but is not the reason for it. The perceived lack of supply in the UK has more to do with 1.4 million properties becoming financial investment products in the form of buy to let, a demand side increase that also reduces the supply of housing available to purchase as a home.

House price inflation arises through the inherent incentive to pursue capital gains through speculation on rising prices, whether homeowner, buy to let or other investor/speculator. Homeowners are more than willing to believe the mantra that house price inflation is caused by lack of supply, as this justifies their speculative investment and removes any personal responsibility. Homeowners, however, are entirely complicit in house price inflation, knowingly or otherwise. A primary driver of house price inflation comes from the incentive to seek a maximum asking price and associated capital gain when selling, combined with the willingness to transfer any such gains, coupled with further borrowing, onto a subsequent property purchase, under the premise of increased wealth; the fabled "property ladder". The effect is inflationary.

It is entirely the notion of tax free and unearned income (i.e. without productive effort) that drives house price inflation. As a result, house prices are always governed by a speculative bubble cycle. In a rising market, the incentive for speculation grows ever stronger, encouraging greater leverage and increased transactions. Supply cannot adjust sufficiently to influence prices and the resulting perceived lack of supply heightens the incentive for speculative behaviour. Eventually the increasing debt level becomes unsustainable and the market collapses, to repeat once capital gains become attainable again.

The only way to control house price inflation and for housing to become for the provision of accommodation and no longer a source of financial speculation and profit seeking is to remove the incentive to seek capital gain. Practically very easy, politically very hard.

More thanks for me, this article crystalises most of my thoughts on the slow-motion car-crash that is the property "industry" (funny, I thought shelter was a human right?).

Lack of supply has been the long running issue but the current tax and interest rate regime actively promote the follow-on problem of "Property as a Pension". As long as property is allowed to generate returns far in excess of savings/investments/pensions then that where all the money will go. At least until the majority of owners start to downsize when there'll be nobody to buy these "assets".

I can only hope that those controlling the market (PMs, banks, developers, all who gain from booming prices) gain some conscience and recognise the long-term damage being done. I fear we'll have to go through another boom and uncontrolled bust before any action is taken... Pretty depressing to think that like Japan we'll be paying the price for decades, even if action was taken right now.

Another excellent article- thank you. You seem to be leaning towards the positions put forward by Henry George in the latter part of the 19th Century, but haven't quite made the leap (perhaps you have, and I've missed it!).
As we can't escape our dependency on land, then naturally the economic excess of labour will manifest itself in higher land rents. In an environment where the definition of private property extends to land, then these higher rents can be collected by the land owners at the expense of the those that create the wealth. While you are correct that distortions in the supply side due to planning restrictions exasperate the problem, in a planning regulation free world, a plot in a city centre would still be worth many times more than a plot in the countryside.
I would simply recognise that the value (increse or constant) or a plot is made by the community who provide services to it, the community who respect ownership of it, the state that protects claims to it, and the state the artificially inflates its price by restricting competition (planning)- and that this is an ongoing value that is consumed by the owner. As proof, if any one of the the elements above were to be removed/ changed significantly, the price of the plot would change hugely.
To tax this consumption is not only fair, but economically would allow people to actually invest- not pay ransom money for 25+ years to banks and landowners. I'm not sure if investing in govt. debt is the solution, but in a free market, if the government can make a good case for investing in it- then I wouldn't object.

"Though not much of one, really - even in the UK, which is often considered "crowded", only about 9% of the land surface is actually built upon. "

Less than that, Frances.

Frances Coppola


I agree. Home ownership is not a bad thing. It is the confusion of homes with investments that is the problem. I didn't discuss the question of rental values in this post, but rents are also pushed up by high house prices. High house prices hurt everyone, one way or another.

A home is a liability, not an asset as it doesn't earn anything. People always get this wrong. But while your post is as always perceptive and right, your solution is unlikely to be implemented in a system which depends on voters - grey or otherwise. I would take the phase 1 of the Help to Buy but drastically reduce the top limit to £100 or £150k for owner-occupiers only (ie not for Buy to Let). This will promote the building of starter homes (including conversions from mills etc as long as a substantial units were involved) which will help people to get on the 'ladder'. It will have minimal effect on the market further up. It will also help people out of rented accommodation and therefore slash the ridiculous housing benefit bill. Phase 2 is clearly stupid, even though popular, and bringing it forwards is just a knee-jerk reaction to the slump in sales this autumn or perhaps a nice line for the Tory conference (I don't know whether Clegg was consulted on this coalition government policy change).

In round numbers we have 25 million homes in the UK. A home (house/apartment/whatever) lasts approximately 100 years, give or take. Some longer but there aren't many those, some rather less like tower blocks pulled down. Any long term house building rate less than 250,000 per year is not replacing the housing stock, let alone providing housing for population growth whether by birth or immigration. This has been going on for at least 30 years so we need a long term 30 year+ plan to restore the housing market to health and stop people imagining that they are 'earning' money because their house value increases. Having your wealth tied up in such illiquid sources is not financially healthy.

To my mind housing is the number one problem of the UK economy and, as you suggest, pre-occupation with is a source of many of our ills. Home ownership per se is not a bad thing - the alternative is to become a victim of landlords who charge 'market' rent on property that they bought 20 years ago and already own outright.

Frances Coppola

Simon, thanks.

A rise in US interest rates would raise funding costs for lenders, which would be likely to force up mortgage interest rates. However, that would risk a property crash. I think therefore that the Government (or the Bank of England) would have to do something to depress funding costs for banks. Indeed they have already done this: Funding for Lending was introduced as a response to rising bank funding costs during the Eurozone crisis, because mortgage rates were starting to increase. They would unquestionably do more to protect the housing market from a crash in the event of a sudden rise in global interest rates.

GRADUAL rises in interest rates could be a good thing for the housing market, because that would depress the tendency of house prices to rise. I'm not sure politicians would see it like that, though.

Thank you for another superb article that goes deeper than most analyses that I have read on this issue.

I wonder how UK property would be affected if interest rates are raised in the US (probably won't happen for a while, but conceivable in the next few years). Could this reduce the demand for gilts, resulting in a rise in UK rates and a property crash, or is it always possible for the UK government to force rates to stay low, under any circumstances? I'm not an economist - I'd be very interested to hear an expert opinion.

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