There is now an increasing amount of evidence demonstrating that the dramatic rise in house prices being seen in the UK and elsewhere is not caused by a lack of housing supply.
This is a hugely important insight, because boosting supply has been the primary focus of government policy for years. If boosting supply does not solve the problem, than government has been wasting its time, our time, and even making the situation worse.
A compelling argument is found in this blog by Ian Mulheirn. In it he shows how home ownership rates fell even when house prices were falling, and home ownership rates fell in all parts of the country following the 2008 financial crisis, even though prices were doing very different things. In short, there appears to be no correlation between high house prices and falling rates of home ownership.
A second argument found in this post by Simon Wren-Lewis, is that rents have not been rising at the same rate as house prices, and if we were really looking at the lack of supply in the housing market, it would show up in rents.
What is driving the high cost of housing?
So what is driving the huge rise in the price of homes? The answer given by the two commentators is low interest rates, secular stagnation, which has been a worldwide phenomenon. Low interest rates mean that saving through traditional low-risk savings accounts backed by government bonds is no longer attractive. Instead, the middle classes become landlords, choosing to buy a second home, and rent it out.
This competition from older landlords with more to spend has driven out younger buyers. The real reason why we have seen a drop in owner occupiers is that first time buyers can not compete with older buyers, primarily, as Mulheirn argues because banks have become more risk averse and require higher levels of deposits. Middle-class, middle-aged buyers who have built up some capital, can borrow more and simply have more cash to spend than younger buyers.
In London another factor can be added to this, the boom in so-called ‘luxury’ housing which has led to a sharp rise in prices in Central London, attracting yet more speculation.
How to bring down house prices
So how can we bring down prices? The obvious answer to this problem is to remove buy-to-let landlords from the market. This can happen though a rise in interest rates – something which the Bank of England is already planning to do, or by making buy-to-let investment harder.
There are a number of ways the latter can be done. Before 1996 there was no such thing as a buy-to-let mortgages, residential landlords had to take out commercial loans which came with much higher interest rates attached. Restricting the supply of buy-to-let mortgages would be one answer.
Another option would be to make being a landlord harder. For example, by increasing obligations on landlords. This would be very welcome from tenants who have long suffered from unscrupulous landlords operating in a low regulation environment. It would also be welcomed by good landlords who find themselves competing with bad ones.
As it happens, help-to-buy is probably one of the worst policy proscriptions possible in this environment. By increasing the amount first time buyers can borrow more inflationary pressure is added to the market, and younger buyers are locked into an ever increasing bubble.
The next crash will be quick
If house prices do start to fall, the nature of the market means that a downturn could quickly turn into a crash. If it is the case that high house prices are being driven by a lack of supply, than any change to this would be gradual. New supply takes years to be built, and it takes years for capacity to build in the construction industry to deliver higher rates of supply. The problem with supply as a driver of high prices is that it requires a long term fix.
However, if house prices are simply a function of low interest rates and the ease of getting a buy-to-let mortgage, then that is a very different issue. Buy-to-let investors can easily switch to other asset classes. If you are making 4% a year on renting a home, and interest rates hit 4%, then why not switch into holding bonds. They are after all far easier to maintain and you don’t need to deal with difficult tenants.
In previous housing market crashes we had a high proportion of owner occupiers. Crashes were driven by increasing mortgage repossession rates. People would fall behind on their mortgage payments, the bank would take over their home and the bank would sell it. When banks sell homes they do not care about the price, they just want rid of it. Banks are not in the business of owning property. Repossessed homes are often sold at a discount, and high rates of repossession start to bring down the market.
Losing your home as an owner-occupier is an extremely serious matter, and most people will do all they can to keep hold of their home. But buy-to-let landlords are different. It is much easier to sell your second home than your only home. What this means is that things could unwind very quickly. Particularly when a large sector of the market are not professional investors and will not have seen a significant house price crash in a long time. As prices start to drop, there could be a stampede to the door.
The only question that remains is when.