Wednesday, 31 July 2013

Economic Myths: Building More Houses Will Make Them Cheaper

Matthew Lynn of Moneyweek has a go at the so called "Generation Y", today's young people.

If you read all the press coverage, you’d find it hard to believe life could get worse for Generation Y. The youngsters born in the 1980s and 1990s appear to have no end of problems – and not just trying to decide whether to buy the iPhone 5 or the Galaxy S4.

They are stuck at home with their parents because they can’t afford overpriced houses. They are burdened with the cost of an education their parents got for free. There are few jobs available and they have to sweat as unpaid interns for years to get on the career ladder. And through taxes they have to subsidise their grandparents’ free bus passes and winter fuel allowances – even though the 60-somethings have more money than them.

But in reality, this generation has a much easier time of it than either Generation X or the Baby Boomers. And they in turn had easier lives than their parents back in the days before generations were alphabet-coded. That hasn’t stopped yet another report this week from laying out the problems faced by today’s 20-somethings. According to the National Housing Federation, a “jilted generation” is being created that can neither afford to buy a house, nor pay spiralling rents. More than 3.5 million young people will be living with their parents by the end of the decade, it argued.


but his solution to the problem outlined by the NHF is a persistent economic myth:

But if Generation Y wants to do something about this, it should campaign for the green belts around our major cities to be ripped up. If planning laws were relaxed, far more houses would be built immediately – lowering the cost of housing.

This is real man-in-the-pub, stands-to-reason stuff. Prices are high because there is high demand and low supply, put up the supply and prices will fall. Sounds reasonable, law of supply and demand and all that, but history shows that is not the case. The 70's in the UK were a time of unprecedented housebuilding. They were also a time of unprecedented house price rises. Prices in Spain and Ireland were unaffected by huge building booms.

What brought them down was a collapse of the credit supply. On the face of it, it seems counter-intuitive, that the price of houses should be controlled not by the supply of houses, but the supply of money, or, more specifically, credit. What Generation Y should be hoping for is not more housebuilding, but a rise in interest rates.

That will reduce the multiplier of annual income that is the maximum the lenders are willing to lend, which, in turn, will reduce the price of housing. Since interest rates can't go down much more without being negative, the only way for them to go in the long term is up.

33 comments:

Mark Wadsworth said...

I think there's a more subtle explanation.

Higher pop density = higher rental values.

If they build more housing, they will tend to build it where prices are higher.

So people will move from low density to high density areas.

Therefore in the high rent areas, rents will go even higher.

Admittedly, rents in low rent areas will fall (see Detroit), but in overall terms rents will go up by more than rent in low rent areas falls.

The only analogy I can think of is that keeping house prices down by building more houses is like trying to cool down a fire by throwing more twigs on it, on the basis that flames are hot and twigs are cool.

Dinero said...

That observation suggests a tweak to the "help to buy scheme" along with new house, first time buyer stipulations also stipulate that the house be out in the sticks. Sounds a bit Soviet though.

Mark Wadsworth said...

Din, fact is, in the UK there are plenty of houses in very marginal locations which are abandoned or which you can buy very cheaply, but nobody wants to live there.

Fact is, people want to move from low or no wage areas to higher wage areas, and higher wage areas are also higher rent areas.

So if they build houses in the right places, yes, wages will go up and the economy will do better (hooray) but most of those gains will go to landowners in the medium term (boo).

There's be no point building more houses in marginal locations ('out in the sticks') to prevent a price bubble, because we already have enough of those and people wouldn't move to them.

Ben Jamin' said...

I've been trying to explain this one for the past few month.

Head, brick wall.

If trying to explain why land is inelastic in supply is difficult for Joe Public to get their heads around, this nuanced consequence of it is next to impossible.

I like to ask people to try a thought experiment.

What would eventually happen to "house prices" if, instead of building a million a year, we demolished a million a year. That would raise prices?

Maybe in the very short term, but very quickly the UK would become denuded. We would just be turning back the clock.

Housing is infrastructure. More infrastructure=more GDP=higher land values.

I still didn't manage to convince anyone. Oh well...

Mark Wadsworth said...

BJ: "Housing is infrastructure. More infrastructure=more GDP=higher land values."

That is the neatest way of explaining. I must remember that one as well.

Problem is, AFAICS, building more homes where people want them is A Good Thing, but the NIMBYs will then turn the argument round and say "So you agree with us, it is stupid building more homes".

Lola said...

There is a seeming interconnectedness between the unwarranted expansion of money and credit and the rises in land (house) prices. All such monetary expansion - which is what inflation actually is - leads to a spike in 'asset' prices. So to stop all that increased 'value' going direct to landowners/landlords you not only have to get LVT going but also do something about the current banking settlement - IMHO, that is.

Mark Wadsworth said...

L, yes, reining in the banks is relatively simple, you just apply common sense. Problem is that they run the country.

Dinero said...
This comment has been removed by the author.
Lola said...

MW. Ho. Ho. That's another one of those things that make you go 'hmmmm'. Certainly they have been very successful at regulatory capture.

Lola said...

...anyway, once 'we' are in power...

Dinero said...



You could try pointing out that people have been building houses in London for a thousand years and prices haven't gone down they have gone up. That might nudge them into realising they haven't quite got a full understanding of the process.
What could reining in the banks entail. setting a maximum multiple of salary?

Mark Wadsworth said...

Din, yes that is a perfectly sensible real life example and I've tried pointing that out but they don't get it (or deliberately misinterpret it to justify NIMBYism).

Fact is, population density, build density* and land values are three different aspects of the same thing.

* Whereby "time taken to travel" is as important as "geographic proximity". So in yer lovely Surrey commuter belt village, you might be surrounded by fields and forests and thirty miles from town, but if there's a railway station, you are half and hour from the centre of London, which is the same as somebody living in the outer suburbs.

L, once we are in government we'll sort out the banking system in the first week or so, job done.

Ralph Musgrave said...

Mark,

Your claim that a reduced supply of credit causes house prices to fall is true, but it doesn’t invalidate the idea that relaxing planning permission would cut the cost of land on which houses can be erected. This is simple basic economics: i.e. cutting demand reduces prices, but so too does cutting costs.

A Policy Exchange work estimated that restrictions on planning permission added £45,000 to the cost of the average house a few years ago when the cost of the average house was £160,000. See:

http://www.policyexchange.org.uk/images/publications/making%20housing%20affordable%20-%20aug%2010.pdf


L fairfax said...

About this
"Prices in Spain and Ireland were unaffected by huge building booms.

What brought them down was a collapse of the credit supply. On the face of it, it seems counter-intuitive, that the price of houses should be controlled not by the supply of houses, but the supply of money, or, more specifically, credit."
My brother in law is trying to buy a house in Spain (Eleche near Alicante) despite the fact that he lives in the UK it seems rather easy to get a mortgage so far.
Despite that prices are very cheap £15 K for a flat that in the UK would be large.
It seems that the oversupply of houses has had some affect on prices.

L fairfax said...

"Din, fact is, in the UK there are plenty of houses in very marginal locations which are abandoned or which you can buy very cheaply, but nobody wants to live there"
If we put people who didn't work there then there would be enough houses for people who work.

Bayard said...

"My brother in law is trying to buy a house in Spain (Eleche near Alicante) despite the fact that he lives in the UK it seems rather easy to get a mortgage so far.
Despite that prices are very cheap £15 K for a flat that in the UK would be large.
It seems that the oversupply of houses has had some affect on prices."

Sorry, my post rather oversimplified what actually happens/happened. House prices are controlled by what people are able to pay for them. This is usually controlled by the supply of credit, as most people buy with borrowed money. However, the supply of credit itself is controlled by what people earn, via the "salary multiplier" that the lenders use to fix the maximum they will lend to borrowers. When average earnings plummet, as they have done in Spain (Spanish unemployment is huge), then this has a knock-on effect right through to house prices.

Bayard said...

RM, If people are prepared to pay £160,000 for a house then that is what it's worth, regardless of whether that price includes £45,000 for planning permission buggeration or not. Take away the planning permission buggeration and the extra £45,000 will go the original vendor, i.e. the landowner. Why should anyone charge £115,000 for a house they know they can sell for £160,000?

L fairfax said...

"When average earnings plummet, as they have done in Spain (Spanish unemployment is huge), then this has a knock-on effect right through to house prices."
I take your point but relative to earnings surely prices have dropped in Spain (unemployment hasn't been that great in Spain for years, although of course worse now)?
In Elche flats have fallen to about 20% -30% of what they were, wages have not fallen that much

L fairfax said...

Don't prices depend on sentiment?
Therefore in a country where lots of houses are being built shouldn't sentiment change eventually?
(That is one reason why I haven't put my savings into a flat in Spain).

Mark Wadsworth said...

Din, YPP's outline banking manifesto is on the YPP blog, the fine detail would include caps on salary multiples etc.

RM, more construction only means that there are more slightly cheaper houses at the margin, the value of the ones in the centre goes up, so the average still goes up.

LF: "If we put people who didn't work there then there would be enough houses for people who work."

Correct. Land Value Tax would achieve this at a stroke.

B, good riposte.

LF, Spain is interesting. But illustrates the point that people create land values. If there are 100,000 physical homes in an area but only enough people to fill 50,000, then those flats aren't worth much. Because the land underneath them is not worth very much.

Bayard and I are assuming that we only build housing which people actually want where they want it.

And, ignoring sentiment and credit availability, if wages fall 10% then house prices fall by a lot mroe than 10% and land prices fall by a lot more than the amount by which hosue prices fall.

L fairfax said...

"Bayard and I are assuming that we only build housing which people actually want where they want it."
In Spain they did but they just aren't enough people!

Mark Wadsworth said...

LF, exactly.

This is the great illusion which drives house price-construction bubbles-booms.

You see somebody build a house near Dublin (where all the people are) and sell it for a huge profit, so you imagine that it was the activity of building a new house which made the money, so (lots of subsidies and tax breaks later) you end up with Tiger Estates dotted all over the countryside which are worthless.

What makes the profit is tapping into the stream of land rents which all the people in the area generate, and then selling it for its capitalised value.

The profit on the new house in Dublin is not new wealth at all, it is existing wealth (the super-profits from agglomeration) which is being redirected slightly and subtly.

Bayard said...

Ireland and Spain are interesting in that houses were built where there was no proven demand, i.e. in the middle of nowhere. This doesn't usually happen and is not what Matthew Lynn is proposing, which is that lots more housing is built where there is demand, i.e. the Green Belts. What is also interesting about Ireland and Spain is the fact that there was no proven demand and lots of supply did not make this new housing cheap until there was an adjustment to the credit supply and people's feeling of how well off they were (the banking crisis).

Mark Wadsworth said...

B, the whole credit availability, sentiment, boom bust in houses prices very much clouds the underlying real value, which is the annual rental value.

If you build a Tiger Estate in the middle of nowhere and try and rent out the houses, you soon notice that their rental value is tuppence ha'penny (or whatever the equivalent is in cents).

People are daft enough to look at the new estate and think "what a nice new estate" but they don't notice that there are no people there and never will be until much too late, by which stage they are saddled with the big mortgage etc.

L fairfax said...

"Ireland and Spain are interesting in that houses were built where there was no proven demand, i.e. in the middle of nowhere."
But in Spain even in towns prices have collapsed. Flats in Elche (I have family there) are 20,000 EUR they were 4 times that a few years ago. (These are rough figures it could be more or less but not by a great deal)
This is an incredible level of collapse.

Mark Wadsworth said...

LF, yes, but that is all noise and fluff. The bubble prices are not real and quite possibly today's cheap as chips prices are not real either.

More important is to look at rental values. Did they treble during the boom? No. Are they down to 20% or 30% of boom levels? No.

Chances are, prices in established towns have fallen by much less than prices in the middle of nowhere.

L fairfax said...

I agree with you, although on the subject of rent my unemployed brother in law [in Elche] was given free accomodation for sometime by someone who could neither sell nor rent their flat.
That is a big drop in rent - although I realize this is anecdotal.

Ben Jamin' said...

"Problem is, AFAICS, building more homes where people want them is A Good Thing, but the NIMBYs will then turn the argument round and say "So you agree with us, it is stupid building more homes".

You then will have to tell them that anything that raises GDP is a good thing. Rental values being a reflection of this.

That fact that land values are also raised, which is a bad thing, is a separate issue. Actually, is not quite. If we collected the land rents, land values would fall we probably wouldn't be having this debate. i.e there'd be a holding cost, and a fair few of the empty properties and 25 million spare bedrooms would be more efficiently allocated.

DBC Reed said...

I would have thought flooding area where there's work with new housing would bring down prices but i) there's not the room(like in central London) ii) the developers/ banks/homeownerist majority don't want house prices brought down .So it won't happen.

Mark Wadsworth said...

BJ, and then they ask me "What rental values? I don't earn any rent. It's just a roof over my head."

DBC, in the short term yes, if you build lots of them quick enough. But after a couple of years, once people move in and shops and pubs open up and the bus routes get laid on, they are as expensive as anywhere else.

Ben Jamin' said...

MW, at least they are asking you nicely and not calling you a communist.

I'd try the simple approach, and say rental values,in their case, is shorthand for the market assessment in monetary terms of the benefit they get from the location they live at.

Which will open another can of worms, but we've definitely got them heading down the right path now :)

Bayard said...

"But in Spain even in towns prices have collapsed."

Well, by "the middle of nowhere" I meant places where no-one really wants to live. In the UK, that's usually towns like Neath, rather than the true middle of nowhere, where surprisingly large numbers people do want to live.

Mark Wadsworth said...

BJ, of course they call me a Communist and then say that I want to flood the country with Somalians and that I'm probably an unemployed drug addict.

B, aha, you allude to the FBRI, which in physical terms is "in the middle of nowhere" but in terms of transport time is only twenty or thirty minutes from the nearest large town.

These people use up colossal amounts of land, because every crappy little village of a few hundred people needs to be separated from the next village by at least a mile in each direction.

At that sort of population density, the UK would only be big enough to house about one million people.