Saturday, 29 November 2008

Investing in bricks and mortar? (3)

Here's another chart showing the components of house prices since Q4 1952, adjusted for wages growth (click to enlarge):
As you can see, in the long run, prices increase pretty much in line with earnings, which is hardly surprising - housing in the UK is in more or less fixed supply and housing is a normal good. This makes a mockery of the idea that property ownership can be a route to riches, or even to a comfortable retirement, except in the short term and for a minority of people who bail out in time.

As I have said before, the bubble periods tend to precede nasty recessions and economic turmoil, I would go one further and argue that the bubbles actually cause the subsequent recessions; this is because asset price bubbles and credit bubbles are two sides of the same coin - they reinforce each other on the way up (as well as steering the economy in totally the wrong direction); the same applies to house price crashes and credit crunches.

As I have also said before, there are two main arguments for having a flat rate tax of (say) 5% per annum on capital values in excess of the pure bricks and mortar value:

1. A 5% tax on the 'location value' would raise an average of £1,000-plus per home, just about enough to replace the main property and wealth-related taxes (Council Tax less Council Tax Benefit, Stamp Duty Land Tax, Inheritance Tax), which would be a welcome simplification and be neither 'regressive' nor 'jealousy surcharge'.

2. A 5% tax on the 'bubble element' would dampen off bubbles as they arise. Let's assume that the average house prices drops to £100,000 again and the system is then introduced, in addition to the £1,000 'location value tax', there would also be an extra £500 bubble tax (enough to replace the other property and wealth related taxes like Capital Gains Tax, the TV licence fee, insurance premium tax and VAT on domestic fuel and home extensions, for example). If house prices then jumped ten per cent faster than wages in a year, people's LVT bills would go up, on average by a further £500, probably sufficient to nudge people into bringing empty properties back on to the market or to rent out a room; nudging others into trading down, and deterring first time buyers (whose rent would not have gone up by £500, especially if they still live at home) from entering the market; and pushing down the profits of landlords by £500, who would then be more likely to sell up (and bank a net profit of £9,500) or discouraging them from buying in the first place. Thus bubbles are unlikely to recur, and even if they do, a sensible government would use the tax on the 'bubble element' to pay off the national debt, or "to fix the roof while the sun is shining", as George Osborne would say.


1. Nominal house prices, taken from Nationwide's UK series.

2. Wages growth derived from Measuringworth.

3. The figures for bricks and mortar (average £70,000 per home) and true location value (average £20,000 per home) are to some extent arbitrary, you can make up your own assumptions on this. For my previous chart I had guesstimated £75,000 rebuild costs at 2007 prices, and land values around £25,000 per plot at their low-point.


Lola said...

Look, I can see where you're coming from with LVT but I am not happy about a bubble tax. It's not my fault that my house price rises because other idiots persist in paying silly prices. I don't want to move, I don't want to trade down, I really do not care what price my house is. It's value to me is where it is and how it serves my sense of belonging.

Part of these bubbles is always related to political failure in controlling the money supply nd running sound money. You have got to have those two as prerequisites to cotrolling house price bubbles, which in the recent past have been driven by ludicrously loose money.

Mark Wadsworth said...

L, more to the point, do you think the bubble tax would be effective?

You know as much about the economics of this as I do - would it be physically possible for prices to rise more than £20,000 or so above their equilibrium level (assuming everything was indexed up with wages growth each year)?

This would equate to a premium of £1,000 per year for ownership rather than renting, FTBs (who ultimately prop up the whole scam) would thus be more likely to stay renting and landlords would be more likely to sell up etc etc. (make up your own examples).

As to controlling the money supply, the BoE might as well try and prevent the tides, AFAICS.

Lola said...

From my market participant perspective loose money was at the root of the recent bubble. In fact it was fundamental. It allowed the BtL boom to work by making money so cheap that the daft - as in far to low - yields on let domestic property seemed to make sense.

Every time I look at this I come back to stupidly cheap and oversupplied money.

There is another factor. It is engrained in the psyche of the English that owning a house is a one way bet to riches. I also think it has something to do with the franchise. The criteria for having a vote in earlier times was to be a property owner (Hence the existence of a 'Freehold Road' street in many towns).

Somehow it has to be explained to people that a house is NOT an investment, it is in fact the opposite. What it is though is a place to live. And yes, it is better to own than rent because of the psychological boost you get from having a place of one's own. It really is your castle.

I don't think tax reform will help this boom and bust problem at all, if Government goes on failing to run sound money policies. Political imperatives make this very unlikely - politicians of all stripes cannot resist crating a boom to make voters feel happy.

The planning system is another factor. Prescotts bonkers policies have exacerbated the problem by distorting the market. Developers were encouraged to build flats to achieve the densities he required. This has backfired mightily as for example in my town (Ipswich) where there are hundreds of unsold new flats.

So politics and bad money are at the root of this, and they are linked factors. It is always politics isn't it?

Simon Fawthrop said...


If we had a "bubble tax" it might encourage voters to punish politicians before the problem got out of hand. A number of economists (sorry can't find the links)have discussed the need for the market to find a way to "short" house prices to reduce bubbles, perhaps this is one way?

Having said that, this is a very long bubble and perhaps there is a 3rd element to the price which is a variable but necessary part?

Lola said...

TGS - I have been looking for a way to short domestic housing for years. Part of my FTB in recent times 'don't buy a house now' presentation was just that - 'don't buy one,short the market'.

There is another way of looking at this. The clients who didn't buy but rented I encouraged to save a sum equivalent to the capital repayment component of the mortgage payment they would have paid. (Generally mortgage payment = rent plus capital repayment component - you rent the house or you rent the money to buy the house). But for long term renters it would be better to buy a housing index fund rather than save into cash, if such a fund could be devised. This is an idea I reckon could be taken up by housing associations whereby renters get to be owners over time, by eventually exchanging their accummulated fund for a property. By indexing the fund it tracks the market both up and down and has a real connection to the market price of homes.

I admit that I have not fully developed this idea, but I am sure that there is something in this.

(If Bloody Brown reads these blogs expect to see the government claim this idea at some stage).

Mark Wadsworth said...

L, you can buy and sell Halifax House Price Index Futures at Spreadfair.

The 'loose money' didn't just cause the bubble; it was also sucked in by it.

A bubble tax would have deterred any BTL investor from about 2002 onwards.

neil craig said...

The problem is that when in a bubble government doesn't want to prick it -it allows the PM to say how well he is doing. Such a tax would work &, hopefully, it wouldn't have to be too strenous on people like Lola who aren't planning to move & thus whose effect onn prices is neutral.

Another solution would be to suspend the regulations which control, building when prices are going up faster than incomes. This would be technically more difficult since the amount of remaining regulation would have to be graduated but, by allowing the supply & demand curves to work would encourage rather than choke off a growing economy.

Mark Wadsworth said...

NC, for sure, liberalising planning laws is important as well, but then you get the Greenies and NIMBYs screaming at you.

And, politically, the PM is always better off representing the interests of existing home-owners (keeping prices up by restricting supply), so the same argument applies.

Mark Wadsworth said...

There's a good (and short) summary on effect of liberal planning laws on house prices (using actual numbers) on the IEA 'Blog.

Anonymous said...

True. So much of politics is not doing the right thing but working some way to reduce the damage done by doing things the wrong way out of political expediency.

Lola said...

MW et al. Yes, the futures contracts on Spreadfair would allow me to short the market, but what I was/am wanting is an idex fund that renters could invest into to create a pool of capital to buy a house that had a realtionship to house prices. This is to give renters confidence that they will be able to afford a house in the future, and stop them rushing in to 'buy a house before they become unaffordable (!)' which mentality drives a lot of the bubble. There is clearly an opening here for somebody and my guess is it is the housing associations who could most effectively exploit this opportunity. It's a win/win because even if the renters never bought a house the eventual value of their fund could be re-organised to pay an income that would cover their rent in perpetuity (I've done some sums on this and it could work). But none of this suits the lefties who want to keep you in financial thrall to them so that they can get re-elecetd.

Mark Wadsworth said...

L, are you thinking more along the lines of a building society or an index fund? Do a proper post on it and then we can all have a look.

Lola said...

MW I am developing a couple of 'papers'. One on this and one on the FSA's RDR. But I can't work out how to publish them on my own blog site!! (other than as a post).

Look, the purpose behnd the index fund is to give renter confidence that they will be able to buy a house in the future if prices are booming. It's best offered by hiusing assoc's as they can deploy economies of scale and get lowish rents plus the contribution. My guess is that doing this will alos compel other private landlords to offer something similar to attract good tenants. This would then do a lot to take out the boom chasers from entering a bubble market.

A reason I don't like bubble taxes (I have a mental image of a apparently naked lady in a bubble bath losing bubbles to tax - but that's my problem) is that bubbles burst, so you'd have to have a negative bubble tax in times of price decline.

Mark Wadsworth said...

L, if the bubble tax were introduced at the bottom of the market (1955, 1970, 1995 for example) the initial revenues would be nil, but there would seldom be a negative bubble. I see no reason to give people rebates if the bubble is negative (that's called 'propping up the housing market').

It would of course be a fluctuating source of income (and if it did its job properly, wouldn't raise much), so it should be used for paying off the national debt or future pensions liabilities rather than regular spending,

Lola said...

Mark, deceitful politicians, especially of the lefty pursuasion will use it to 'regulate' markets. It just won't work. You really do not need to do this. The bubbles will correct themselves. Those fool enough to get involved at the wrong price will suffer. Although I know that market timing is impossible, the case of the housing market might well be the exception. Not one sensible person I know felt that house prices at the levels from about 2002 to 2008 were at all sustainable. So why any FTB got involved escapes me, especially those buying commodity houses. If they'd been at all sensible and withdrawn from the market the bubble would have been less extreme. But as money was sooo cheap and soooo plentiful they just felt they were immortal.

Simon Fawthrop said...


ref my earlier post about aboout shorting housing, its the Case-Schiller incides. Timmy reports on it, again, half way down this post

I'm sure I first read about it in the Ecomomist, but that's behind a subscription wall and I can't ifnd it.