A New Housing Bubble?
The 'Help to Buy' scheme has been extended, giving Londoners a 40pc government loan when buying a new-build property. However, it can be argued that this would cause a new housing bubble. Is there a better way to increase the supply of housing?
Interest Rates
One would assume that with higher market
prices of houses, demand would fall. However, figures 8 and 9 clearly refute
this intuition, with the surge in the number of property sales in 1973, 1989
and 2004 correlating with rapid increases in the average house prices, both at
current prices and when adjusted for inflation.
However, we should not conflate correlation
with causation. Indeed, it seems that interest rates, rather than the actual
house price, determines the demand for housing. Take a look at figure 10, which
highlights the base rate set by the Bank of England. The rapid decline in
property sales in 1992 corresponds to a sudden hike in interest rates in the
same year. The vast proportion of homebuyers take out a mortgage when buying a
home, and so the interest rate vastly influences their decision as to whether
to buy a house or not: a rapid surge in interest rates increases the monthly
repayments and acts as a deterrent, and vice versa.
Government Schemes
However, the rapid decline in the number of
properties bought in the early 1990s, whilst the interest rates were pushed
lower and lower, appears to contradict this argument. This is not the case, for
government policy changed drastically in this period, acting as the overriding
factor. From 1987 to 1999 the government reduced tax relief on the interest
paid on mortgages.
Despite the decrease in the base rate, this
effectively increased the monthly repayments to such an extent that potential
homebuyers felt the repayments were too high to justify the purchase of a new
home. In contrast, the recent ‘Help To Buy’ scheme has increased demand for
homes, with the government offering a loan of up to 20pc of the property’s value, (40pc in London boroughs), to help first-time buyers on their first step on to the property ladder. The loan is interest free for the first 5 years, and the interest would be below market-rates thereafter.
However, it can be argued that Osborne’s ‘Help to Buy’ scheme could inflate, (yet another), housing bubble. Mortgage lenders would have perverse incentives under the scheme- the lenders may take greater risks in who they lend money to because the government takes part of the loss. Moreover, should construction not increase, house prices would increase dramatically, as there would be a greater demand for housing from those would otherwise not be able to afford the homes as well as divorced couples, pensioners and students. It has been argued by Ben Southwood, Head of Macroeconomic policy at the Adam Smith Institute, that the government should relax planning laws on Greenfield sites, in order to increase construction and the supply of houses. However, before the government relaxes planning laws, they need to encourage development on brownfield sites in cities. Currently, there is a low demand for Brownfield sites, due to the cost of demolishing houses and checking for contamination, for example. However, in my view, the government should subsidise firms wishing to develop of these sites, thus incentivising more firms to build there and increase the supply of houses without promoting urban sprawl.
The increase in demand for rented accommodation was largely due to the 1988 Housing Act, which allowed landlords to set their own rents, effectively removing the earlier cap on rents. The result? An increase in the quality, and thus demand for rented accommodation. Homebuyers are able to compare the quality of accommodation at each price, encouraging competition between tenants to improve standards in order to win customers; the free market at work.
Negative Equity Trap
The bursting of the housing bubble of 1990 and
2008 discouraged people from purchasing investment houses. Speculative buying
had been reignited in 1989-1990, with most borrowing all of the money needed to
purchase a home. This meant that when house prices decreased, they found
themselves in a negative equity trap; owing more money than the market price of
their home. Coupled with the increase in repossession, households were
discouraged from purchasing these speculative, or investment, homes, demand
plummeted and prices decreased.
Long-term factors
Long-term factors affecting the increase in
the demand for housing are due to the increase in discretionary income, and
increase in the number of households. Figure 11 highlights the steady increase
in real disposable income since 1971. As disposable income has increased, there
has been an increase in demand for owner-occupied properties. The decreased
rate of increasing income corresponds to falls in house prices (late 1980s),
whilst an increase in the rate of increasing income corresponds to increases in
the price of homes (early 2000s). Due to the evolution of our society,
pensioners are living longer and tend to live by themselves; divorce rates have
increased and more young people are choosing to live by themselves as soon as
they leave education. This has caused an increase in the demand for single
dwellings, increasing demand from a new dimension.
References
http://www.bbc.co.uk/news/uk-24061897
Figures 8, 9, 10, 11: Anderton, Economics, (Pearson, 2008)
