Building More Houses Will Not Cure The Property Crisis

Conventional wisdom, echoed by the European Commission, last week, is that central to curing Britain's property crisis is the need to build more houses. This is repeated by the media so frequently as to make it seem like a truism. But, conventional wisdom is wrong. Britain's property crisis will not be cured by building more houses, any more than global food shortages will be cured by simply producing more food. In both cases, there is a failure to understand the basic economic distinction between need and demand. There are lots of things that people may need, or even simply want – like an expensive sports car – but without the money to buy them, their need does not constitute a demand.

In reality, the problem of world hunger has never been about a shortage of food. For the last 200 years, the world has produced more food than was needed to feed the global population, and as time has progressed, despite the catastrophic warnings of Malthus and his latter day followers, the world has increased its ability to feed itself even more. The problem of world hunger is not shortage of food, but shortage of money in the hands of millions of people to be able to buy the food that is available.

The Irish Famine was a perfect example, of this. The general understanding of the famine was that the Irish peasants and labourers starved to death because of repeated failure of their staple crop the potato. Its certainly true that the potato crop failed disastrously several times, and its true that the peasants relied on the potatoes they grew themselves for a massive part of their diet. But, the reason that was the case, was that the land they had themselves to work was poor, whilst the land they worked for the capitalist farmers and landlords, was given over to the production of crops required by Britain. Those crops were bought by Britain at relatively high prices, particularly as they were protected from European competition by the Corn Laws. Those high prices put them beyond the purchasing power of the very Irish peasants whose labour produced them!

When the potato crop failed, those Irish peasants could not simply switch to the consumption of these other crops, even though there was an abundance of them, because they could not afford to buy them, especially as the crop failure pushed up the prices of these other crops even further. The Irish Marxist, James Connolly relates the story, and describes how the famine was neither due to the failure of the potato crop nor to British Imperialism, as some nationalists were quick to claim, but was due to capitalism, the operation of the market, which placed the need to sell commodities at a profit above the need of human beings not to starve to death.

The starkest example of that, provided by Connolly, was that when British workers clubbed together to buy food to send to the Irish peasants and labourers, the food was left to rot on the docks, because the authorities insisted that it could only be distributed, when all of the other food available on the Irish market had been sold at the market price!

“Early in the course of the famine the English Premier, Lord John Russell, declared that nothing must be done to interfere with private enterprise or the regular course of trade, and this was the settled policy of the Government from first to last. A Treasury Minute of August 31, 1846, provided that “depots for the sale of food were to be established at Longford, Banagher, Limerick, Galway, Waterford, and Sligo, and subordinate depots at other places on the western coast”, but the rules provided that such depots were not to be opened where food could be obtained from private dealers, and, when opened, food was to be sold at prices which would permit of private dealers competing.” 

Connolly - Labour In Irish History, Chapter 13

At least, Cameron has not yet decided to use this approach in relation to the growth of food banks to cover a similar situation in Britain today!

Given the absurdity of capitalism, there is no contradiction that in a world where the real price of food has been falling, for a large portion of its population, and where, in Britain, those cheap prices mean that the average family is estimated to throw away a third of the food they buy, and in China the latest means of displaying your affluence is to order far more food in restaurants than you can eat, so as to leave a large part of it, that in both these countries, there are also millions of people who cannot afford to buy the food they need, let alone that millions of other people in the globe, continue to go hungry for lack of the means to buy food.

But, a similar, though not identical situation exists in relation to the crisis in the UK property market. The idea is put forward that the crisis in the property market could be resolved by building more houses. Yet, more houses that are as overpriced as the ones already for sale, that millions cannot buy would do no more to cure the crisis than does producing more food at prices that millions cannot afford to buy! The underlying assumption is that if the supply of houses increased, the price of houses would fall. But, that is to misunderstand how prices are determined. It is to get the cause and effect the wrong way round. Prices are determined by two things. The cost of production and the average rate of profit. If the cost of building a house on average is £200,000, and the average rate of profit is 10%, then for builders to build additional houses, they must be able to expect to sell those houses for £220,000.

Herein lies the problem. If builders are to believe they can sell a large number of additional houses, they must believe they can make at least this normal profit. But, for that to be the case one of two things is required. Either, workers wages must rise massively – given that the current house price to earnings ratio is more than double its historic average, wages would probably have to rise by more than 100% - or else the cost of building houses must fall, so that builders can sell them at lower prices, and still make this average profit. Given that real wages continue to fall, the first option is out of the question. In relation to the second option, the fact is that the cost of building houses, like the cost of producing every other commodity, has fallen as a result of rising productivity. The problem is that as house prices have soared astronomically, the cost of building land has soared with it, and the cost of the land represents a major component of the cost of building the house. That creates a chicken and egg situation. Unless house prices fall, building land prices will continue to rise. Unless building land prices fall, the cost of building new houses will continue to rise.

As with the problem of people being able to afford to buy food, large numbers of people cannot afford to buy houses, despite record low interest rates. Suppose builders carried on regardless, and build large numbers of houses, so that the supply of houses rose beyond the current demand. As a result, the average price of houses then falls to £180,000, and more people can afford to buy them. The problem is that there would be no reason for builders to do this in the first place, because at £220,000 they were only just making the average profit. By building more, if this increase in supply did result in prices falling to £180,000, not only would they make no profit, but they would make a £20,000 per house loss. Capitalist builders like every other capitalist do not build houses for the fun of it, or to meet people's housing needs, but to make profits.

In fact, although there is a lot of nonsense spoken about the problems of planning regulations preventing housebuilding, the building companies have planning permission for around 400,000 homes, that they have not acted upon. The builders are not building additional houses, because they know that they could not sell more houses than they are currently building, at prices that would guarantee they made normal profits. That being the case, it suits the builders to sit on their land banks, on the basis that they expect them to continue to appreciate in value. This latter fact, is also why many landowners, are in no rush to sell land for building.

The alternative would be for large numbers of houses to be built that might be bought up by buy to let speculators. That is no doubt one reason, the Liberal-Tories have introduced their proposals on releasing pension funds. Having imposed a cap on the amount of interest that can be earned on savings, and thereby also capped annuity rates, via the official Bank of England interest rate, the government hopes that thousands of people will squander their pension pot in the deluded belief that they might be able to provide themselves with a pension by buying property to rent.

But, some thought shows why no one in their right mind would be drawn into such a scam. The world and their dog now accepts that the UK housing market has once more been driven into a huge speculative bubble, as a result of deliberate government policy. The IMF yesterday were the latest organisation to warn about it. As with every other bubble, this one too will burst, and as the biggest bubble ever, the bang will reverberate more loudly than any in the past. So, if the idea is to reduce prices by building more houses, why would anyone risk their pension pot buying an asset whose price this additional building is designed to reduce?

That is especially the case, given that there has never been a case where a bubble has been deflated slowly. In much of the country, the existing bubble would already have burst were it not for unprecedented intervention by the state to prevent it, including support for the banks to enable them to avoid having to foreclose on non-performing loans. But, its a different thing to forestall the bursting of a bubble by such supportive intervention, as opposed to action designed to reduce prices slowly. The former is like furiously pumping additional air into an increasingly leaky tyre, whilst the latter is like trying to deflate an over inflated balloon, by pushing a pin into it slowly!

If a large number of additional houses were built with the intention of private buy to let landlords buying them, these landlords would not only face making large capital losses on the value of their property, but the increased supply of property to let, under such conditions, would lead to falling rents, just at a time when those landlords will be facing rising mortgage payments, as global interest rates rise. So, once again, unless the government can con large numbers of unsophisticated investors to use their pension pots to buy up such property to rent, there would not be sufficient demand, for new built houses, at prices that would enable the builders to make normal profits.

So, again there would be no reason for the builders to build these additional houses. Again, that is why they have not done so already. The only place where builders seem keen to build is in London, where they can sell properties to very rich speculators, foreign and domestic. But, the lesson is shown in places like Singapore, where many of those same speculators are already getting burned, as property prices begin to crash, let alone what happened to people who thought a house could act as their pension pot in the US, Ireland and Spain, but who saw the price of those houses fall by around 60%.

There would be one way that a large number of additional houses could cure the crisis. That is if these houses were built to be rented out at low rents by local councils. That would provide people who needed houses with somewhere to live, it would put downward pressure on rents, and on house prices. Another thing that would help would be if councils were allowed to compulsory purchase the land required to build these houses at a price related to historic building land prices rather than current inflated market prices. However, given the fact that successive governments have prevented councils from building council houses, that is not going to happen. But, even if it did, the likelihood is that it would be done in such a way that the interests of builders, and landowners were protected at the expense of taxpayers.

In other words, councils would have to buy these houses at current inflated market prices from builders. It would simply be a way of providing private builders with a guaranteed market for their production, where none such currently exists on a large scale. The additional demand for building land, would then also push up building land prices even further, protecting the interests of the Tories historic supporters in the landowning class. In order to cover the inflated costs of buying these houses, councils would either have to recover the funds from raising Council Tax, or the government would have to cover it by subsidising the councils out of raising taxes on workers.

But, the fact is that the claims about there being a shortage of houses is in any case nonsense. It may be true in London, but there actually large numbers of housing units are being built, and thousands that have already been built lie empty, as the owners bought them to obtain a potential capital gain, as their price rises, not in order to obtain rent in the meantime. However, in most of the country, a look down any road, or in any estate agents window, or on their website shows that there is no shortage of existing houses for sale. Many of them remain on sale for up to two years, because they cannot find buyers at the current asking prices. There is not a shortage of supply of houses, but only a shortage of supply of houses at prices that buyers are prepared to pay, or are able to pay.

Britain has 1 million empty homes, which is not that much less than the 1.5 million empty homes in Spain that hang over a market that has already fallen by 50%, and continues to fall. The largest Spanish property website says that it expects Spanish property prices to fall by another 15% from here. In fact, there are probably more than 1 million empty homes in Britain, because some owners, particularly of the more expensive properties will be keen to pretend that the property is occupied for various reasons, not least to avoid the property being squatted. I know of a number of such properties locally. Then there are those 400,000 houses that have planning permissions that have not been acted upon. There is in reality no shortage of supply.

But, of course, the other side of that is what has happened to demand compared to supply. The reason that prices have risen astronomically is because government policy has deliberately encouraged a rise in demand. I have lost count of the number of ludicrous TV programmes over the last year or so that have featured teenagers who felt hard done by, because they could not afford to buy a house out of their own wages. It is presented as though this is some totally new situation. In fact, in the 1970's and before, when most of the people who today are considered to have lived in some golden age of property buying, were in that situation, none of us would have dreamed of being able to buy a house. Most of us could not have bought a house in our teens with two people's wages let alone one! Most people had to save for many years as a couple before they could raise the money for a deposit to buy a house, and then only when they were in their mid twenties.

That is manifest in the data on house occupancy.  In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents. Source:  Halifax.

As Moneyweek point out,

“The population has gone up, of course. But the housing stock has risen too. In fact, according to an interesting report from economic research group Fathom Financial Consulting, while the rate of building decreased over the last decade, the quantity of ‘housing per person’ has risen by nearly 50% since 1970, and is still increasing.!"

The difference is that, in the same way that more households have become multi-car households, and in the same way that an increased number of households means an increased number of car owners, so an increased number of single person households requires a much larger number of homes than does the same number of people living in multi-occupancy homes. An increased availability of credit was a means of encouraging an increase in the number of smaller households, each of which then become a cost-centre useful for facilitating the realisation of produced surplus-value. This has been a piece of deliberate government policy to bolster house prices, so as to keep the financial bubble inflated, both to protect the banks who are insolvent other than for these fictitious house prices, and to encourage people to borrow money against these inflated property prices as an alternative to decent wages to cover their consumption needs.

But, just as there is a huge difference between someone who needs food because otherwise they will starve, and someone who simply wants more food to demonstrate how affluent they are, so there is a huge difference between someone who needs a home because otherwise they would be homeless or living in squalid conditions, and someone who simply wants a home, because they have been convinced they should have one, just as they should have the latest designer clothes, iPhone or whatever.

A cure for Britain's housing crisis requires a bursting of the property bubble. That will happen sooner or later anyway. Once house prices crash definitively, and people get used to the idea that they are not going to simply go back up again in their lifetime, especially as global interest rates are now set to rise steadily over the next 25 years, then houses will become affordable once more without people driving themselves into levels of debt that in previous times have resulted in people being driven into slavery and penury. It will mean that first time buyers will be able to seriously consider being able to save enough money for a good deposit on a house, or even as I did with my first house to save up enough money to buy it for cash, thereby avoiding a lifetime of debt. It will mean all those people who have wanted to move up to a better house but have been unable to, as the property bubble has pushed the prices of those better houses further and further out of their reach, will be able to do so, making their houses available for fist-time buyers.

The fall in house prices, will then cause the price of building land to crash giving builders and landowners no reason to hoard their land banks, but instead to make them available for new building. It will mean that on the back of these lower land prices, builders will be able to build houses at much lower cost, whilst still making the average profit, and thereby massively reducing the price of new build houses. Lower houses prices, and the increase in supply this will make possible, will also push rents lower. The key to curing Britain's housing crisis is not an increase in the supply of houses to reduce prices, it is a reduction of current prices, so that the conditions are created that will enable an increase in the supply of houses at prices that people can afford to demand.