Housing – It’s Not About the Price Tag.

No economics blog is complete without a piece on housing. So here is my two cents…


Once upon a time there were two men: Tim and Jack.

They don’t know each other. But they both want to buy a house – the same house.
Tim hasn’t got much spare cash so he would have to borrow lots of money to buy the house.
Jack  has a large amount of spare cash and wouldn’t have to borrow any money to buy the house.

It is the clash between these two potential buyers that is causing problems in the housing market.

The big problem with the housing market is that the following things are true:
People with little money need houses.
People with lots of money want houses.
Or put another way, housing is one of the essentials of life – but it is also one of the best investments.

Tim’s situation is complicated. Because the cost of a house is not the same as the price of the house. The cost of the house for Tim is really the price of the house plus the cost of borrowing money (ie interest). A very rough estimate is that over 25 years you pay the same in interest as you borrow (assuming “normal” interest rates and not adjusting for inflation during the mortgage pay off period).

Jack’s situation is simpler. He can buy the house outright. So the cost of the house for Jack is strikingly lower than the cost of the house for Tim. In addition, Jack already has a house that he lives in. So this new house will be let on the rental market, bring in a substantial income – probably even making the purchase pay for itself in the long run. The only thing that Jack is losing out on is the option to invest his money in something more profitable than housing. But have you seen the interest rates lately?! In these troubled times – with rental income coming in and the nominal value of the house ever rising – property seems like a very safe bet – and if the housing or rental market goes belly up, he will at least have the physical asset of the house (brick and mortar as it’s often called).

(Now, there is another guy half way between Tim and Jack called Dan who already has a house, But he can only afford half the cost of another house. He could get a buy-to-let mortgage to cover the rest of the house price equal to the rent he can expect to earn. Dan’s situation is not really that helpful in this typically brutal economic analogy – he just adds more investment demand pressure to the housing market – but worth mentioning anyway.)

Now Tim must find this situation terribly unfair. This is not a level playing field – as all the factors go in Jack’s favour. It’s a horrible irony that Tim who has little money  has to pay a much higher “cost” than Jack who is flush.

So, we see investors forcing up the price for housing, making housing less affordable for people who just want to own their own home.

Let’s clear up a quick quibble:

Tim could rent.

Yes, Tim could rent. But we know that after 25 years of renting you have nothing to show for that expenditure – an expenditure which is probably a massive fraction of your overall earnings. Whereas if he was paying a mortgage, he would have a house at the end of it – which would (probably) have increased in value. If he rented, someone else would get all his rental money.

And let’s be clear that this is very real social problem. People are prepared to pay higher and higher proportions of their income often based on risky credit. The rise of house prices is more likely to encourage people to take on dangerous debt than it is to make them choose to not purchase.

A couple of statistics from David Smith’s excellent book “Free Lunch” show the scale of this:

More than 80% of borrowing in Britain is mortgages.

Household debt rose from £390 billion at the end of the 1990-1992 recession to £1430 billion by the start of the 2008-2009 downfall.


So these two guys (and Dan!) are putting massive demand pressure on the housing market, forcing prices ever upward. But there are other factors at play:

Interest Rates – the ultimate double edged sword!

When interest rates go down, the cost of borrowing falls enabling more Tims to borrow more – and Jacks are tempted to save less and put their money in an investment property.

When interest rates go up, the cost of borrowing money goes up. (So the cost of the house goes up for Tim.) When interest rates are high, people like Tim can’t afford to borrow so much in the first place. So demand is lessened. This makes the “price tag” of houses fall – making them cheaper for Jack. But a fall in price might make Jack nervous about housing as an investment property. If interest rates rise significantly, more mortgage holders will be unable to pay and will have to sell their homes. This increase in houses for sale is an increase in supply that will lower the price tag. And, of course, as interest rates rise, saving becomes more attractive, so fewer people choose to invest and the price tag falls again. (Irrelevant to Tim who still has to borrow the money at a higher cost.)

The Increasing Number of People Wanting to Buy

I don’t have any data as to the extent of this as a factor. Essentially though, as population increases so the demand for housing increases. But it’s important to note that this only takes effect if the new or expanding population is wealthy enough, or has access to enough credit, to enter the housing market.

My House is My Pension

This is an interesting area. The proportion of UK incomes now spent on somewhere to live has massively increased. People are foregoing some pleasures in order to invest their money in their own home. One of these “pleasures” is saving – or investing in a pension. People are increasingly seeing their house (or investment properties) as their pension.

The Weak Investment Climate

The notion of seeing your house as your pension is strengthened by the current poor investment climate. Low interest rates, perceived low return on investments and a general negative perception of pensions all contribute to investors wanting to put their money in housing stock. “Bricks and mortar” has always been seen as a safe investment.


So on one hand people are desperate to buy their own home so they can stop throwing their money away in rent.

On the other hand, we have people with all their savings tied up in property.

For me, the priority has to be Tim being able to afford his own home.

Housing is an essential – it needn’t be bought, but I would prefer it if Tim didn’t have to give away all his money to a Jack and have nothing to show for it.

But I also don’t want to see Tim over-burdened with debt.

So what can we do about it?
Let’s look at the traditional levers for affecting price: reducing demand (including access to credit) and increasing supply.

We could limit the amount of money people can borrow. eg borrowers may only borrow 8 times their annual salary. This will limit the number of people who can borrow money to buy their own home. Unfortunately, this means that Tim is less likely to be able to buy – but lucky old Jack won’t be put off buying. For me, this is a counter-productive policy. There is an argument that the reduction in credit will drive down price and this may prevent people becoming over-burdened with debt. But ultimately it will prevent the Tims of the world being able to buy. It won’t affect Jack – and Tim needs a house much more than Jack.

We could limit the appeal of housing as an investment option. eg legislate that one person can only own one house. This will affect Jack as he will have to find other investment options. This may even cause a beneficial increase in investment in the wider economy – and it will definitely cause a fall in house prices – beneficial for Tim.

We could increase the number of houses to buy. The more properties for sale, the less competitive the market and down go prices. (Although I am dubious about the effect of this in isolation as the 90s house price explosion was not caused by a lack of housing supply but initially by a free flow of credit and later by an increase in demand for investment property.)


It is my opinion that housing must be seen as a social essential first and an investment option second. This is not only a social good, but it also forces investors to put their money into investment options that might actually be productive.
My solution would be to slowly reduce the desirability of housing as an investment option. Preferably starting with dis-incentivising those who have large residential property portfolios. The double benefit to investors is that housing has secure value and produces easy rental income.

So here are some actions that we could take:

  • Raise tax on rental income. (Recommended.)
  • Cap rent.
  • Restrict the availability of buy to let mortgages. Sorry Dan! (Recommended.)
  • Restrict the number of houses that an individual can own. (Recommended.)
  • Make other investment options more attractive. (Too vague but recommended!)
  • Build more housing.
  • Wait for interest rates to rise. Saving becomes more attractive for people with cash to invest, mortgage payments become more expensive, so prices drop make housing less attractive as an investment.

I am keen for people to comment (constructively) and I am happy to be (politely) proved wrong.

Since writing this I have listened to an episode of Radio 4’s Analysis from 27 July 2014 which covers some extra detail about this subject – in particular seeing housing investments as a pension alternative. Definitely worth a listen. http://www.bbc.co.uk/programmes/b049y9pz

On 21st September 2014 information came from the ONS that stamp duty was 25% up on the previous year – but income tax was flat, despite a record breaking fall in unemployment. This adds more weight to the argument that investment money that should be “trickling down” into the economy is getting stored away in safe investments such as housing.

This is an excellent analysis of interest rates and how they are connected to housing via the transmission mechanism:


One thought on “Housing – It’s Not About the Price Tag.

  1. Anthony says:

    Interesting points there Chris. I’d be interested to hear your thoughts on social housing, the right to buy, and bedroom tax.
    The right to buy is interesting. A family’s situation is such that the local authority recognises the need to house them, for one or more of various reasons. Their situation improves and they find themselves in the position to be able to afford the heavily discounted price the council is willing to allow them to buy the house for. With low interest rates they can just about afford it.
    That’s one less council house available to families like them in situations that they were in.
    The pressure on social housing increases. Private landlords know this and rent out poorly maintained properties to people desperate for accommodation.
    This family are sitting pretty, but then interest rates rise. The family now struggle to pay the mortgage, fall into debit and loose their house. A landlord with money buys it and rents it out.
    This family, down on their luck, apply for social housing, but there aren’t any because everyone else has exercised their right to buy.

    Not the full story, but a real possibility.

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