22 October 2015

How to fix Britain’s broken housing market

By Thomas Aubrey

John Jacob Astor was one of the top ten richest people of all time. He invested heavily in Manhattan real estate in the early 1800s with the profits from his fur business. Astor reckoned that New York was likely to become a major world city, and that by releasing only small land parcels as demand increased due to the productive activity of New Yorkers, he would become very rich as prices rose.

Today in London, the stock of planning permission plots is just under 225,000 plots – almost double the number from 10 years ago. But building rates have not moved much in the last decade, delivering on average less than 25,000 units per year. The main reason behind this shortfall is the high cost of land. High land prices reduce the viability of many housing projects and prevent infrastructure being funded from the uptick in land values. High land prices also increase the volatility of house prices and macroeconomic instability.

High land costs in growing city regions are exacerbated by investors who have worked out Astor’s secret to success. Forty-five per cent of the plots with planning permission in London are owned by firms with no intention of building on the site. Holding off land from the market to drive up prices is the easiest way to get rich from the productive work of others. The process of setting up a business, undertaking R&D, creating jobs, dealing with clients is far more risky than buying up land, and in most cases far less profitable.

If George Osborne wants to see a step change in productivity growth and house building, he will need to take a momentous step in the autumn statement. He can either continue to preside over a rentier economy where the rewards of productivity in dynamic city regions flow to those who own the land. Or he could change the way land market operates and instigate a more productive economy permitting the rewards to flow to entrepreneurs and the private and public sector workers who constitute successful city regions.

Failure to take this tough decision will mean the lack of commercial office space will drive up rental costs in city regions stinting the very entrepreneurial activity the chancellor wishes to see. Higher rental costs force new, innovative businesses to allocate capital away from R&D and employment towards rent. Workers are spending an ever higher proportion of their salaries on rent with record house prices putting home ownership out of reach of vast swathes of the work force. Housing benefit in the UK is already at 1.4 per cent of GDP, nearly 10 times bigger than that in Germany.

One of the main drivers of the difference in housing benefit is due to the price at which land is acquired, which is a function of how the local land market operates. In Germany, land is acquired at use value, in the Netherlands at a multiple of 10, and in growing British city regions at a multiple of 200. The more efficient land markets of Germany and the Netherlands have permitted a much greater rate of housebuilding. Crucially both systems use the uptick in land values to finance the necessary investment in transport, schools and hospitals.

The last major attempt to resolve the conflict between the rentier and productive economies was undertaken by Lloyd George in his 1909 budget, and vocally supported by the then president of the board of trade, Winston Churchill. They proposed a land value tax to ensure that landlords were unable to benefit from the productive work of others. Unsurprisingly the House of Lords – mainly populated by landowners – disagreed and voted against the tax.

The chancellor may well be right in thinking that a land value tax is not the best way forward politically to resolve this conundrum, however, Osborne could tweak the 1961 Land Compensation Act whereby the acquisition of land in designated housing zones would be treated differently to other land plots and could be acquired at levels closer to use value.

Osborne has already shown he can take on the vested interests within his party and improve the efficient functioning of the economy. The amount landlords can claim in mortgage tax relief will now fall to 20 per cent in conjunction with the removal of the automatic 10 per cent wear and tear allowance. But if he wants to increase housing construction he needs to follow the advice of Adam Smith and ensure that a great deal more land is brought to market, as its high price is preventing the very capital investment he desires. The failure to provide space for the businesses of the future, to house our growing firms, entrepreneurs and workers can be considered to have been the greatest failure of our economic system. And it’s about time this changed.

You can find the full comparative report on Britain’s housing market for Policy Network here.

Thomas Aubrey is senior adviser at Policy Network and founder of Credit Capital Advisory