Financing of new housing supply

Written submission from Dr Tim Leunig (FNHS 52)

Summary

- This submission argues that the nations’ housing needs will be met when the planning system is liberalised, and known to be liberalised

- At that point housing costs will fall, affordability will increase, and fewer people will be "priced-out"

- Once developers know that their land-banks are a depreciating asset, rather than an appreciating asset, they will build them out very quickly.

- Government financial support, in any shape or form, will raise housing costs in the medium term. It should be avoided.

In detail

(short answers to your specific questions follow at the end, but should be read in the context of this section)

In an economy in which everything is competitively supplied, and made up of things that are themselves competitively supplied, consumers will get a very good deal. However, not everything is competitively supplied, which means that monopoly suppliers of anything – talent, money, land – can "expropriate the economic rent".

For example, the production of televisions is broadly competitive. As the world gets better at producing televisions the biggest effect is that television prices fall. Workers and shareholders might gain slightly, but consumers gain most.

It is very different in football. If Sheffield Wednesday improve, win the FA Cup, get promoted twice, get into Europe win the Champions League and do really well financially, fans will not see prices fall. Nor will Milan Mandarić get rich. What will happen instead is that the players will get rich. That is how football works: top class footballers are near monopoly suppliers of top class football, and can "expropriate the economic rent".

Housing development requires land, labour – skilled and unskilled – and raw materials. Except in a handful of locations, none of these are in short supply. As such, housing should be like television. Sadly, one effect of the planning system is that land for development is in scarce supply, aggravated by being owned largely by a handful of developers. As such, landowners are able to "expropriate the economic rent"

This has a profound implication: broadly speaking any money that is put in to the sector by government will, sooner or later, simply filter through into higher land prices. Schemes to "get the industry moving", "help first-time buyers", and so on do nothing of the sort. All they do is inflate land prices, which generally makes it less likely that the industry will get moving, and certainly does not help first-time buyers.

We know that it costs around £100,000 to build a 1000 square foot property. In some circumstances we would have to add an amount to clear the site (brown field development), or to provide utilities to the site (green field development). These rarely add more than £30,000 per house.

Clearly, if developers wrote down the value of their land to zero, they could make a profit of £10,000 by building houses, and offered them for between £110,000 and £140,000. We can be confident that in most parts of the country they would sell family houses at these prices as fast as they could build them. The reason the market has stalled is that developers hold land on their books at very high prices. The reason that they cannot find buyers at prices that make them money is that they overpaid for land.

In this context schemes that put government money into the industry make the situation worse, not better.

Developers are sitting on large land banks, including significant numbers of plots with planning permission. Workers and raw materials are available. Developers are not building because they take the view that the planning system is sclerotic, and that prices will rise in future. Genuine planning liberalisation, so the house prices would fall in future would lead developers would build houses as quickly as they could. In that context it would be better to sell now, rather than wait. Sitting on land would be a bad strategy for developers, just as sitting on steel is a bad strategy for Ford, or sitting on chips is a bad strategy for my local chip shop.

There are lots of ways to change the planning system. We could return to the pre-1947 town and country planning act system. In essence they said that anyone who owned land could build on it. There is no doubt that were we to do this we would get a very large number of houses built in the south-east. There are a lot of people who own land who would be willing to see it built on. After all, agricultural land is worth £15,000 a hectare, and even taking into account the land that is needed for roads and other infrastructure, you can still build at least 20 houses to a hectare. A farmer could build houses for £130,000, sell them instantly for £150,000 – far less than current prices – and make £19,000 after subtracting the agricultural value of the land. A profit of £380,000 per hectare will persuade a lot of farmers to build over their farms. If this happened, developers would know that prices would soon be falling to those sorts of levels, and would build out their existing planning permissions as quickly as they would: they would then be sitting on a depreciating asset. There are, of course, good reasons to oppose this approach: planning exists for a reason, and this approach could well lead to carbon-intensive American "exurbs".

An alternate approach is that put forward by Alex Morton at PolicyExchange. He has argued that far fewer people should have the right to oppose development. Broadly speaking if those who are immediately adjacent to the development can be won round, the rest of the community will not be permitted to stand in the way of development. Again, this is likely to lead to a huge increase in house building, which again means that developers will build out the permissions that they currently have before prices fall. Again, there are risks to sidelining the planning profession.

I proposed an approach in a 2007 CentreForum paper, In my back yard: unlocking the planning system, updated in my recently launched 2011 paper and Community land auctions: working towards implementation. This system is known as "land auctions". It is best thought of as a form of competitive tendering. When a local authority wants to buy chairs for the local school, it invites everyone who can supply chairs to name their price, and describe the chairs. The council then picks the best combination of price and quality – the "best value" chairs. The council gets a good deal, and the low price benefits local people by keeping taxes down.

Land auctions work the same way. The council states that it is willing to allow development, and invites people to offer their land for development, naming the price they want for it. All land that is not ineligible for development – sites of special scientific interest and the like – may be offered. The council then decides what should be developed, taking into account the suitability of the land, and the price that the landowner wants. The council grants planning permission on this land (this is the only way to get planning permission), and auctions it to developers, self builders, financial institutions and others, keeping the difference. I estimate that the council would receive about £45,000 per house in the south-east as a whole, and significantly higher than this in places where we are particularly need of housing.

There are strengths and weaknesses of all of these approaches. By and large, the less democratic involvement there is, the more houses we will get, and the faster they will appear. That said, less democratic involvement means greater unpopularity, as people see the houses as being foisted on them. That is why I think community land auctions will work. They incorporate the legitimate concerns that people have about development, and which they should be able to express through the democratic process, into a system that will also deliver us more houses, because of the scale of incentives that are on offer to local communities.

Finally, a note on social housing. The reason Britain needs so much social housing is that market housing is very expensive. If market housing were cheaper, fewer people would need social housing in the first place. Furthermore, more people currently in social housing would choose to move out, freeing up social housing for those in need. We should never forget that more people in social housing would prefer to be owner occupiers and would like to remain as social tenants (the evidence is in John Hills report, Ends and Means). Finally, if market houses were cheaper, social housing would be cheaper to supply, not least because social housing landlords could simply buy market housing.

You set the following questions, which I now answer briefly.

How and where the more limited capital and revenue public subsidy can best be applied to provide the biggest return on the investment, in housing supply terms;

=> almost without exception government capital and revenue subsidies have positive effects only in the very short run. The long-run implication is simply to raise the cost of housing, and the cost of land. There is no gain whatsoever.

What the role is of state lending or investment, as opposed to grant funding, and the appropriate balance between them;

=> both of these are to be avoided wherever possible, as they both raise the cost of housing, and the cost of land. The government should never grant aid, lend or guarantee private house sales in any shape or form. The best way to increase the availability of social housing would be to release more land for development, so that market prices fall, as explained above. There is no need for further government money to achieve decent housing; on the contrary, we should be able to take at least £5bn off the housing benefit bill within five-seven years without any restrictions on eligibility, by increasing the supply of market housing.

What the role is of the public sector in providing support in kind-for example land or guarantees-as opposed to cash, and what the barriers are to this happening;

=> this is generally an even worse idea, since it is very hard to evaluate such schemes, and very hard to perform rigourous cost benefit analysis to find the real cost to the public purse, or the value provided.

How long-term private finance, especially from large financial institutions, could be brought into the private and social rented sectors, and what the barriers are to that happening;

=> long-term private finance will come into both the private and social rented sector when it is profitable. In the case of the private rented sector there is a widespread belief that "buy to let" is extremely profitable, although there is little evidence for this. As a result, we get a myriad of small landlords, who each make a "profit" in accountancy terms, that is, they cover their costs. But they do not make a profit in "economic terms", because they fail to cover the opportunity cost of the capital they invest, and the time they spend managing properties. Large financial institutions do not wish to compete with people who are willing to make very low profits. This tells us that the only way we are likely to see large financial organisations into the private rented sector is if rents rise relative to prices. That is not a desirable outcome. Private money will come into the social rented sector so long as the return is sufficient. Given that the government can borrow money at much lower rates in the private sector – particularly at the moment – it is not clear why we would want to borrow money from the private sector, rather than have government borrow it.

How housing associations and, potentially, ALMOs might be enabled to increase the amount of private finance going into housing supply;

=> see previous question

How the reform of the council Housing Revenue Account system might enable more funding to be made available for housing supply;

=> "reform" will not per se enable more funding to be made available, although clearly the winners will have more money that they can use to build more houses, while the losers will have less money and will be able to build fewer houses.

How effective the Government’s ‘Affordable Rent’ proposals are likely to be in increasing the funds available for new housing supply, and how sustainable this might be over the medium to long term. 

=> The move to "affordable rent" will allow social housing providers to pay more for property up front. As such, they will be better able to outcompete other people in the housing market. Thus we are likely to see a sustainable rise in the amount of social housing, at the expense of a fall in market housing. (This is in the context of the planning system constraining the total amount of property that is built). Thus the move to "affordable rent" will lead to more social housing, but less owner occupation and fewer private rented properties. It is not clear whether this is welfare enhancing. On the one hand we know the people in need of social housing are in real housing need, but on the other hand we also know that people in social housing would rather be in owner occupation, and the more generally social housing has relatively low rates of occupant satisfaction. Increasing the amount of social housing at the expense of private rented and owner occupied housing therefore has ambiguous welfare effects. Increasing all housing by reforming the planning system would be a much better idea.

About the author

Tim Leunig is Chief Economist at the CentreForum think tank. He is the author of In my back yard: unlocking the planning system and Community land auctions: working towards implementation. He served on the academic advisory board to the Barker Review of Land Use Planning. He is also Reader in Economic History at the London School of Economics, and an affiliated member of the LSE’s Spatial Economics Research Centre.

December 2011