Buy a new car and you can be fairly certain that in 5 years time its
resale value will be HALF what you paid for it. It's logical really. Wear
and tear shortens its useful remaining life. This reduces what it is worth
to the next owner.
Turn to houses and all logic seems to go out of the window. If your
timing is right, you can buy a new house, live in it for 5 years, then
sell it for TWICE what you paid for it!
It doesn't make sense does it... until you work out that during those
5 years the value of the bricks and mortar didn't, in fact, go up at all.
The thing that went up was the 'market' value of the patch of dormant
soil the house is sitting on.
Graph: all is not what it seems, the rise in house
prices is, in fact, all about increasing land values. The true value of
the bricks and mortar is reflected in the depreciating value of the house
and what an insurer will pay out to cover the cost of rebuilding it should
it, for example, be destroyed by fire.
Graph: the rise in land values (and what can be charged
for rents) is on a different planet to the insignificant rise in living
wages since the 50s. Perhaps this helps explain how it was possible to
support a family on a single male income in the 60s and 70s.
This should beg a lot of questions, like who are the principle beneficiaries
of this trend in land values? Like, why, in this green and pleasant land
is it fast becoming unaffordable for young adults to set themselves up
in a permanent home close to jobs and public services? Like, is it right
that you should have to commit half
your adult earnings to paying off the perverse interest loaded cost of
that 80 square metres of land hidden under your house - a plot otherwise
sufficient to keep a sheep or two in grass, in a country where unpopulated
land, from the window seat of an aeroplane, does not look to be in short
It is clear that we can not look to government, nor the mainstream
media for answers to these questions. Neither are about to take responsibility
for the approaching recession.
So why does it happen?
Firstly, people who assume that the value of a home will only ever go
up, may not be old enough to have bourne witness to the damage done by
the last market crash. If you break history down into periods of 8 or
9 years, such an assumption proves to be highly unreliable.
Graph: house prices 1975 - 2006 illustrating that
what goes up, also comes down. See here
for the latest version of this graph.
More reliable is the observation that over the last few hundred years
(excluding the war years) roughly every 18 years people have found themselves
at the bottom of a deep economic recession and, since so much of the UK's
wealth is invested in property, these recessions and the fortunes of our
housing market are inextricably intertwined.
It is well understood now that busts follow speculative bubbles - periods
of intense buying activity - much of it speculative investment - with
the promise of easy profits. Take the Dot.com
In the case of housing, the bubble is primed by easy-to-arrange bank
loans at times of irresistibly low interest rates. At such times property
starts to look like a golden investment, offering returns of say 10-20%
per annum (and no capital gains tax to pay on selling) compared to a saving
account's feeble few percent return (before tax).
It is easy to see how the borrow and spend mentality becomes contagious
in times of near zero interest rates and over-zealous lending. When rates
are low the conditions are right for the housing market to pick up again.
The construction industry re-engages to capitalise on rising prices, and
as demand outstrips supply of viable plots (many held off the market in
the hope of making even higher profits on sale), the bidding war begins,
land prices rocket, and as homeowners see this increase reflected in the
increasing market value of their homes, they release equity to buy big
ticket items (cars, holidays). Consumption grows, confidence and feel-good
abound... then the government (now at hands length through the Bank of
England) finally acts to 'cool' this unsustainable growth in indebtedness
by pushing up the interest rates.
When interest rates rise, repayments on those loans that seemed such
good value just a few years ago, also rise and start to hurt. Affordability
becomes an issue. Buyers get cold feet, demand drops, the certainty of
an easy and profitable future sale evaporates, building firms shed employees,
unemployment rises, repossessions climb and, hey presto, we wake up one
morning with a headache at the bottom of a deep pit.
Having a mortgage of 4-6 times your salary and less job security is
stressful. But bankers understand that most people prioritise keeping
the roof above their heads ... in fact, the banks profit handsomely from
the proportionately much higher loans that inflated land prices enable
them to make. It becomes a self-perpetuating cycle. The principle losers
are those that lose their homes or are stuck with an unnecessarily high
burden of debt repayments and a house that may take another 8 years to
return to its pre-crash value.
Civil servants and politicians aren't thick. If there was a will to
change this pattern which generally hurts the many to the benefit of the
few, it might be done by taxing the unearned incomes from land (tax 'money
for nothing'). It might be possible for the treasury to collect enough
income from this to entirely substitute, if not dramatically reduce, income
tax, VAT, and the multitude of further 'stealth' taxes which burden and
discourage hard workers and entrepreneurs.
Lloyd George and Winston Churchill proposed such a plan
in 1909 as part of the People's
Budget. The budget recommended a 20% tax on the unearned increases
in privately owned land's value (to be paid at the point of sale or when
passed on following the owner's death), plus a tax on land privately owned
but sitting vacant.
US National Home price index at June 2010 suggests US house prices heading
down again after a brief stimulus driven recovery
Graph: How recent house price inflation compares by country
Graph: mmm... UK land prices looking a bit peaky?
Graph: Average UK house price to earnings ratios - 3.5 times earnings
is usually considered the maximum for sound lending.
Graph: It's not about the value of bricks and mortar. Since the '89
crash, UK land values fell, then have risen to alpine heights, with house
prices necessarily rising to accomodate this. Residential land values
have risen by 764% (x 7) since 1986. For more, visit Section 10 of the
very helpful Housing Statistics
Briefing May 2006 report from English Partnerships.