The UK Housing Problem

Bricks and motor

The Housing Problem

Buying a house in the UK has been drilled into every person from a young age. There is an idea that renting is dead money and buying a house is the best investment you can make. When you retire there is a significantly less financial burden on a homeowner than someone who is renting. You can also change it significantly in ways that someone who is renting could not. In the last 47 years, the annual growth in house prices has been about 8.75%. The average house price in the UK now sits around £247,355 and the medium wage being £31,461 so that gives price to earnings ratio of ~7.8. This is drastically different depending on location so two extreme cases would be

• Stoke on Trent, Medium house price £109,894, wage £22,082 giving an HP/E of 4.98.
• London, Medium house price £464,998, wage £30,311 giving an HP/E of 15.34.

So year on year house prices are going to become more unaffordable for people. The problem for young people is getting the deposit together, in many cases, they could actually pay a mortgage as it’s generally lower than rent. Many banks will only allow you to put down a 5% deposit but on average a buyer will put down a 15% deposit. So that would mean that you would need £ 37,103.25 with fees and moving cost you need around £40,000. As well the deposit issue, UK banks will only allow individuals to borrow around four times their annual salary. This is due to irrepressible lending that caused the crash in 2008. The Bank Of England also hoped that this would stem the increasing levels and debt and the rising house prices, however, this has only had a minor effect. Depending on the Bank's risk tolerance and how the economy is performing this may change. So the average person earning £31,461 wants to buy that average house of £247,355. But the bank will only lend them four times their annual income. So let's build an equation to solve this problem.

So if we plug in the numbers:

£126,111 = = £247, 355 — (30,311 * 4)

So the average person would need £126,111 and in many cases a lot more depending on the area. This is clear unachievable on their own, in many cases, people often get help from their parents or buy with someone thus changing the variables in the equation. A couple both earning average incomes would need a deposit of over twice their joint average earnings to buy a median-priced home in London. A single person would require a deposit of almost nine times their earnings. This is prohibitive to the majority of first-time buyers.

You may think that there should be something done about this. Let's think about why it be might controversial to artificially lower prices. In the UK home ownership sits at 65.5% so more than half of the country does not want house prices to be lowered. Because in most cases it’s their biggest asset. The UK also has two 2.6 Million landlords which own about 5.45 Million between them. Many of these landlords depend on these house prices increasing so they can sell the property for a lump sum when they retire as it's common practice to have bought to let the property on an interest-only mortgage whereby you only pay the interest and not the actual loan to buy the house. Which should yield around 8.75% return plus any extra rental payment that is leftover from interest payment and repairs.

Why are house prices so high?

Supply

There is a range of factors that ensure prices are kept consistently high in the UK. The first is housing stock, we need more houses than we currently produce. It’s estimated that we need 170,000 additional private sector houses and 75,000 social sector houses each year. But we aren’t making anywhere near that and both labor and Tories have both failed their targets of house building. Last year the UK built ~180,000 houses, we had a shortfall of around 70,000. Because this has been happening for a long time this has created a housing deficit in the UK, with a million houses needed to fill this deficit. The demand is high but supply is low and therefore the price is high.

Interest Rates

Interest rates are currently at historic lows with the Bank of England base at 0.1%. Interest rates are directly correlated with how the economy is performing. As the economy has taken several shocks recently, due to Brexit and COVID-19 the rate is frozen at its all-time low. This makes borrowing extremely cheap with the current average interest rate for a mortgage around 2%. As a mortgage is a fixed-term loan the interest rates are very important as they decide how much your monthly payments are going to be. For example, if you borrow a £100,000 with a £10,000 deposit then you owe the bank £90,000 and you agree to pay it over 25 years then you would need to pay the bank £426.79 a month. However, if interest rates rose to 10% then you would be required to pay the bank £817.83 per month almost double the original amount. So as we can see that low-interest rates allow for houses to rise in value because more people can afford to pay a mortgage. Whereas if interest rates were to increase to as high as 10% then fewer people would be able to afford their mortgages. When getting a mortgage you should always stress test your monthly payments by calculating if you can afford the interest payment if the interest rate went to 6% which is three times the Bank Of England's target inflation rate. This also applies to current homeowners, as fixed-rate mortgages only last around 5 years. If there isn’t a demand for houses at the current price point then market forces would force the prices to drop or house builders wouldn’t sell any houses.

Location

Location, people want houses where there are jobs and other amenities. There isn’t a point in building houses in northern Scotland if no one wants to live there and there isn’t the job and the amenities to bring people to the area. However, in places like London where there is an extreme demand for housing because of jobs and great amenities land is expensive so it’s not very easy. So one solution is to spread jobs around the UK. Incentivize private companies to move to other cities would allow more houses where there is more land and therefore is cheaper. It also spread wealth across the country. More salaries spent in the local area which would provide a much-needed boost to the midlands and the north. This could be led by the public sector, place Government department in cities or towns with low job growth. Manchester is a great example where this has worked very well. The public sector started to invest heavily in Manchester and creating tech jobs. The private sector then soon followed them. It’s now a great Tech hub, with high-paying jobs and relatively low houses cost.

Solutions to our Bricks and Motor problem

Increase Interest rates

Interest rates are good indicators of how the economy is performing. When the economy isn’t performing well the Bank of England will lower interest rates to provide cheap credit so people can borrow money more easily which gives people more access to cash which they can then spend in the economy. It also lowers the burden on people with loans, mortgages, and credit cards. So provided the economy is in a fit enough state a rise interest rate would help lower house prices. However, it would make it header to get a mortgage so it’s a double-edged sword.

Limiting buy to let

As discussed above there are 5.6 million homes owned by private landlords, 20% of the population rents in the private sector. There already has been a mass of new laws and protection for people who rent and more on the way. There is currently ongoing consultation on section 21 which allows landlords to end tenancy agreements with two months' notice. This would make it more difficult to evict tenants. If this becomes law then it makes renting a lot more permanent and would more people of safety net. Capital gains may be increased in the new tax year of 2021/2022 which means when selling the buy to let a property you will have to additional tax in the increase of the value of the property. Ensure landlords pay a fair share of tax and ensure tenants have more security when renting is a very good thing. However, limiting buy to let too hard is a double edge sword. There is a need for a rental market it gives the economy flexibility. If you want to work in London for 12 months but don’t want to buy for example you’re a contractor or you’re a young professional that wants to spend a few years in the city then renting is a perfect option. It’s also a great option for student accommodation which in its very design is temporary.

Rent Cap

Should we attack the biggest outgoing for most young people which is their rent payment, even more so in cities like London? This would allow more people to save but also provide more disposable income for people which they then could spend on goods and services helping the economy as a whole, not just the rental property sector. However, some would argue in a free capital country that we should allow market forces to decide how much rent should be.

Buy another person

The simple and easiest option to get on the property market is to buy with another person. An additional person will help double your saving power much greater as well as being able to share the expense of owning a house.

Live with your parents

This isn’t possible for everyone, but it is by far the easiest way if your buying alone to get in the market. Rent and saving are very hard, just think if you could save what you pay in rent each month and put that towards your deposit.

Instant Saving Accounts (ISA)

An ISA is a tax-free wrapper around a saving account in which that any interest made in the account is completely tax-free. The current annual limit for all ISA account is £20,000, this resets every tax year. The Government created two ISA to help save for a deposit as it realized that first-time buyers can afford the monthly payments for a mortgage but were struggling to get the deposit together. The first ISA was the fitting named “Help to Buy ISA” this is a scheme where the government would help you get £15,000. Where you would pay £200 per month and the Government would pay £50 as a bonus. This bonus is capped at £3000, so effectively you save £12,000 and the Government give you £3000. With the idea that if two people brought two together with two ISA that would give them a deposit of £30,000. The limiting factor of this ISA is that you can only save £200 per month so if target lower earners and would take 5 years to complete the while ISA. Additionally, unless you were buying in London the value of the house could not be more than £250,000, whereas London’s value would be £450,000.

So is only really worth it if you start in your early 20s. The second ISA product the Government developed was the “Life Time ISA” also know as the LISA. The LISA has a £4000 yearly limit, however, it has a few caveats. First, the money can only be used to buy a house or for a pension which you can withdraw from at the age of 60. If you withdraw the money before these conditions are met then you are charged a 20% fee as a penalty. The Government will pay 25% interest on deposits into your LISA. Which makes this a great option to save for a house as there is no cap on the government bonus and the price limit is very generous for a first-time buyer.

Making more money

This is obvious. If you can put yourself forward for a job or a promotion and gain more income for the same work with the same hours then this is the most effective way to increase your income. When saving up for a house there are multipliers at work, so if getting that pay increase allows you to max out the LISA then all that money is getting 25% interest, although this interest isn’t compound because the interest is only applied to deposits, not on the balance. If you think back to the deposit equation then you will remember that your annual income is multiplied by your affordability ratio in our example is was four. So if you get a £2500 pay rise then that means you apply for a mortgage that £10,000 more.

Increase Supply

The housing shortage is the main reason the UK houses market is broken and why currently homeownership is out of reach for so many people. As I mentioned in the above section the only real way to cure this problem is to increase supply above demand. However, this is harder than it seems. The government can only incentivise building companies a certain amount. The government can provide more funding for local councils to build social houses, this is currently done through low-interest loans. That each council can apply for and get providing it can make the repayment terms. If the government could provide a surplus in social housing then the private sector would have a small market and would have to compete more with other housebuilders to get buyers. This may also make buyers build houses that aren’t just a copy and paste of the same house in a row. Individual-looking houses are more attractive than cheaply-made new builds that have no character. The government could also set the bar for quality if a council set a standard level of quality and then the private sector would have to be better than that or else you would just get a council house.