house prices – finance grabs punters by the balls with the invisible hand of the free market

Housing is the third rail of British investment classes, and I don’t usually go there for the simple reason that I don’t invest in it.

However, I never really spent much time working out exactly why this asset class is so heady and dangerous. I spent a lot of time looking in the rear-view mirrror working out how it hurt me, examining how, after 20 years of actually paying down the mortgage I had just about broken even relative to the estimated cost of renting, and how terribly front-loaded the risk was – I got away with it because I stayed in the same job for 24 years and bought that house six months into that job.

Even Monevator declared the asset class overvalued and he’s not a fellow who likes to let on that crystal balls have their place at very rare times 🙂 Although I am still chortling about this –

by the 1980s they could begin amassing the property wealth they have today – aided enormously by the right-to-buy and buy-to-let booms that the current Government is only just applying the brakes to.

Not me, mate, I took the sucker punch here and I’ve read the early 1990s news reports that predate the Web where 3 million of my compatriots were in negative equity. The specifically housing part of my networth is probably less than a tenth of the total, and I own half the equity in the house outright (Mrs Ermine owns the other half, not a bank 🙂 ). I do own land elsewhere that roughly doubles that, arguably my property asset class worth is about a suburban semi . Before Londoners start to spit bricks and think the Ermine is on the Sunday Times Rich List, remember that house prices in the provinces are much lower than in London.

As an aside, I’m intrigued by the result of 80 years of peace in Europe leading to the nonchalance of

it could eventually be the country I live in. The gulf between what you can buy in the UK and in the great livable cities of Europe is staggering.

The ermine is a jittery fellow, and even if we discount Brexit, I hear the distant drumbeats of serious social unrest in Europe. Sometimes it takes an outsider to clarify the matter

At different times and for different reasons, all of the large European states—the United Kingdom, France, Italy, Germany—have blocked attempts to create a common foreign and defense policy, and as a result they have no diplomatic or political clout.

They haven’t wanted European leadership, and most of them wouldn’t have wanted American leadership either, even if any had been on offer. The richest economy in the world has a power vacuum at its heart and no army. Now the consequences are literally washing up on Europe’s shores.

But that’s not the point of this post. It is the discovery of the cogent rant linked to here in the comments of Monevator’s Yes, we do have a house price problem article. Unfortunately it’s far too long, so my service here is to summarise some of the observations in a post that is too long but a hundredth of the size:

In an industrial consumer society, shelter is the one basic Maslow need most people buy on credit

1402_Maslow's_Hierarchy_of_Needs.svgTake a look at the bottom two layers, which are basic and fundamental needs. Most of us don’t buy food on credit – cash is king here, from income. If you do buy love you probably use cash too 😉 Unlike in the US, healthcare is free in the UK. Although I am sure that there are many who would like to try, we don’t currently charge for air, and most people pay for water as they go along too.

Unfortunately there’s one big item that addresses homeostasis, sleep, security of body etc, and that is shelter from the rain and other hazards, in short, housing. A hairless mammal in a Northern European climate needs a home. The vast majority of people, on leaving the parental home, are not rich enough to buy a house outright. They need to borrow most of the price.

The free market fails dismally where everyone buys an essential product with credit

If I want to buy a pound of apples, or a car, markets work well, because what is called market substitution happens if suppliers price-gouge. I switch to oranges if apples are too dear, I use public transport or a bicycle if cars are too dear. In this way the balance of power is matched – if the buyers are too tight the product is withdrawn from sale because producers don’t find it worth their while, if the producers want all the money the buyers disappear. Adam Smith’s Invisible Hand does its job well when everybody can walk away and do without. When you can’t, the Invisible Hand grabs you by the balls and your heart usually follows. Nowhere is this clearer than with housing.

Continue reading “house prices – finance grabs punters by the balls with the invisible hand of the free market”


your pension should be worth more than your house by the time you retire

Interesting point made by Jonathan challenging my assertion that for the middle class, buying their house is nearly always their biggest cost. Jonathan took a total lifecycle point of view

Well, no. For the middle class, our biggest cost is now building the defined-contribution pension fund.

Although I was thinking of the monthly running cost in saying the house was the largest cost he made me think, and run the arithmetic. In my area a family home is about 5-6x  the middle household disposable income of 24,400, according to the ONS[ref]Middle income Households 1977-2011 Note this includes Londoners, so in my area the median income is probably significantly lower[/ref]. I was seriously gobsmacked by that disposable income – here’s the infographic, I didn’t dream it up.

 incomes of households in the middle of the income distribution (ONS)
incomes of households in the middle of the income distribution (ONS)

I looked for a second source[ref]f’rinstance check this Grauniad article on the subject – a couple with two kids would be in the middle with a post-tax income of 31k, I wouldn’t find 31k that out of keeping with the ONS 24k disposable income (ie after rent) [/ref] but it seems to stack up. I had a much lower estimate for disposable income, from all the hollering you get in the papers about the squeezed middle. I’m still finding this hard to believe. Looks to me the squeezed middle is sitting pretty and it supports my feeling that Britain is far, far richer than the Britain I grew up in (I left home in 1978, a year after the infographic’s start date). We should bear in mind that the middle is defined in the logical American way, rather than the British way, where nearly everybody seems to define themselves as the middle class unless they are members of the landed aristocracy or they’re currently wiping down their hands on their blue overalls at the time they are polled.

Much of the screaming from the squeezed middle you hear about in the papers would be from what the Americans would call the working class if they were to use such a term. The ONS defines the middle in a different way to most British journalism, though logic is on their side.

This middle exists, in a Britain where I saw a van today that would come and valet your car onsite, FFS. Another van drives around supplying ironing service to suburban households, while another trails the city dustcarts and pressure washes your wheelie bins for you for a fee. All these goods and services are presumably some of what that 24k median household income goes on, while the rest of us seem to be ramping up our credit cards again. The ‘squeezed middle’ feels squeezed because before 2007 it spent a lot of its disposable income and consumer credit  on consumer goods, a hell of a lot more than it did 30 years ago. Although the 1970s had issues, I don’t think that people were anywhere near as miserable[ref]Britain’s happiness in decline – BBC – from 2006, I shudder to think what it looks like now![/ref] as you’d expect only spending half as much on consumer goods, and consumer goods now are probably far better value in general now 😉

People will cite housing as the major source of hurt nowadays  but the average house is about 5-6x household annual income. I paid 5x my annual income when I first bought a house. I recall sitting in the Broadcasting House bar in 1988 grouching into my beer about how it wasn’t fair I could never buy a house etc etc, just like Generation Rent do now – and eventually identified my problem and got the hell out of London. Generation Renters might want to observe that buying a house soon after that on such a high income multiple still classifies as the most stupendous personal finance mistake I have ever made, although some social trends [ref]I started work before the arrival of women into the workforce that started in the 1970s was complete, so I was competing with a mix of single earner households and two-earner households[/ref] may mean income multiples need to be considered for a couple rather than an individual; I was single when I bought that house so there was only one earner by definition. I also needed a 20% deposit. Look also at the 5% fall in direct and indirect taxation between then and now.

However, Jonathan is absolutely right, if this median couple had accumulated a pension fund of 150k this would pay about 5% annually, roughly £7500, which is a big climbdown on their 24k previous disposable income[ref]The State Pension would be about £7500 for each of them, so this isn’t necessarily a terrible position, it depends how old they want to be when they retire – added in that brings them up to over half their pre-retirement disposable income[/ref]. If they doubled their savings, the savings would pay about half their pre-retirement disposable income ,which was the usual target for a final salary pension scheme.

However, even if they target pension savings of twice the house price in real terms, the house will still be their largest cost in the 30-50 year old range while they are servicing the mortgage. This is because unlike a pension you want to use a house before you’ve paid for it so you have to pay interest, that usually ends up being about twice the original price in real terms when you tot all the repayments up, and allow for the fact that your later payments are made in money that’s worth less due to inflation (you typically pay about three times the nominal purchase price over 25 years).

Added to that you buy your house over about 25 years, whereas if you start early you have 40 years to buy a pension. [ref]this is slightly misleading as in practice you may do much more of the heavy lifting in the later years, when you may be a 40% taxpayer, you probably earn more and you may have paid off your mortgage, meaning you can save more out of pre-tax income. The magic of compound interest roughly doubles the value of your early payments over 40 years – my savings profile much more than doubled as I got older, so my later contributions are more significant than my early ones.[/ref]

You need a lot of money to end up like this in retirement rather than rooting about in the bins like Top Cat, so go easy on buying too much house if your pesnion fund ends up less than the price of your house... (photo LdF/iStockPhoto)
You need a lot of money to end up like this in retirement rather than rooting about in the bins like Top Cat, so go easy on buying too much house if your pension fund ends up less than the price of your house… (photo LdF/iStock)

It’s a sobering thought, however, that you should have a pension savings target of twice the value of your (paid off!) house. Consumerism does enough of our heads in that some people appear to be surprised to find out that an interest-only mortgage doesn’t actually buy you the house and act all surprised at 50 that you can’t have lots of foreign holidays, school fees and what-have you and get to own your house.

Because of the peculiar emotional magnetism of housing to Britons’ national characters many people end up with far too much house relative to their pension savings. It isn’t easy to sell your house off brick by brick, and there seem to be issues with equity release schemes, but that’s where you’re going to end up if you have loads of house equity but sod all pension income/free cash flow. So beware, all those who say my house is my pension. Who are you going to sell it to, and how? In my experience of ex-colleagues surprisingly few people really do downsize when the kids fly the nest (assuming that they do, of course). They get used to a house and it seems to encapsulate all sorts of warm fuzzy happy memories. It just doesn’t seem to happen that often, even in cases where it would help financially strapped empty nesters. The child-free have an easier time in this regard as their housing requirements don’t have to increase to accommodate kids and then contract again afterwards.

I came across this backwards – I looked at what I wanted to achieve as my desired early retirement pension income. I discovered I ended up with big numbers. I had to target ISA and AVC savings so unlike many Britons the sunk cost of my house is quite a bit less than half of my net worth[ref]I also don’t count the house as part of my net worth, more as part of my income in the rent I don’t have to pay[/ref]. However, it’s notable that most of my ex-colleagues had much better and more expensive houses – their relative asset allocation was usually much more housing-heavy than mine. I get the feeling that for most Britons their house is their largest asset by the time they retire.

This fondness and faith in property leads Britons to go into BTL and indeed purchase property abroad. Although buy-to-let is a business, it does also increase exposure to residential property as an asset class. I don’t know enough about BTL to know if BTL mortgages come with recourse, ie the mortgage company can come chasing you for other assets other than the house the loan is secured on. If it did I could see a world of hurt under some circumstances (rising interest rates being the most likely).

However, if these middle class households really do have 24k disposable income per annum, then they have no excuse for failing to save or a pension. Let’s face it, stick half that into index-linked savings certificates that track inflation but don’t pay a real return, and 20 years later you have more pension savings than the average UK house price.

It’s not as horrendously big an ask as it first sounds, because you actually save for a pension before you use it, unlike that house. In practice it will cost about the same or perhaps less in total lifecycle cost, because you don’t pay interest on it, and you benefit from up to 40 years compound investment return on the savings. You also don’t get any tax breaks on buying the house.

But you do have to start, and like for any large savings goal the earlier the better…

Just leave the housing market alone, Dave

So the taxpayer is going to back 95% mortgages for first time buyers to buy new build homes. Now where have we seen this before? Governments fiddling in the housing market. Such a bright idea, it goes horribly wrong each and every time. You’re grubbing about with what is probably most people’s single most valuable financial asset, purchased on a highly leveraged basis. Small errors can get magnified stupendously.

What on earth could go wrong? Well, for a start the impecunious are usually better off looking to the second-hand market to get better value. It’s why I have never bought a new car. I could afford it, but I have no desire to take the sucker punch for that brand new kudos. Same for houses. I’ve never bought a new one, because the value is so poor. Let other people take the brand-new premium first. So why the heck is the Government screwing the first time buyers by making this mortgage guarantee conditional on them buying a new house? Yes, it’s good for the housebuilders, but why get the most cash-strapped to take the hit too?

There seems to be a belief that it’s every Briton’s human right to be able to buy a house in ther 20s. It isn’t. Some people are too poor to buy a house. That’s tough, but there are alternatives and have been throughout history. It’s called renting, and also sharing with others.

Let’s take a look at the decision-making process in how people buy houses. People look at what they can afford to spend at the time they are buying. If they are really clever they look ahead a little bit and allow for the extra cost of children, should that be a consideration. They then imagine that will carry on for the foreseeable future, and spend right up to that limit.

Make financing easier? Buyers will drive the capital cost of the houses up, as they can finance higher capital sums. Apply distorting measures to starter homes? Starter homes will go up more than second-rung homes. It’ll be harder for those that don’t qualify for the distorting measures, and the distorting measures will go into the pockets of house builders. It will take longer for the ‘beneficiaries’ of the largesse to pay off the increased prices they paid, because the largesse comes in the form of mortgage guarantees, encouraging them to overpay.

It’s about time the government discovered the value of the one of the principles of Hippocratic Oath in meddling in the housing market.

Primum non nocere – First, Do No Harm

Just leave it alone, Dave, let it be. That way existing house owners that benefited from the rising prices in the past get to take the hit, as they have to drop their prices to get a sale at all. The history of UK government intervention in the housing market is littered with epic fails.

Let’s hear it for:

  1. Mrs Thatcher in the 1980s selling council houses for below cost price to buy votes. What could possibly go wrong? Britain has no effective social housing any more, inflated property prices, and people so poor they would never buy houses elsewhere in Europe end up overpaying for houses they can’t afford and can’t maintain properly. They used to be able to rent from professional landlords on a reasonably stable basis. Now they have to rent from BTL amateur landlords on 6 month shorthold tenancies.
  2. Mortgage Interest Relief At Source What could possibly go wrong? Make mortgages less expensive and the punters will bid up the price of houses till the amount they pay is the same. At least this was axed a while back
  3.  95% taxpayer-backed mortgages for first time buyers to buy new build homesWhat could possibly go wrong? So we’ve subsidized foolish banks like Northern Rock that lend people more than they could buy, then flogged them to Richard Branson at a loss. Hey, let’s just cut out the middleman and lose the money straight off. What’s going to happen? People will bid up the cost of first time starter homes and expose themselves to the risk of negative equity, but never mind, the taxpayer will underwrite the losses.

Twits. When is government going to learn to butt out of the housing market. Their job is to provide equitable contract law, building controls, town planning and a Land Registry so that buying and selling houses is safe for both parties and the necessary disclosures and titles are made. Some basic regulation of rents, requiring some professionalism in landlords and taxing BTLers on their capital gains is probably as far as they need to go.

We’re about to enter a second long recession. Jobs will go. The last thing we should be doing is influencing people to take a long term illiquid investment on at a higher price than the market would normally set. It took me 10 years to recover from the cock-up of buying a house at a price inflated by stupid government intervention, Nigel Lawson, you know who you are. I wouldn’t do that now, but you can’t put an old head on young shoulders. I was lucky enough to keep my job and not need to move for those 10 years, the likelihood of that happening to a first-time buyer now is a lot less.

We probably shouldn’t actually stop house buyers acting foolishly in the face of market volatility, but as society we really shouldn’t wilfully add to that volatility. The housing market is a zero-sum game. Make it easier for today’s first-time buyers to buy a house, and you make it harder for the next bunch that comes along. What’s so hard to understand about that?

UKAR gets on the dog-and-bone to chavs and tells them to pay mortgage before Sky

Sounds all right to me, what’s not to like? Deborah Orr of the Grauniad thought it patronising, but it really is a fair cop. UK Asset Resolution, which represents the taxpayers of this sceptred isle, are using credit checks and have identified 30,000 customers who are going to be in the brown stuff when interest rates rise. These checks will flag those who have rising unsecured debts. Not all of these will be chavs, of course, some will be people who have genuinely fallen on hard times since the heady days of Northern Rock’s 125% mortgages.

However, if you are the sort that prioritises the continued supply of sport on TV over keeping a roof over your head, then to be honest you shouldn’t really be in charge of a mortgage. Some financial vehicles need a modicum of training to drive…

It’s hard to argue with the appropriately named UKAR head honcho Richard Banks

“They need to think about what is their most important debt. It is not their credit card or renewing their Sky subscription, or going out for the latest mobile technology. It is their mortgage.”

Quite. If you haven’t jumped to that then there’s nothing patronising about it 🙂

Apart from that I am generally with the cut of Deborah Orr’s argument. I’m not generally with the Graun’s view of Margaret Thatcher, who did sort out some pretty toxic stuff. However, Thatcher’s abuse of power in seizing control of some collectively owned assets and flogging them off to buy votes was a devastating stroke of evil genius, and council house sales started the ball rolling.

I recall from many decades ago genuinely mixed council housing which had aspirational blue collar families as well as a few of what we now know as chavs. There were some sink estates too, but council housing was generally far more mixed in family incomes that social housing appears to be now.

What Thatcher’s move did, as well as buying her three elections, was give free housing capital to an awful lot of people, which in itself wasn’t so bad, but it bottom-sliced what was to become social housing, concentrating people by the lack of income and wealth. She may not have meant to do that, but it seems to be what has all too often happened. And it forced upon us the current dysfunctional housing market which seems to make nobody particularly happy.

Most jobs in Britain don’t pay enough to be able to afford a house at 3.5 times income, and I would go further in asserting that the standard of financial education is such that there are a lot of people who had mortgages that didn’t understand what they were for. They appeared to be under the misapprehension that they were virtual ATMs which regularly doled out free money, to be used for holidays or Tarquin and Jemima’s school fees, rather than a way of buying a damned expensive consumer good called a house, secured upon the house.

This fact that most families didn’t earn enough to be able to buy a house was acknowledged in the council house system, where only the rich or the frugal owned their houses, but now it makes us hostage to working for The Man for 40 years, plus crazy asset bubbles.

So though I’m all for UKAR ringing up people to tell them to pay the mortgage before their Sky subscription, perhaps we do need to think about whether owner-occupation is such a great idea in a globalised world of unstable jobs. How the heck we row back from here I have no idea, but we do seem to have got ourselves into a hole. Thanks a lot, Thatch…