The housing crisis is real… but so are possible solutions

Having a roof over one’s head is a fundamental human need. Yet, in many countries– Europe and beyond– housing affordability is becoming a serious issue. More and more people are forced out of their homes due to rent increase. As this phenomenon grows, have we thoroughly considered all the possible solutions to tackle this problem? And are we ready for a shift in perception?

Jamil Nur

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Housing affordability, as a rule of thumb, is measured as the amount of rent or mortgage over income. When your rent or mortgage surpasses 30% of your income, you are considered subject to financial stress (Meen 2018).

In the UK, the average gross monthly wage is estimated to be around £2,400/ €2,800 (ONS, 2019), while the cost of a one-bedroom flat varies widely across cities, from £500/ €5901Report by More Than for the newspaper The Telegraph. See biography. a week in Norwich, a medium-sized city (213,000 inhabitants) in the East of England, to £900/ €1,075 in the relatively close but smaller town of Cambridge (126,000 thousands residents), where I am currently living. 

To understand the housing crisis, let’s ask ourselves why Cambridge is so expensive?

Cambridge is home to the largest cluster of tech companies in Europe such as Amazon, Apple, and the pharmaceutical multinational AstraZeneca, which moved its headquarters to the university-city in 2013. These companies (almost 5,000) account for 61,000 jobs. This means that not only students, but also corporate employees, entrepreneurs and investors want to locate in areas where knowledge is produced. The existence of what, in technical terms, is known as knowledge spillover2In economics, a spillover, also known as externality, is an unintended consequence of an event on agents that were not supposed to be concerned by that event. In the case of knowledge, it is meant in a positive sense: the proximity of firms within common or different industries will facilitate the circulation of knowledge (the opportunity to exchange ideas) and consequently innovation and growth., leads to an agglomeration effect3The benefits of a more dense exchange of knowledge, together with the reduction in production costs, and a greater division of labour, lead firms to concentrate in defined areas, creating an agglomeration effect, meaning an increase in productivity due to the mere location of economic activities. attracting many people to the same place. This in general is a positive development, since a higher concentration of productive people magnifies productivity all around. 

The downside, however, is that in cities, space is limited… When many people want to live in the same place, housing prices go up. And though we should also expect salaries to go up with prices, it is not often the case.

In Cambridge, while average salaries (£3,300/ €3,900) are higher than the national average, they are still not sufficiently high enough to pay the rent (£900/ €1,075) once taxes and utilities are deducted (between £150/ €170 and £400/ € 470). And these figures are still misleading because average salaries are calculated based on the highest wages. If we instead look at median wages (£2,600/ € 3,110), representing 50% of the population, then we see that more than half of Cambridge’s workforce, at average rent prices, are under housing stress.

Cities are victims of their own success. When people move in, prices go up and, because the supply of housing takes time to adjust, other people will have to move out. In Cambridge, key workers are forced to live in surrounding towns and commute back to the city. This translates into 23 days of their year spent in traffic. In the UK, this is the most time spent in traffic, representing twice the London congestion (Admiral, 2018). It is evident that housing affordability is not just a question of individual and collective welfare, but also of productivity loss, a condition faced by many European capitals. 

What are the traditional solutions & why do they fall short in tackling the problem?

1. Increase access to ownership
Often representing an immediate approach if housing is deemed unaffordable, increasing access to ownership can be done in 2 ways…

1.1 Raising loan-to-value ratios4Increasing the percentage of the house value that can be borrowed from a bank as mortgage.
In other words, increasing borrowing capacity. Seems like a good idea right? Well… it depends. This would have little effect if prices keep rising. In addition, it may trigger problems similar to those at the root of the 2007 American housing crisis when several borrowers with unstable financial resources obtained loans up to 100% of the real-estate value… and suddenly were unable to pay.

1.2 Providing prospecting mortgage borrowers with additional equity lines from public lenders.
The creation of additional equity lines proposes an interesting concept long theorised by economists, but rarely mainstreamed. With one exception, the Help-to-Buy Equity Loan scheme introduced by the UK government in 2013, which, since its inception, has provided almost £10 billion/ €11,8 billion in equity financing. This instrument implies the willingness of a government agency to provide capital of up to 20% (40% in London since February 2016) of the property purchase price in exchange for the same share of its future value. Basically, the idea is to reduce the buyer’s exposure to debt, and to allow capital-constrained households to access the market. An appealing idea in theory… 

Yet, a recent evaluation of the scheme (Benetton et al, 2019) revealed that households who took advantage of the program simply bought more expensive properties, without reducing their mortgage debt and house-price risk exposure. Moreover, it appears that households refusing to take advantage of the program did so because they do not want to share, with the government, the possible future appreciation of their home.

So much for increasing access to ownership. So, what else can be done to improve affordability?

2. Increase the supply of housing 
Well, if houses are expensive why not increase supply? After all, by the law of economics, if quantity goes up, prices should go down. It seems, however, that the situation is more complex than that. To understand why, we need to take a small step back and ponder upon the nature of housing itself, which is a good that is both consumed and used as investment

While most people buy houses to live in, many consider purchasing homes as a means to obtain profit: either as a steady additional income by renting it out, or as a lump-sum payment by reselling it at a higher price. An indiscriminate increase in the supply of housing will not necessarily help reduce prices as long as investment motives dominate consumer ones. Why? Because any new supply of housing is likely to be targeted by large domestic and international investors who are exclusively interested in build-to-rent schemes, and of properties built to be sold only at market value.

In the UK, where almost a million families are on the waiting list for social housing (Shelter, 2017), only 6,463 homes for social rent were built in 2018, a 78% decrease from the 30,000 homes a decade ago (MHCLG, 2018).5Although there formally exist affordable housing requirements for developers, quotas are often missed, or exchanged with financial or in-kind contributions (e.g. investment in infrastructure) to local councils facing ever tightening budget constraints.

Also, many households today take on an investment approach towards housing, convinced that if the value of their home goes up, then they will be able to reap its increase in value. In reality, when all prices increase, for the vast majority of homeowners, cashing capital gains is only possible when buying smaller homes (with less amenities), moving to lower-priced areas, or by altogether giving up owner-occupation in favor of renting. In all these cases, investment has a negative impact on consumption.

We see then that increasing access to ownership, or indiscriminately augmenting the supply of housing may not prove to be effective remedies to the affordability crisis.

What are some possible avenues worth exploring? 

1. Addressing cultural & systemic issues from a long-term EU perspective

If we want to favor the consumer nature of housing, one daring proposition is to reconsider its fiscal treatment when it’s traded as a form of investment. Indeed, if housing continues to be viewed as just another asset in a diversified portfolio, then it should be taxed as non-residential capital. This requires a form of fiscal neutrality based on a simple principle: different forms of investment should be subject to the same tax treatment. 

While it may be reasonable to provide some form of advantage for households buying their first home (constituting their main residence), capital gains and property taxes should be harmonised across countries when housing becomes subject to large investment operations. However, in practice, while European countries adopt similar fiscal policies with respect to non-residential capital6Expenditures by firms on capital such as tools, machinery, and factories., achieving a fiscal convergence for housing (when treated as residential investment7Expenditures on residential structures and residential equipment that is owned by landlords and rented to tenants.) is a very difficult objective to achieve for 2 reasons…

Reason 1 – Cultural values greatly differ between countries 
In Germany, for example, purchasing a home is not perceived as a necessary investment by many households. Its homeownership rate is the lowest (51%) in the European Union (EU), and there are no particular subsidies for such an acquisition: mortgage interest rates are not deductible from income tax, capital gains are taxed if the house is bought and resold in a short period, and properties are taxed at historic cadastral value8The value given to each property, based on data found on the land registry. It is much lower than the market value of the property and can never be larger than the market value but with constant revaluation (although below the market). In Greece, on the other hand– with a homeownership rate nearing 77% ten years ago (now at 73.5%)– mortgage interest rates are deductible from income tax, there are no capital gain taxes (the 15% tax rate introduced by law in 2013 has never been enforced), and properties are taxed at fluctuating market value. 

Reason 2 – No common fiscal policy
The European Union has no mandate for the introduction of a common fiscal policy, which, to date, remains its single biggest structural challenge. Thus, while bold, we can set aside– for now– proposals for fiscal neutrality and harmonisation, marking them as key objectives for future agendas. 

2. Revisiting the paradigm of social housing: the Vienna’s approach
Austria proposes an interesting solution where 25% of the country’s residential building stock is social-rented housing. While Austria’s real estate market very much resembles its German neighbor, with a 55.4% homeownership rate (the second lowest in Europe after Germany) and identical fiscal policies, its social-rented housing surpasses its German counterpart by 20 percentage points. And though Austria is not the country with the highest share of social housing (the Netherlands is at 32%), it has manage to maintain a lower homeownership rate compared to the Netherlands who is at 67%, and an even lower rate of private rental (16% in comparison to Germany’s 49%).

What sets Austria aside and Vienna in particular– where the percentage of renting households surpasses 70%, among the highest in the world, with 60% of the population living in the 440,000 social homes– is the fact that ownership of socially rented stock is shared by municipal governments and by state-subsidised limited-profit private developers (Scanlon et al, 2015). The functioning of the latter is regulated by the city: the municipality buys land deemed suitable for development and solicits fitting construction, whose ownership will rest with the developers.9A competitive bid for development ensures that social housing benefits from high value development by attracting the best architects and contractors. This in turn allows the city to rent half of the new apartments to lower-income residents10The upper income threshold is at €45,000 for singles, and at €68,000 for couples. and the remaining units to moderate-income households. Because rents are regulated by the municipality, residents pay 20 to 25% of their income on housing (versus 46% in Paris and 49% in London), well below the affordability threshold, and are not required to move out if their income levels increase over the years. This allows for diversity within social housing, impeding the emergence of segregated neighborhoods and of stigma over public reliance. 

So, what is the social cost of this approach? It’s not shocking nor burdensome. In Vienna, this translates into a 1% tax on the salaries of every resident, half of it directly deducted from wages and the other half matched by employers.  

What is the state of social housing beyond Vienna?

In cities like Berlin with a tradition of affordable rents and housing prices, rates are now surging while the development of social housing drops. More than 80% of apartments are rented in Berlin and rent prices have been rising by 120% since 2004. Tenant associations blame this on the overall reduction in social housing (15% of total housing stock in 1987 to 3% in 2015 (Kofner, 2017) and its progressive privatisation.

In the UK, on the other hand, the introduction of the “Right to Buy”11A policy in the United Kingdom (with the exception of Scotland since 1 August 2016 and Wales from 26 Jan 2019) which gives secure tenants of councils and some housing associations the legal right to buy, at a large discount, the council house they are living in. policy, with the 1980 Housing Act, allowed tenants to purchase the council homes12A council house is a form of British public or social housing built by local authorities. in which they lived. However, this policy contributed to a drastic reduction in council homes (in other words, social housing). Profits gained by local authorities from homes sold13These home were sold largely below market value. were not reinvested in the construction of new social housing. This also led to greater social stratification since only wealthier tenants were able to purchase their homes. 

To aggravate the situation more, in 2016, 42% of the homes purchased under the “Right to Buy” scheme in London were rented out by private landlords. With the bulk of homes now concentrated in the hands of owners, there have been several instances in which the local authorities pay these private landlords to house homeless families (Copley, 2019).14In addition, the introduction of a borrowing cap in 2012 on the ability of local authorities to borrow against the value of their Housing Revenue Account funds (composed of rents from council homes and the market value of public housing) further curtailed the capacity to invest in new affordable housing.

A need for pragmatism dosed with a shift in perception 

Solving the housing affordability crisis requires the right policies at the right time. But it is crucial not to adopt the standard blueprint one-size-fits-all approach. The Austrian case described in this article has to be interpreted within its historic context. Faced with a dramatic housing crisis during and in the aftermath of the First World War, the government introduced a strict rent control policy that had a disincentivising effect on the private development of rental buildings. Over time, the policy encouraged a decrease in land prices, spurring land acquisitions by local authorities, and paving the way for a large investment in social housing (Condon, 2018).

If we want to solve the housing affordability crisis, we should first start seeing housing for what it really is, a primary consumer good, rather than a form of savings or investment. This will not happen overnight. Strong agglomeration forces, cultural values and financial incentives all need to be factored in when tailoring new solutions.

But while the shift in public perception may only happen in the long run, the Vienna example at least demonstrates the existence of policies incentivising the adoption of a new paradigm in which social housing is not perceived as a fallback solution for more deprived citizens. The objective here is not to copy the Vienna experience verbatim—or any other experience for that matter— but to identify the flaws in our modern systems, consider all possible solutions, and adapt them in an effort to close this pressing housing gap. Because, as the saying goes in the development field… a successful country is not one in which the deprived own cars, but in which the wealthy use public transportation.

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