Thoughts through the cycle: W5 March ’21

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The housing issue: Crisis of supply or crisis of aspiration?

  • Largely forgotten now, Edward Bernays (1891-1995) was as important a figure as anyone in the emergence of the consumer society in America during the twentieth century. A pioneer of public relations theory (he in fact came up with the term ‘public relations’), Bernays believed that consumer psychology was the key to encouraging people not only to buy what they needed but also what they wanted.
  • That Bernays used the tools of psychology to help companies sell their products is perhaps not wholly a surprise when you consider that his uncle was Sigmund Freud. In a famous campaign for tobacco firms in the 1920s, he hyped cigarettes as ‘torches of freedom’ and got attractive debutantes to smoke them at a fourth of July parade in New York as a means of overcoming the prevailing taboo in American society against women smoking in public. Outrage today, no doubt, but it worked – the taboo was broken, and cigarette sales amongst women rocketed higher.
  • Bernays’ use of psychology to unlock the aspirations of the consumer is now so commonplace as almost to pass without notice. If one had for example noticed the snazzy advertisements in the weekend colour supplements over the past five years advertising Ballymore’s Embassy Gardens development in London, the message was a simple one of stylish living in the centre of a global city in a community of attractive young professionals.
  • Embassy Gardens gets its name from its proximity to the new US embassy building nearby. The area formerly known as Nine Elms was previously one of those in-between places in London where even buses didn’t go. One could see fashionable Chelsea from the wrong side of the river. A bit of rebranding though, and you have an oasis of calm in a global metropolis, or something like that.
  • While not exclusive to them, the British do love a property story, and for much of the last 50 years, faith in rising property prices has been well founded. The negative-equity trap of the early 1990s is a distant memory, and the 2007-8 global financial crisis saw a bit of a dip but, with zero-interest rates and lots of quantitative easing from the Bank of England, the market rallied and the property mantra stayed intact.
  • It is not just residential property that gets the Brits excited. Back in 2013, attempting to show that austerity was over and to do something that three successive Labour governments had failed to do, the Conservative coalition government IPO’d the Royal Mail (with the ticker RMG.LN).
  • City grandees with long memories knew how the likes of British Petroleum (BP.LN) had roofed on their stock market debuts. Institutional interest was strong. In a bid to resurrect the popularity of the ‘Tell Sid’ campaign in the 1980s to increase shareholding amongst the wider population, there was a large retail component to the share offering.
  • A key part of the story was the property angle. The Royal Mail had a number of sites scattered throughout London which could be sold off and monetised, releasing mucho value to shareholders, or so the broker pitch went. The jewels in the property portfolio included Mount Pleasant just north of the City of London, and of course a large site at Nine Elms.
  • The IPO came at 330p but the stock closed on its first day at 450p amidst frantic institutional and hedge-fund buying, largely it seemed driven by the belief that public sector IPOs were always mis-priced. The stock initially peaked around 600p late in 2013 as institutional investors were forced to add to their holdings ahead of the stock’s inclusion in the FTSE 100 Index. Hedge funds sold to these institutional accounts, taking a nice short-term profit in the process. In the meantime, despite some spikes, the stock drifted as the core mail business declined, a victim of what seemed to be an increasingly digital age. The recent rally in the stock has been driven by rising operating profits from the parcel business during lockdown (see graph below). The property angle never really amounted to much, but it was a nice story at the time.

Source: Bloomberg, 25th March 2021. Past performance is not a guide to future results. The prices of investments and income from them may fall as well as rise and an investor’s investment is subject to potential loss, in whole or in part.

  • It seems that the Embassy Gardens development in Nine Elms never really lived up to its promise either. In a recent article in the weekend FT (‘Soaring charges leave residents ‘trapped’ with increasingly costly London homes’, FT, 13/03/2021), one Embassy Gardens resident complains that the service charge had increased 58% since 2015 to over £6,500 per annum. He is quoted as saying:

“It just feels like I am a cash cow in my own home… I am liable for a service charge that goes up 10-15 per cent per annum and I cannot reduce or opt out of it. I don’t think I’ll every buy leasehold again.”

  • The ire in the article is very much directed at the property company Ballymore since it seems this sharp practice of hiking the service charge is a feature across several of its other developments in London. Nonetheless, the sentiments expressed offer a number of themes which can be unpacked and which seem of general relevance, not least the pain of cost inflation (in what might soon turn out to be another era of inflation) as well as the implicit problem of investing in assets where liquidity is poor. Housing is one of those odd things nowadays which is both utility (a good to be consumed, albeit a resalable one) as well as something which has increasingly been treated as an investment, especially as a means of amassing wealth for retirement.
  • Although the ‘right-to-buy’ policy (allowing council tenants of a certain length of tenure to buy their flats or houses) actually started in the 1960s, it was the push under Margaret Thatcher’s governments in the 1980s which saw the policy come to the fore of public consciousness, especially as a tool to feed the ownership aspirations in a burgeoning consumer society. The more recent help-to-buy policy (instituted by the Conservative coalition in 2013) is just another iteration of right-to-buy, only this time with taxpayers implicitly underwriting the mortgage lending.
  • Despite all this, home ownership actually peaked in 2007 ahead of the global financial crisis. When one is therefore talking about the housing crisis, one is not really talking about homelessness as such. Homelessness is a scourge in a highly affluent society, especially given the large number of former service personnel who often find themselves in the unfortunate position of living on the street. Nor is one talking about those, particularly women and children, who find themselves at physical risk while living in low-quality, temporary council accommodation. Both of these instances constitute a clear and appalling policy failure, both at a local and central government level.
  • The housing crisis is one of affordability. No less august a figure than Martin Wolf, chief economist at the FT, recently wrote an article about this specific topic, saying “the cost of housing is often a big political issue” (“British Housing is expensive and its supply must increase”, FT, 21/03/2021). He states that the price to earnings ratio in the UK is an average 8.4x, the same as in 2007 and considerably higher than the 1950 to 2000 average of 4.8x.
  • What is the cause? Mr Wolf says it is not interest rates (these have been declining everywhere so there is no claim to exceptionalism for the UK, and within the UK, the problem of price rises in London is greater than elsewhere despite interest rates being the same everywhere). He concludes that supply is the issue, and there is a dig at the land-banks of the property development companies which can be used to control supply, and by doing so keep prices high.
  • There is however a real problem with the supply story here. If there is a genuine supply side issue, then where are all the homeless people? This is not a facetious or joking question (quite the opposite – see the comment above on homelessness and temporary housing, both of which constitute social outrages in such an apparently wealthy and caring country). If there isn’t really a housing shortage but a problem with prices, wouldn’t it be better to describe the housing issue not as a crisis of supply but instead as a crisis of aspiration? That is something quite different.
  • There is one glaring omission from Mr Wolf’s argument, and in part it results from his dismissal of low interest rates as a cause of high prices. The thing that has driven house prices higher in the last 50 years has been the rapid expansion of household borrowing, and therefore the supply that we should be concerned with is not the supply of housing but the supply of lending from banks and building societies. One can get a sense of the change from the graph below, which shows household debt as a percentage of GDP (courtesy the Bank for International Settlement). This graph includes both secured (mortgage) lending and unsecured (credit card) debt, but the trend is a clear one.

Source: Bank of International Settlement, 31st December 2020.

  • While property shows on TV would have us believe that repainting the downstairs toilet from pigeon melange to mole’s breath can add £25k to your house price, the slightly more prosaic driver of house prices is bank leverage ratios and lending limits, especially the limits stipulated under the various iterations of the Basel banking rules. So long as the supply of credit keeps on going up, so will house prices. The good thing about interest is that it accrues over time, so even when rates are low, the stock of debt keeps rising. The housing market is safe for now.
  • One potential fly in the ointment comes from New Zealand, that unlikely hotbed of central bank policy innovation that actually brought us the 2% central inflation target in the 1990s. An amendment to the New Zealand Reserve Bank’s mandate earlier this year means it must now consider house prices with respect to its interest rate policy (‘New Zealand Government Forces Central Bank to Include Housing in Rate Setting’, Bloomberg, 24/02/2021). This follows a sharp run up in house prices due to lower interest rates, a point about which the FT’s Martin Wolf might disagree. No other central bank has hinted that it would follow suit, but it is a timely reminder of how the provision of credit, both in terms of loan amounts and costs, is the real driver of a lot of the wealth we see around us these days.

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