Financial Structures

Housing is a fundamental need, But because of its price and enduring qualities it is an investment, which usually requires a long-term loan under the terms of the Capital Market. The first most liberating fact to recognise is that over a lifetime, which is the natural period of its consumption, housing is actually quite cheap! And most of us know this from our own experience.

The problem is that in the early years of a mortgage repayment costs are very high. But, the loan is fixed by the price on the day of purchase and from then on, inflation and the effects of investment with time cause the costs to fall. By the time of retirement for most homeowners, the mortgage is paid off and the option exists to draw cash out of a growing capital asset.

For low-income families the initial cost of repayments is prohibitive. Without a loan, the free market has another solution. A landlord makes the investment and sells accommodation by rent as a consumer service. As the value of the house increases, the rent increases and the tenant has no share in the investment. The market works against the tenant in a private market.

It is because the free market makes this fundamental distinction between a consumer service and investment, that so often, it has the effect of making a distinction between the rich and the poor. It is the task of government to create structures, which allow investment to work also for the benefit of the poor. This is not an unusual process for governments, pensions are an example of investment in the capital market to provide funding for old age.

Council housing was an investment structure to provide affordable housing. Government provided the subsidy to make rents affordably when the initial loan repayments were high. But the powerful effect of investment in the stock was utilised to gradually remove the need for subsidy.

Governments then, created the structure, which allowed investment to work for the benefit of the poor. In 1948, nearly 60% of the population lived in private rented accommodation, much of it in slum conditions, so the provision was made for the majority of the working population. As the financial power of investment reduced the need for subsidy, low cost balanced rents were equivalent to the benefit yielded by the investment of home ownership. Financially, the two systems of ownership and rented council housing were different, but they both benefited from investment in the capital market and they yielded a finacial benefit, which differed only in its timing. Home ownership and council housing were financially complementary.

When this investment structure for affordable rented accommodation graduated to cost balanced rents, there was no financial reason to limit its access. It could have met the wider needs of a more affluent and mobile population. We should now look at these claims of financial efficiency more closely.

The Realisation of Investment

The realisation of investment benefit is not an immediate process, it requires the evolution of time. First, to understand this evolution, we can look at the real value expenditure devoted to a single property over its normal lifetime. This provides a clear view of investment efficiency. The chosen values and rates are quite arbitrary, but the important information lies in the relative shapes of the curves. The Excel spreadsheets for both graphs are available for examination with any alternative parameters. (To download the spreadsheets right-click the graph links and Save Target As).

Graph 1 Compares the real costs of housing provision. The base year is 2004 (all costs are calculated at 2004 values) on a £150,000 property. The model assumes fixed inflation at 5% and fixed 25 year mortgage lending at 7%. It assumes that a private rent is 7% of capital value and that owner occupied houses are re-sold on average, every 20 years. Maintenance and replacement are funded by an annual cost at 1% of capital value for owner-occupiers and 2% for rented property. The term 'council house' here, means 'cost-balanced rented housing', which is no longer the case for today's council housing.

Low costs are achieved by the council house and by the owner-occupier. By definition private rents are consistently high. The cyclic pattern of the owner-occupier sector house occurs because, on average, they are resold every 20 years. The investment cost on a resold property is thus renewed and catches up again, with the level of inflation. This is very good for the money lending market, but it reduces the cost efficiency of the accommodation function of owner-occupation compared with rented stock.

Financing a Housing Stock

By extending the financial model of a single house, we can examine the financial mechanisms, which determine the cost-balanced properties of housing stock. Lets look at the way it works. The graph shows a building programme of 400 houses a year for 50 years, by which time a stock of 20,000 houses would be completed. New 25-year loans are raised each year and the total costs are shown as a weekly cost per house. As the programme proceeds costs fall due to inflation. After 25 years, the first year’s houses are paid off and because this happens each year from now on, the fall in cost accelerates. After 50 years, building stops and costs fall more rapidly again. After 75 years, all the houses are paid off and only the costs of maintenance remain. The yellow lines indicate different degrees of affordability.

The investment advantage applied to a rented stock is even more powerful than the investment of home ownership, which is diminished by periodic resales within the lifetime of the building. In the 1960s, when many of the initial targets had been met, we should have reformed the system to a more universal low cost rented system, repositioned to meet the needs of a wealthier population with more mobile and variable aspirations.

Graph 2. Model Parameters

Real Values on Base Year 2004

Unit Cost:	£150,000
Target Stock:	20,000
Building Rate:	400/yr
Loan Rate:	7%
Loan Period:	25yrs
RPI:	5%
Mang & Maint:	2%
Nat avg Wage:	£500

Although fixed values for inflation and loan charge rates etc., never occur in reality, the principle of the model is valid. It clearly shows the powerful financial principles upon which low cost rented accommodation is based. Housing policy today suffers from the decision, taken in 1971, to abolish the use of this principle. This is the meaning of the market rent policy. The popular view was misled by two political slogans – “Fair Rents” and “Right-to-Buy”. Private builders cannot take the loss of providing “affordable” housing. Without the stock and cost-balanced rents, most of the current talk about affordable housing is in cuckoo land.

Viable policy cannot escape the reality of the capital housing market, nor can it ignore the criteria of affordability. By using the financial advantage of investment in a building stock, affordability can gradually be achieved at cost-balanced rent without subsidy. However, the rents would have to be very high in the early years, while the stock is being established and quite apart from the question of affordability, it would be unfair to the early tenants. Therefore subsidy is required in the early years. But unlike housing benefit, subsidy to support the initial high cost stage is not a permanent and growing burden to the taxpayer. The graph shows that cost-balanced rents can bring affordable housing well into the range of low-income families.

The basis of this low-cost solution is the establishment of a housing stock. This principle is deliberately dismantled and destroyed by the discounted sales of the Right-to-Buy policy. Much can be learned about the resilience of the investment based public housing system from the 1960s and early 1970s before the final centralisation of housing policy under the new financial system.

Colchester is a typical small English town. Between 1971 and 1974, the local council housing system supported a new building programme, which increased the stock by 15% over three years (that is huge!) on a balanced budget with no subsidy.

The Policy of Tenure

The current policy of paying housing benefit to support high rents has a huge cost, which becomes the permanent burden of the taxpayer.

This case is supported by the following paragraphs of the government housing green paper "Quality and choice: a decent home for all", which describes the period from the middle of Mr. Heaths housing policy to the end of Mrs. Thatcher’s.

11.2 Over the last 20 years, the role of Housing Benefit has increased substantially in real terms. In 1978/79, £2.3 billion (at 1998/99 prices) was spent on Housing Benefit. By 1998/99 this figure had increased to £11.1 billion. This reflects, in part, a long-term shift in the balance of public spending on support from direct "bricks and mortar" subsidy to personal subsidy in the form of Housing Benefit. As the chart below shows, in England the balance has moved from 84% bricks and mortar subsidy and 16% personal subsidy in 1979, to 27% bricks and mortar subsidy and 73% personal subsidy by 1998-99".

(these building subsidies refer to the newly formed Housing Associations, since council subsidies had long ceased).

11.3 Since 1997, a combination of a healthy economy and record levels of people in employment has allowed us to get social security spending - including Housing Benefit -under control. But because spending is driven by changes in rent levels as well as the number of people getting the benefit, Housing Benefit spending is forecast to continue to rise at 1.4% per year in real terms between 1998/99 and 2001/02

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