How can UK policy-makers make homes more affordable?

Housing in the UK has become seriously unaffordable; the problem is likely to get worse; and younger people are being hit the hardest. Reforms that could be effective in solving the crisis are considered politically infeasible – while popular policies are ineffective or, worse, counterproductive.

Putting a deposit down for a home is one of the largest financial decisions many people will ever make. Affordability is a crucial condition of being able to take this step.

The most common measure of housing affordability is the house price-to-income ratio. Houses are considered affordable if median prices are no more than three times median salaries.

In England and Wales in 2022, the median annual earnings for someone on a full-time salary was £33,400. This would mean that an affordable home would cost £100,000.

Instead, the median price of a housing unit (a house or flat, for example) in 2022 was around £270,000. In certain parts of the country, such as London and the South East, homes are considerably more expensive (see Figure 1).

Figure 1: Median house price by region, 2022Q4

Source: Nationwide

The housing affordability crisis is particularly severe in parts of England. But it is also a global phenomenon. Housing affordability around the world has declined for decades, especially in major cities and tourist locations.

In 2021, there were five times as many areas with price-to-earnings ratios above 10 compared with just a decade ago, based on a sample of over 400 metropolitan areas across nine countries (including the UK). So, the number of exclusive areas is growing.

Falling interest rates over a long period partly explain this trend. But affordability has seriously deteriorated even when taking interest rates into account. Indeed, the ratio of first-time buyer mortgage loans as a percentage of take-home pay doubled in the UK between 1995 and 2022, increasing by 160% in London.

In addition, the problem is not just confined to house prices and would-be-buyers: private rents are also seriously unaffordable relative to earnings.

The affordability crisis in the UK has hit the younger generation the hardest. For decades, the homeownership rate has been increasing steadily for over-65-year-olds. But homeownership among 25-34-year-olds peaked during the late 1970s.

It fell by half over the period from 1989 to 2016. The number of adults living with their parents in England and Wales rose by 700,000 in a decade to 4.9 million in 2021.

This crisis doesn’t only create generational inequality. High housing costs also discourage workers from moving to the most productive cities, hampering economic growth.

Why has housing become so unaffordable in the UK?

Put simply, there is a major shortage of housing. Looking at the data, the main explanatory factors are a combination of severe supply constraints in desirable cities (such as London, Cambridge and Oxford), working in conjunction with growing demand for housing in these locations. Stagnant supply, together with surging demand, puts upward pressure on prices.

The rising demand for housing over several decades is mainly the result of rising real incomes and, to a lesser extent, population growth.

Mortgage interest rates also affect demand. Real and nominal interest rates go up (lowering demand) and down (increasing demand), but they cannot rise or fall forever. This is unlike incomes and population, which both trend upwards in the long run, in nominal and real terms. So, interest rates cannot explain price trends over many decades.

But rising demand alone does not necessarily decrease housing affordability. In fact, to the extent that supply is responsive, increasing real incomes should make housing more affordable.

Similarly, a fall in real house prices does not necessarily make housing more affordable. The price decline may be primarily driven by falling real incomes and a poor economic outlook.

The main issue is unresponsive supply. In other words, the UK has not built enough properties to keep housing affordable. Between 1970 and 2022, house prices in the UK increased in real terms by 441%, yet construction fell by 46%: from 378,320 to 205,340 units. The system is broken.

But why is supply so unresponsive to rising prices? The main culprit is regulatory supply constraints. The UK’s ‘development control’ planning system is highly inflexible. Its decision-making is also unpredictable, adding risk to the development process. The primary effect of this clunky framework is to constrain development.

Would-be developers also face opposition from local communities. Residents afflicted by ‘NIMBYism’, who declare ‘not in my back yard’ at the prospect of new building projects, often push back against plans to construct more homes. This, together with restrictive planning regulations, means development is constrained in all directions.

For example, large cities in England cannot grow horizontally because they are surrounded by massive green belts. Residential land use is off-limits in these areas, even for places close to existing transport nodes.

Height restrictions and view corridors prevent vertical expansion. The protected view corridor from King Henry’s Mound in Richmond Park to St Paul’s Cathedral, for example, benefits only a few. The opportunity costs in the form of forgone construction, higher property prices and rents across the capital are huge.

Lastly, many inner cities are, to a large extent, ‘preserved’ by conservation areas and listed buildings. These prevent redevelopment at higher density and higher energy efficiency.

Conservative estimates suggest that if the South East (the most restrictive region in England) had the same levels of restrictions as the North East (the least restrictive region in England, but still highly restrictive by international standards), house prices in 2008 would have been 25% lower.

To make matters worse, the benefits associated with permitting residential development and the costs are not geographically aligned.

Planning decisions in England are made by local authorities. They face the brunt of the cost of providing additional infrastructure and services. Local officials are elected by NIMBYist residents who fear that residential developments could shrink local school catchment areas, make local roads more congested, or obstruct views.

Despite facing most of the cost, local authorities (and existing residents) reap few of the benefits in the form of additional local revenue (through council tax). And the caveat with that bit of extra revenue is that it is redistributed away again in future years through the central government grants system, which allocates resources based on needs.

New residential construction does generate wider benefits in the form of lower housing costs. This increases housing consumption per capita. But these benefits typically do not accrue locally (and if they do, existing homeowners don’t like them because it also means that their assets have become less valuable).

Instead, they accrue at a much broader geographical scale. Each additional development only reduces market-wide housing costs marginally – and since new developments often create local amenities, prices sometimes even slightly increase locally. The downward cost adjustment becomes large only across the whole system.

All of this suggests that local officials have virtually no positive incentive – in terms of taxes and spending – to permit residential development. Without addressing this issue, the situation is unlikely to improve.

How might policy-makers address the housing affordability conundrum?

Resolving the crisis would require some radical reforms. Policy-makers should reform the planning system away from the extraordinarily restrictive and idiosyncratic development control system towards a rule-based zoning system.

They should also redesign the system to cater less to NIMBYist pressures and focus more on its core purpose – that is, correcting market failures.

Further, policy-makers should require horizontal and vertical planning constraints to undergo social cost/social benefit considerations. Crucially, if the costs exceed the benefits, they should go.

More specifically, the UK government should replace Section 106 agreements with a Developer Levy. They should also phase out the highly inefficient stamp duty land tax and replace it – in a revenue-neutral way – with a much-reformed council tax. The latter should become a proper local annual tax on property values, and local authorities should be allowed to keep the revenues.

The trouble with these proposed reforms is that they are unpopular among politicians wanting to get re-elected. Such reforms are complex, they have an implementation cost, and the benefits accrue only in the future.

Further, the median voter in the UK is an existing homeowner who is likely to believe him or herself to be a beneficiary of the status quo with rising house prices. This makes change hard to sell.

It is much easier for policy-makers to enact new policies that stimulate housing demand. But these demand-side policies are, at best, ineffective, or, at worst, counterproductive. This is especially the case in desirable and supply-constrained areas where housing is most desperately needed.

The government’s Help to Buy equity loan scheme is a perfect example. A recent evaluation reveals that the policy not only failed to induce additional housing construction in the severely supply-constrained Greater London, but also increased the price of new-build houses by far more than the implicit government subsidy.

The policy did work better near the border between England and Wales, where supply is less constrained. But housing is needed where affordability is worst and productive jobs are located, not in remote areas where housing is still reasonably affordable.

If anything, Help to Buy helped to increase commuting distances, contributing to carbon and other emissions. Clearly, such a scheme is not the solution.

What should policy-makers do next?

At a superficial level, the answer is straightforward: reform the planning and tax systems to increase housing supply. But there doesn’t currently appear to be appetite to do this.

One fundamental issue is that existing homeowners believe that they benefit from the status quo with ever rising house prices. This view is flawed for at least three reasons.

First, existing homeowners can only actually unlock their housing wealth if they sell and move to a much less desirable place or leave the country.

Second, our wellbeing is driven by the quality, size and location of our homes, not by how much our house is worth. The sad truth is that many people live in cramped and sub-par housing too far from the workplace, precisely because it is so limited in supply and, therefore, expensive.

Third, many existing homeowners are older and have children who are themselves desperately looking for adequate housing. Parents may not realise that their opposition to reform indirectly hurts the prospects of their offspring.

Solving the conundrum requires two things to happen. First, the current situation is partly the result of poorly informed voters. It is therefore crucial to persuade the median voter that they may not benefit from the status quo. It is also vital to convince benevolent policy-makers that demand-side policies hurt rather than help.

Second, the young and their YIMBY movement (‘yes in my back yard’) do not have a political majority. To succeed, they must persuade altruistic parents and grandparents that radical reforms are desperately needed. In other words, what is needed is a coalition across generations.