We look at the role of finance in the housing crisis, and how we might improve things
Following the third of our workshops held in partnership with the Wikihouse Foundation, Alastair Parvin writes about innovative policies and models for funding housing.
One of the things that makes the housing crisis such a fiendishly difficult nut to crack is that there is no single cause. It is a complex knot of locked-in interests and behaviours — each individually understandable, but collectively disastrous.
The danger is that because we find complex, knotty multi-layered problems incredibly hard to understand we’re tempted to jump to over-simplified diagnoses; and over-simplified solutions, that only address one part of the broken system. In order to understand the housing crisis, we need to resist some of these easy, simple myths and half-truths that shroud it.
The most common myth about housing is that it is just a problem of supply and demand. If we just spend more money to ‘build more homes’, all will be fine. Needless to say, it’s not that simple.
Another common belief is that the reason we have a housing crisis is that we have a shortage of land. That is half true — but it’s not necessarily a very helpful way of looking at it. In truth, housing only takes up around 1.1% of the land in the UK (amusingly, this is only half the area taken up by golf courses in England). So no, there is no land scarcity. So what we actually mean by ‘land shortage’ is actually a scarcity of land with planning permission, connected to infrastructure (roads, schools etc) and close to jobs. Ultimately of course, as a society we have as much land as we give ourselves permission to use, and that doesn’t just mean building on greenbelts — it also includes the permission to densify land which is already built on.
This, naturally, turns the spotlight onto the mechanism by which we collectively give ourselves permission to use the land we have: the planning system. As we have explored previously, there is no doubt that the UK planning system is in bad need of an upgrade, but it’s important that we have one. Even if we had no planning system at all, there would probably still inevitably be some degree of scarcity of land for housing, either due to geographical limits, or proximity to jobs, infrastructure and culture.
It is into this condition of underlying scarcity that the other key piece of the puzzle fits, and it is the piece that is arguably the least well understood. That piece is the banking system.
Since demand for land is always larger than supply, prices tend to inflate. However, that inflation should be limited by people’s ability to borrow, and banks’ ability to lend. This would be fine if banks ability to lend was limited by the amount of savings they held, but this (as explained very elegantly by Positive Money) is not how banking works. When banks make mortgage loans they are, in effect, writing an IOU, and conjuring new money into existence.
At the same time, the rise of securitisation meant banks made their profit not from the interest paid back by borrowers over time, but by bundling up those new IOUs and trading them.
The result, as we know, was a plunge in interest rates as banks (and governments) sought to encourage homebuyers to take on as much new debt as possible, and that new cheap debt flooded into the housing market, inflating an unsustainable property bubble. That, in turn, triggered ever more land and property speculation, spiralling prices upwards and upwards, until in 2008 the music stopped.
Despite everything that has happened since 2008, amazingly little has changed. Land prices remain high, and the market for new land is almost entirely dominated by speculators. The reason for this is that for the large part, only speculators have the kind of capital required to be able to outbid other buyers and purchase plots for housing, and to take on the level of risk and delays involved in fighting through planning and developing new homes.
This means that when it comes to building new homes, over the last half century we have become almost totally dependent on a small group of very large speculators who act as intermediaries — buying land, securing planning permission and building homes which they then sell to homeowners (for as much as they are able to borrow) in order to return a profit to their shareholders. It’s incredibly risky, debt-heavy, unaffordable and short termist. In the property sector, this model is referred to as the ‘current trader’ model. Chris Cook summarises it rather more neatly as the ‘four Bs model’: buy, borrow, build and b*gger-off.
It is our assumed dependency on this model of development that shapes almost everything we think we know about housing; from our planning system to national policy and above all, to the way we invest in development.
If you are a landowner (for example a local authority, constrained by best-value rules) it is difficult to justify selling that land to anyone other than one of these speculative developers, who can pay the highest price.
If you are an investor (for example, a pension fund) looking to invest not just in existing property but in the development of new homes and neighbourhoods, there are few options other than investing in these speculative development companies.
In truth, that model alone has never built the number of quality of homes that we need, and now more than ever it is failing. As land costs rise but incomes stagnate, that model is increasingly no longer ‘viable’ (profitable) in many areas, and on many sites, especially small and medium-sized sites.
This is not to say that there is no one else out there who could be building homes and neighbourhoods. From social landlords and community development businesses to custom and self builders, there is a diverse array of people and organisations who, with the ability to buy or rent a plot of land, could and would build sustainable, affordable, resilient homes and neighbourhoods. The problem is that these other sectors are not yet seen as investable, and so can’t buy the land.
That’s why, for the third in our series of events with Nesta, WikiHouse Foundation convened a workshop, bringing together pioneers, experts and practitioners to think not about top-down reform of the financial system itself, but about the future of how we will finance new homes and neighbourhoods; to imagine new innovative models that could be (and in some cases, are already being) piloted.
The workshop was opened by three presentations. The first, by Beth Stratford, gave a clear-eyed overview of the UK housing crisis from the perspective of land and finance. (You can see her presentation here.) In the second, Simon Chouffot of Naked House shared the perspective of a community development company actually leading development of a neighbourhood of homes. In the third, Bruce Davis of peer-to-peer investment platform Abundance spoke from the perspective of potential investors.
The assembled brains then went to work exploring a range of models and innovations that take a fundamentally different approach to investment in homes, or have serious potential to become key factors in unlocking new ways to invest. Of course, it would be impossible to try to capture the full depth and breadth of the conversation, but it is worth capturing a few key takeaway themes and insights.
Finance the homes separately from the land One of the most confusing (and dumb) characteristics of the ‘current trader’ model is that it bundles the cost of the land into the cost of development. By financing the home (a consumer durable) separately from the land (a licensed property asset), in many cases it is possible to massively improve affordability. This might include leasing the land rather than selling it (arguably far more responsible in the case of publicly-owned land), deferring purchase over time, or collective purchase of the land. For example, a neighbourhood development company can purchase the land, represent a more appealing prospect to investors, because the risk of defaulting is spread over the whole neighbourhood. Matthew Benson of Rettie’s has proposed the use of ‘land bonds’, whereby a neighbourhood development company (for example a cooperative) could finance the cost of land by issuing 25 year bonds.
Invest for long-term returns Another flaw in the current trader model is its short-termism. This hurts twice over — first it means that we, the buyers, have to stump up for the full capital cost (plus profit) straight away, and second because it means that the developer building the homes has absolutely no interest whatsoever in the quality, sustainability or long-term performance of the neighbourhood as a place to live. Not surprisingly, almost any model whereby the developer (whether a landlord, a neighbourhood development company or the residents themselves) sticks around, and takes a long-term view of value/returns, begins to change this dynamic. Instantly it becomes viable (and necessary) to invest in better homes that don’t leak energy — and money, and in fostering local jobs and communities.
Fixed-price land, not bidding It is not just the absolute cost of the land and homes themselves that make it hard for landowners to sell their land to anyone other than speculative developers, and hard for investors to back them. It is also the uncertainty of the process itself. Unlike speculative developers, community developers don’t have the kind of capital reserves that allow them to participate in a bidding war. This puts them in a catch-22, whereby they are unable to buy a site without an investor, but unable to attract an investor without demonstrating that they have access to a good site. Local authorities (and private landlords) can help unlock this simply by offering plots for sale at a pre-fixed market-appropriate price, then selecting their buyer on the basis of their ability to deliver on their wider place-making objectives and affordability. In cases where the local authority is bringing new land into use through the planning system, they can use this mechanism to offer the plots at an affordable rate, and capture the uplift themselves to spend on infrastructure such as roads and schools.
Standard template contracts Another idea raised in the workshop was a way of addressing the cost of legal overheads. Put simply, it costs community developers and local authorities tens of thousands of pounds (often paid at risk) to pay for new contracts to be re-drawn up every time. Even for small sites where there is little competition from speculative developers, local authorities often find they simply don’t have a framework to sell or rent the site to a community builder. There is an obvious opportunity here for a straightforward and powerful market intervention: to commission and certify a series of standard open contract templates for land purchase/rent that can be used by anyone off-the-shelf.
A National Citizens Land Trust The community land trust (CLT) model has already proved to be hugely successful in taking land out of the speculative market and into a separate parallel class where it is — in effect — treated as a long term community good, rather than as a speculative asset. This makes it possible to rent that land to homeowners at a price consistently lower than the external market value. Beth Stratford (and others) have begun to explore the viability of scaling this model by creating a National Citizens Land Trust. Existing homeowners could choose to sell the land beneath their homes into the NCLT while new land could also be brought forward for development, secure in the knowledge that the housing on it would remain affordable forever. It’s an idea that could offer a serious strategy for addressing the housing affordability crisis in the UK, as well as avoiding the dangers of triggering a price crash that could leave millions in negative equity.
The new building societies The building societies were originally created to manifest the kind of banking that we all wish we had anyway — the It’s a Wonderful Life model — whereby the savings of each generation allow the next to build their homes, rewarded with a fair rate of interest. With new forms of digitally-enabled peer-to-peer lending, can we imagine a revival of the building society-as-platform?
De-risking development Across all of this lies the question of why we ever relied on developers as intermediaries to build our homes in the first place. The answer is not just in their land buying power — it is also that the process of finding land, getting planning permission, designing and developing homes is risky, opaque and fraught. Costs can easily escalate, especially with inexperienced clients. That risk comes at a measurable cost — and that cost is a barrier for investors and lenders. However, in the 21st century a lot of that risk is completely avoidable. In an age where we have more and better data than ever, digital tools and platforms have the potential to bring transparency, predictability, automation and trust to the development process — to literally ‘design out’ many of the risks that make development such a risky proposition. This is WikiHouse Foundation’s next project, prototyping the first open, ‘smart’ supply chain platform for building information; a kind of world wide web for the built environment. The objective is to make it as simple and transparent as possible for almost anyone to act as developers, to build sustainable, resilient homes and neighbourhoods, and to make it easy and low risk for industry, regulators and lenders to support and invest in them.
If that ambition seems rather geeky and tech-centric, it’s worth reflecting on the potential rewards for society and for the economy if such a piece of common digital infrastructure could work. It is, ultimately, about capacity building. If we can expand the capacity to build homes beyond just a few speculative development companies, it would unlock a whole new economy — a new spectrum of ways to invest in resilient, sustainable infrastructure, places and people, and to get a stable return for your money along the way.
With huge thanks to all those who contributed to the workshop, and to Newspeak House for hosting us.
Note: Nesta has committed to funding the Wikihouse Foundation £50,000 to support the development of the OpenChain, the first fully digitised supply chain for housebuilding. As part of our partnership with the Wikihouse Foundation, we are holding three workshops on topics of mutual interest over the course of the year. This was the third workshop, following workshops on distributed manufacturing and the future of planning.