Solving the Housing Crisis
by George Hatjoullis
Home ownership can be viewed as buy-to-let where you are your own tenant. There are many advantages to this arrangement, notably tax. You waive any rent so income tax does not enter the equation. Sale of the property is capital gains tax exempt. There are advantages with stamp duty. There may be a greater selection of properties to buy than to rent. You can be as good or as bad a landlord as you choose. You have security of tenure. The terms of an owner occupation mortgage are materially better than those of a buy-to-let. There are also disadvantages. You are invested in a single property asset, in a single location. The specific risk is huge. The liquidity risk is huge. It is easier to get a buy-to-let mortgage. You are responsible for managing and maintaining the property.
In both cases you have great specific risk (unless you are a big landlord) and you are leveraged and this contributes to the high returns from single property investment. You put down 50k and buy a 500k property. The price rises 10% so you make 50k. That is 100% return on equity (the 50k deposit). This also illustrates the absurdity of the existing system of home acquisition. It assumes ever rising prices. For long periods this is a reasonable assumption, but punctuated by occasional crashes. The last general UK crash was 1987-1994. Many have forgotten. Looking abroad one can find more recent crashes. Indeed within the UK there have been regional soft spots. If you owned a property in one of these locations then the property boom has passed you by.
The present system also favours those in larger and more valuable properties. A first time buyer will eventually need to trade up. The assumed steady house price inflation constantly transfers money wealth upwards because the absolute amount you need to spend to trade up increases with price inflation. If you pay too much initially the overpayments cumulate to a huge error over time. First time buyers think they have solved the problem by getting on the housing ladder. They have merely ameliorated the problem. Perversely, first time buyers should be hoping prices crash even after they have bought.
If I went to a bank and asked to borrow 500k to invest in a Real Estate Investment Trust they would probably show me the door. But let us assume they would listen first. I could show them my income and outgoings and that I could comfortably service the debt. The loan would be secured on the value of the trust. I could even let them choose the trust or a selection of trusts. These trusts invest in a wide range of property assets and pay out 90% of taxable income. They have high dividend yields, 4-5% not atypical. The loan interest would thus be more or less covered by the yield. Many trusts trade at large discounts to net asset value. So in effect I would be borrowing to buy a selection of assets at below what the valuers believe they are worth, generating a dividend income that will cover most if not all of the interest, on top of the fact that my income could service the debt in any event. Still I suspect they would show me the door.
One reason might be that REITs are already leveraged. But if the NAV is 30% more than the price of a share there is quite a buffer for the bank (assuming valuations are reasonable). The REIT generates income from rents but is not subject to corporation tax. In exchange it pays out 90% of net income. If the discount to NAV makes the bank nervous they can insist you invest in a REIT that trades at or above NAV. They exist as well. It logically makes no difference. Information is largely in the public domain so these discounts and premiums are probably accurate reflections of this information. If this is not the case then there are some serious anomalies in this sector that are hard to explain.
The purpose of this little diatribe is to highlight that owner occupation is a popular investment because of the tax advantages and the ease with which leverage is available. If the tax advantages are removed and leverage is equally available for diversified, liquid REITs then owner occupation looks less interesting. In this situation you could borrow to invest in a portfolio of REITs and rent somewhere suitable to live (perhaps owned by one of your REITs). If you change jobs, have a family, divorce, etc you can move to more suitable rented accommodation without the hassle and expense of selling up and buying again. The greater willingness to invest via REITs would expand the availability and range of accommodation as the demand and capital allocated expand. It is a different model of property ownership but everyone can still own property and have somewhere to live.
The solution to the housing crisis lies in creating a system of flexible accommodation units that allow people to move around without penalty. Council housing fixes people in one location and there may be no suitable work in this location. Owner occupation creates friction on movement and in some extreme regional cases may mean it is impossible. A system of flexible accommodation units providing good standard accommodation of the right type would allow friction free movement. It could be highly regulated according to standard and security of tenure. It could be coordinated with support services. It could be funded and managed by either public or private capital or both. It does not preclude owner occupation. It may however require that a system so biased in favour of owner occupation be reformed.