The Impossibility of Building Decent Affordable Homes

  ..and how attempts to do this naturally increase PRS profits.

Who Pays To Make A Home Affordable?

According to government figures, half of all so-called "affordable" homes delivered between 2018 and 2023 were provided through developer contributions. This is where house-builders are required to sell some units to housing associations or first time buyers at below market value, or otherwise make a financial contribution towards affordable housing. This levy increases the marginal cost of supply of new housing stock significantly, and economic fundamentals tell us that is counter-productive. The wider housing market is dominated by transactions of older housing stock, not new-builds, but given the marginal cost of supply for all market segments is driven by new-build costs, the levy increases resale house prices and PRS rents too.

We know if Supply drops, Prices will rise and so forth, but there is quite a lot more to what the renowned economist Alfred Marshall defined in 1890 with brilliant clarity as the "Principles of Supply and Demand". For one thing (in the general case) at the equilibrium point: Market Price is equal to the Marginal Cost of Supply; not the average cost as many policy makers intuitively and incorrectly assume.

An increase in marginal cost (inclusive of any additional taxes or levies) will move the market equilibrium point to one at a lower level of supply and an increase in market price. All market rents are higher with such a new-build levy, not because landlords are greedy or socially irresponsible, but because it's a natural consequence in a market environment with such a ill-conceived policy in effect (and this is not the only policy having such an effect).

As an illustration: a requirement that 25% of units are sold at 20% discount in new developments can be expected to add ~6.66% to the cost of delivering the unsubsidised 75% of new units. If the market will stand that higher price and the projects go ahead, a similar % increase will carry through directly to the local resale and PRS rental markets as a consequence of that levy, making homes generally less affordable in the area for everyone renting privately or buying.

Or if the developers do not expect to be able to market successfully at the higher price the levy implies, the projects either do not go ahead (and supply is lower than it otherwise would be), or do with an excessive level of "value-engineering", that is, the building of substantively lower quality homes. In that scenario, the wider market is not affected immediately, but the issues with having a greater proliferation low quality homes and their rapid deterioration of condition will have longer-term consequences for the wider housing market. It will take decades longer than otherwise to get out of the affordability crisis if we do not build homes that are of average size and well-built such that they will be an attractive affordable option in, say, 50 years time.

Older homes will always have a lower capital value than a new-build of the same size due to the fact that whilst there is an intrinsic utility value they share, the condition and value of the building, fixtures and fittings in an older property will have depreciated. The public's expectations are naturally benchmarked by the prices/rents (according to size and location) of housing of median condition and age. The full market price of new-builds plainly does not fall into the category of what would generally be described as "affordable" when the market has predominately lower value depreciated older stock. Even with discounts passed on by housing associations through shared ownership schemes, the reductions only really bring a new-build price down to where overall median house prices and rents are in any case.

A few of these subsidised new "affordable homes" are offered at Social Rent which are, of course, affordable by comparison to anything else for a lucky tenant who qualifies and obtains such a home. But this is very small proportion. The subsidised housing that is counted as "new affordable homes" are for the most part not all especially affordable and often of low quality too.

Whilst there is clearly social value in providing subsidised housing at a Social Rent to those most in need, such subsidies should come from general taxation. All forms of "affordable housing" schemes wherever that is funded from developer contributions do more harm than good in respect to their overall impact on affordability throughout the housing market.

If a politician proposed that NHS services could be improved with extra funding sourced from an increase in taxes specifically on doctors' upper earnings, the concept would be widely understood as being guaranteed to cause more problems for NHS service provision than it solved; and the proponent would be lambasted from all sides for the folly of such an obviously impractical idea. Yet, no-one bats an eyelid when this has been going on for years in the housing market, and there's no sign that the new government which has grander ambitions than the last on housing supply and affordability even understands there is an issue with this funding model for affordable housing.

At the local level in Portsmouth, the Local Plan expects that "build-to-rent" will meet the need for expected increases in PRS demand in the coming years. The Plan does not address the issue of affordability of new-build property for younger, lower-income households that make up the bulk of PRS tenants. It can be expected that the more affordable older PRS stock will still be first-choice for most tenants going forward. And those landlords who might be considering investing in new-build, I'd suggest plan a relatively early exit too, before the 10 year guarantee expires, as quality issues can be expected.

So, despite the uncertainty around the Renter's Rights Bill (RRB), the outlook and fundamentals for PRS returns in the Portsmouth area over the next 20 years remains as strong as ever, and as good as anywhere in the South of England. And when it comes to deciding on long-term investments, fundamentals matter most I'd say. Even for those landlords just entering the market or who are on an acquisition cycle, gross yields I observe are currently higher than at any time in the last 18 years, and mortgage lenders have a lot of unallocated mortgage pots right so financing is easy right now too.