Economics: Hot property, but not too hot to handle
Look forward to healthy house prices, says Steven Bell. Just don't expect them to go through the roof
Sunday 11 August 1996
Now, with the market turning bullish again, some people are starting to talk about taking another spin at winning easy riches.
Housing pundits agree: the market is recovering, prices are rising, the transaction log-jam is breaking up. But the speculative treasure hunts of the past probably won't be repeated for at least three good reasons.
First, speculation in any area is highly risky and gambling with your home can ruin your life, as people caught in the negative equity trap have discovered. Second, the market is very uneven across the regions. Third, the tax system, which used to penalise financial investments and favour housing, has changed dramatically.
According to the Halifax Building Society index, house prices in London and the south-east rose a little last year. By the end of this year, we at Deutsche Morgan Grenfell expect annual house price inflation to be running at about 8 per cent. At the end of next year, our projections show house price inflation at 10 per cent in the south-east and 11 per cent in London.
By contrast, the housing market is still weak in most of the rest of the country. In the West Midlands and the North, for example, which only started to boom in 1989 after the market collapsed in the South, the cycle seems to be at least a year behind, and our projections show house prices growing at only half the South's rate.
The UK has experienced two house price booms in the past 25 years: in the mid-1970s and the late 1980s. However, the taxation of housing and other financial investments has changed substantially since then. Comparisons with 1974 are staggering. At that time, inflation was running at 16 per cent and due to rise to 25 per cent in 1975. Yet the peak in the mortgage rate was only 11 per cent, so in real terms interest rates were negative. Despite this, 100 per cent of mortgage interest payments received tax relief at the borrower's highest marginal rate. For the basic-rate taxpayer this was 33 per cent, and for the highest-rate taxpayer a remarkable 83 per cent. House prices could have fallen in real terms by up to 20 per cent and it would still have been worth borrowing to buy a house.
On the other hand, investing in financial assets looked very unattractive. Tax, inflation and disastrous financial performance took a heavy toll on savers. The stock and equity markets were highly volatile and very weak, and even when inflation rose to 25 per cent, bank deposit rates never reached double figures. Interest on building society deposits peaked at 7.6 per cent.
This pathetic rate was taxed, and for those with investment income of more than pounds 2,000 a year there was a surcharge which climbed to 15 per cent. This produced the astonishing result that some people on very high incomes faced a marginal tax rate of 98 per cent. Little wonder that the housing market experienced the speculative frenzy which took prices in relation to ordinary incomes to levels never seen before or since.
By the time of the boom in the late 1980s, the tax privileges for home owners had diminished but not disappeared. There was a pounds 30,000 limit on the amount of a mortgage that was eligible for tax relief, but it was still available at the top marginal rate.
Financial assets, however, were much more attractive. Despite its ups and downs, the stock market was generating very high returns. As a result of Nigel Lawson's tough monetary policy at the Treasury, interest rates reached 15 per cent - well above inflation, which never exceeded 11 per cent. Lower tax rates meant that savers kept more of their returns, and there was relief for capital gains due to inflation. In addition, we had the beginnings of tax-free investments in the form of business expansion schemes, personal equity plans and tax-exempt special savings accounts. Indeed, many retired people were very comfortable living on building society interest.
Almost 10 years on, the tax treatment of financial investments remains favourable. Anyone who has taken their full allowance in a PEP every year has accumulated a substantial stock of tax-free investments. Meanwhile, mortgage interest tax relief has dwindled to an almost trivial level.
Will all this change under Labour? To be sure, the chances of punitive tax rates being reintroduced are nil. Nor would New Labour bring back the mortgage subsidies which many observers believe caused so many problems in the 1980s. But an incoming Labour government will need to raise tax revenue. And the Treasury already has its eye on the mountain of cash stored in tax-free investments.
We believe that house prices are heading higher; indeed we are the most optimistic of all the leading forecasters. Yet the financial landscape has changed dramatically in the UK and the speculative excesses seen in the past two booms are unlikely to be repeated.
Steven Bell is an economist at Deutsche Morgan Grenfell. The company's latest report, "Can the Housing Market boom again?", priced at pounds 75, can be obtained by contacting Debbie Isbell on 0171 545 2085.
Mortgage interest tax relief
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