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Anglo-German differences in housing market dynamics
European Economic Review 36 (1992) 539448. North-Holland
The European Housing Market
Anglo-German differences in housing market dynamics The role of institutions
and macro economic policy*
John Muellbauer Nt#?eld College, Oxford, OX1 INF, UK
1. lIttroduction
Over the last 30 years, there have been large differences in the cyclical behaviour of owner-occupied housing markets in Britain and Germany. The U.K. experienced massive booms in the early 1970s and in the mid to late 198Os, seen in house price/income ratio.’ Germany experienced significant fluctuations also see fig. 1. A remarkable feature of the 1980s has been that the German house price/income ratio has moved like the mirror image of the British: first falling sharply, and rising at the end of the decade, just as the British market turned down. The cyclical pattern of land price to income ratios reveals similar contrasts but volatility was higher in the U.K., see fig. 2. This paper interprets econometric models of house prices in Britain and Germany to throw light on housing market dynamics. Among the various factors which might help account for the different experiences are economic growth, demography, inflation, real interest rates, structural differences in the *Acknowledgements are due first to Alan Holmans for his path breaking work in bringing together empirical material on the comparative international study of housing markets. I am gratehtl for helptitl discussions to Franz Hubert, Konrad Stahl, Horst Tomann and Andrew Ty-rie, and to Christianne Kraus for assistance with German data. Errors, however, are mine alone. This is a condensed version of a longer paper in Milne and Holly (1992). %come is measured by per capita personal disposable income. German house prices come from Holmans (1991) and are a simple average of prices of detached and terraced houses published by the Ring Deutscher Makler which Holmans has carefully chained together. The data begin in 1972. U.K. house prices refer to the Department of the Environment second-hand house price index. This is based on a survey of building societies. In 1967 the index is spliced to an index from the Nationwide Building Society. The series have been adjusted by subtracting a 0.3% per annum trend for quality improvements and also adjusted for temporary distortions in coverage in the 1980s because of the large scale invasion by banks into the mortgage market. 00142921/92/SO5.00 0 1992-Elsevier Science Publishers B.V. AU rights reserved
J. Muelhuer,
540
. .. . ..‘O
An&-&mum
d@rences in housing market dynantks
F
F
Fig. 1. Log house price/income ratios for Britain and Germany (standardized in 1981). ..s.
_
..1.
.
a.,.
,
Britain
Fig. 2. Log housing land price/income ratios for Britain and Germany (standardized in 1975).
provision of mortgage credit and the financial liberalisation which occurred in Britain in the 19809, differences in tax regimes, differences in the provision and regulation of rented housing, and differences in the system of land use planning. Given the role of housing wealth in helping to drive consumer expenditure and the balance of payments, see Muellbauer and Murphy (1990), this analysis helps to explain substantial parts of the differences in macroeconomic behaviour between Britain and Germany. However, a priori, it seems
J. Muellbauer, Angla-German di&rences in housing marketdynamics
likely that these wealth effects are much smaller in Germany, owner-occupation is under 50% and housing wealth is less liquid.
541
where
2. A framework for aaalysis Fluctuations in house prices are best analysed in terms of an inverted demand function for houses given last period’s housing stock. In the short term, the housing stock can be taken as fixed. In our work on U.K. house prices, Muellbauer and Murphy (1991) we use the following key demand shifters to explain variations in the owner occupied house price/income ratio: population relative to the lagged housing stock, the lagged proportion of owner occupied houses (since expansions in the supply of rental housing will have a smaller effect on the price of owner occupied houses), real income, demography, a real interest rate, the lagged rate of return in housing relative to liquid assets, changes in nominal interest rates and the mortgage stock” to income ratio. With 35 years’ data and large data variations, there is good scope for identifying a reasonably robust model. Moreover, the aggregate U.K. model is consistent with regional variations between the South East and the rest of the economy. For German house price data, we have only 17 years and less independent variation. It is impossible to pin down a robust model. Nevertheless, there are some interesting indications which result from the attempt to estimate a U.K. style model. 3. Rates of interest and rates of return Some of the most important differences in institutions and historical experience between Britain and Germany arise with rates of interest and rates of return. There are five major differences. The first concerns mortgage interest rate tax relief. In Britain, mortgage interest costs are tax deductible up to an upper loan limit which was ~25,000 between 1974 and 1983 and f30,OOOsince. In Germany, individuals receive a once only 8 year allowance which allows them to offset against tax part of the purchase price of a home. In 1987 mortgage interest tax relief was abolished in Germany having previously been of limited significance, except during 19831987 when it was extended to stabilize a depressed market. When inflation and interest rates both rise, tax relief reduces the real interest cost of borrowing. This cannot happen in the German system. This is one contributing element to the second great difference in historical ?he mortgage stock is adjusted for equity withdrawal. This occurs when additional mortgage borrowing is diverted into non-housing uses. In the latter half of the 1980s as much as one half of net mortgage advances are estimated by the Bank of England to have gone into non-housing UseS.
J. Muellbauer, AngbGer~
542
diffknces in housing market dynamics
.-
-.I”
Fig. 3. Real mortgage rates in Britain and Germany.
experience which occurred in the 1970s. Between 1970 and 1980 the real cost of mortgage borrowing for a standard rate tax payer in Britain averaged minus 5% per annum. Nominal interest rates remained low compared with general inflation for a decade. This brought about a remarkable transfer of resources to mortgage borrowers, especially higher rate tax payers who faced an even more negative borrowing cost and financial sector employees with subsidized mortgages. Not surprisingly, the demand for loans had to be rationed. In Germany, the real annual mortgage rate for bank loans shown in fig. 3 never even became negative though it too was relatively low in the 1973-1976 periold. However, the subsidized rate of interest charged by German Bausparkassen3 of about 5% was exceeded by inflation in 19731975 and in 1978. Nevertheless, the overall real cost of mortgage borrowing was much less volatile in Germany. The third element of institutional difference lies in fixed rate loans which have been the norm in Germany and in floating rate loans which are the British norm. This is connected, of course, with a post-war history of less volatile inflation and less volatile nominal interest rates in Germany than the U.K. A fixed rate loan system probably entails a lower behavioural sensitivity to interest rates than does a floating rate system. When interest rates are rising, German borrowers have an incentive to lock in before they rise further and an incentive to wait for even lower rates when interest rates are falling. The fourth major difference concerns gearing. In the 1980s average loan to 3SeeBkch-Supan and Stahl (1991) for an analysis of the system, which accounts for about one quarter of housing loans.
J. Muellbauer, Anglo-German d#wences
in housing market dynamics
543
value ratios for first time buyers in the U.K. reached unprecedented levels of 85% as financial liberalization took hold. A large minority of first time buyers in 1988 and 1989 obtained lW/, loan to value ratios, though in practice, transaction costs would have reduced the effective ratio to perhaps 95%. Such gearing enormously amplifies the rate of return in housing. In general this is (d In hp +rate of imputed rate)/( 1- Iur),
rent - lur x after tax mortgage
interest
where lor is the loan to value ratio and A lnhp is the proportionate rate of house price appreciation. This is to be compared with the alternative rate of return of which an interest rate on liquid deposits can be taken as representative. I am not aware of quantitative information on gearing in Germany and how it may have changed over time. First time buyers in Germany tend to be in their late 30s and in their 40s and to have saved up substantal deposits. Gearing in Germany is certainly, on the average, lower than in Britain. This brings us to the fifth big difference which is part cause as well as effect of the different historical experiences in German and British housing markets. Because of the house price rises which have been experienced in the U.K. relatively to the level of interest rates and because of the higher level of gearing, relative rates of return from investing in housing have several times exceeded levels of 60% per annum and on average until 1989 have been systematically higher than saving in a liquid form. This has not been the case in Germany where, for most of the 198Os, the relative rate of return in housing was negative and where, in the last 20 years, it has never reached spectacular levels. The very different British experience over long periods surely is a major cause of the explicitly speculative character of the British obsession with mortgages and owner occupation. These points are illustrated in figs. 3 and 4. Fig. 3 compares the real cost of mortgage borrowing in Britain and Germany: much more volatile in Britain and lower in the 1970s. In Germany, the real cost of borrowing rose steadily from 1976 to 1987. However, the figure overstates the rise a little, since we do not build in German mortgage interest tax relief. Our British measure is for a standard rate tax payer and builds in the declining importance in the 1980s of mortgage interest tax relief as increasing numbers of mortgages exceeded the E30,OOOlimit for relief. This explains part of the increase in the real cost of borrowing, but, of course, real interest rates worldwide have been high in the 1980s. Fig. 4 measures the difference in the rate of return in housing and in liquid assets in Britain and Germany faced by first time buyers. However, we understate the rate of return in housing in each country by around 3 or 4”/,, amplified by gearing, by omitting the
Fig. 4. The geared rate of return (excluding imputed rent) for first time buyers in Britain and Germany.
imputed rent component. We assume an average loan to value ratio for first time buyers in Germany of 0.6 while in Britain we take ratios recorded by building societies.4 Our British evidence suggests that both the current real rate of interest and the lagged relative rate of return in housing have highly sign&ant effects on house prices. The latter suggests an element of extrapolative expectations so that last year’s rate of return influences this year’s demand for housing. This contributes to the overshooting of house prices. The lagged relative rate of return appears to be quite irrelevant in Germany. Since, even after including an imputed rent component, it has always been low and has not fluctuated greatly, this is hardly surprising. Germany is much less prone to speculative fever in its housing markets. In Britain, Hendry (1984) and we ourselves find that we have to build in a ‘frenzy’ affect to capture the cyclical peaks. When the rate of return in housing rises, transactions costs become relatively less important. Thus, an increase from 15% to 20”/, in the rate of return is more important for demand than an increase from 10% to 15%. We find empirical evidence of such a non-linear response in Britain. 4To cOmmmtfurther on the figures for Germany, note that the interest rate series is for variable rate mortgages which the Bundesbank publishes ba& to 1967. The Bundesbank only began publishing interest rates for fixed rate mortgages in 1982. Tht figures exaggerate An&German differences for two reasons. One is that we have made no allowance for the limited degree of mortgage interest tax relief which existed in Germany before 1987. see Tomann (1990). The second is that we have made no adjustment for depreciation allowances. For buyers of new houses with a marginal tax rate of, say, WA, these allowances increase the rate of return by 2.5% before gearing is taken into account or 6.25% adjusting for gearing with a loan to value ratio of 0.6.
J. Muellbauer, Anglo-German di@wnces in housing market dynamics
545
4 T&e evolution of the mortgage stock As in Hendry (1984), the evidence for both countries suggests that both the mortgage stock/income ratio and its rate of growth help to explain changes in the house price/income ratio. In Germany there has been fairly steady growth in the mortgage stock/income ratio apart from the strong upswing that occurred in 19791982. The data unfortunately include mortgages by landlords acquiring property in order to rent it out. The rate of change peaked in 1981, coinciding with the peak in the real German house price. The mortgage stock/income ratio is, of course, endogenous. A substantial part of the phenomenal growth in the British mortgage stock/income ratio from a level below Germany’s in 1980 to a level greatly in excess by 1989 can be attributed to financial liberalization. However, the growth of the mortgage stock has been Mated by the growth of equity withdrawal in which mortgage borrowing in diverted to non-housing uses such as consumption or investment in financial assets. Our final conclusion is that financial liberalization acting through the mortgage stock has permanently raised the U.K. house price/income ratio by around 12% and contributed even more in the short run to the 1980s house price boom.
5. Income, tbe housing stock, population and demography For the U.K. we find, like Hendry (1984) that the steady state demand for housing has an income elasticity of around 1, perhaps just over, given the mortgage stock/income ratio. We can combine the steady state effect on the house price/income ratio of the lagged housing stock, population and per capita real income using the parameters estimated from the British model. For 1962 to 1988, this measure tends to decline in Germany and rise in the U.K., suggesting greater German success in matching the supply of houses with rising income and rising population. There is also evidence of a short term effect in the form of the rate of growth of population either absolutely or relative to last year’s stock, suggesting that when population changes, the short term impact on house prices is greater than in the long term. Similarly to the intluence of demography, the effect appears to be bigger in Germany than in Britain. This is consistent with the view that Germans buy houses primarily as places to live while for the British, the portfolio investment motive is a very important consideration. For Britain we measure demography using data on the proportions of mortgage borrowing by age and using these to weight the fraction of the population in each age group. The average age of the borrowers taking out a mortgage is around 32. In Germany, it is considerably higher, perhaps around 40. From published data on the number of people aged between 25 and 40, we lag this measure by 7 years to give an average age of 40 for the
546
J. MuelW,
An&-Geman
ti@mccsin housing mtirkt
d-s
cohort and divide by total population. Thisis a~ fairly-crudemeasurebut it peaks in 1981, coinciding with the peak in the house price/income ratio and the peak in the rate of growth of the mortgage stock/income ratio. Demography appears to be an important part ~of the story of the last German housing boom. Together with immigration into West Germany and recent economic growth, the renewed upturn in numbers in this cohort is surely a part explanation for the new house price boom gathering force since 1988. Let us turn to housing tenure and the supply side. In Germany in 1985 around 42”/, of households were owner occupiers, up about 6”/, from 7 years before.’ There is a flourishing private rental market. Rents have tended to increase relative to house prices in the 19809, probably reflecting a weakening of rent controls which were never severe anyway. In Britain, controls on rent and conditions of tenure are endemic, see Hohnans (1987), and were tightened in the Rent Acts of 1965 and 1974. Housing supply did not grow strongly in the 1980s. In part, this is because the construction of social housing for rent fell, by the end of the decade to about one quarter of its 1979 level and there was not a large expansion of private house building. Why private construction did not rise by more is not entirely clear. There may have been a temporary supply bottleneck in the construction sector with commercial development booming at the same time as demand for houses. One gets the impression that in the areas of the most rapid economic growth, German planning authorities are more amenable to economic development than is the case in Britain but it is difficult to find hard evidence for this. There may also be a temporary land hoarding phenomenon where British landowners hold back from selling in the upswing hoping for higher prices later and then cannot sell once the bubble has burst.
6. conclosiom
German housing markets have operated -in a radically difkent ennironment than British ones. The absence of mortgage interest tax relief, less volatile inflation and real interest rates, in turn reflected in fixed rate loans being the norm, lower levels of gearing and less of an increase in gearing than experienced in Britain are a11important institutional differences. We can escape the past only slowly: a history of a relatively low and relatively steady rate of return in housing contrasts sharply with the opposite situation in Britain. This is i%f@ted in behaviour which is much more Mueneed by speculative rate of return factors in Britain and much more by the . . mlis was paFtly tile Ftsidt of-tile to-~eoadettttltwsas OfFaltad property CllCOUF@Cd by the 1977 cxtcmaionof depmiation allomca to cxistin~ dwellings.
J. Muellbauer,Anglo-Germandiffhnces in housing market dynamics
547
fundamentals of demography, population growth and income growth in Germany. The supply side in Germany has been more hostile to house price booms. A large private rental sector offers continuous alternatives to owner occupation and, for whatever reasons, housing supply appears to have been more responsive to demand increases than in Britain. One unambiguous factor has been the sharp cut in construction of social housing in Britain. There are other factors that we have not yet mentioned. Property taxes exist in Germany and will shortly return in Britain. The anticipation of their abolition undoubtedly contributed to the 1988-1989 house price peak. Transactions costs are greater in Germany, in part because of the 2% turnover tax, so that the ‘trading-up’ phenomenon is less prevalent, and housing wealth is less liquid. What of the future? British mortgage borrowers have experienced an unprecedent shock in 1990-1991. It is feared that close to 90,000 homes may be repossessed in 1991. Mortgage interest tax relief on home improvements has been abolished and relief has been limited to one per property as opposed to one per tax unit. In 1991, relief at higher rates of tax was abolished. Real interest rates are at very high levels and are likely to remain so given ERM membership and pressures from German reunitication. The 1988 Housing Act and subsidies to new providers of rented accommodation have probably stemmed the decline of the private rented sector. It seems likely that they mark the beginning of a long term recovery in that sector. More could and should be done in terms of tax reform and the supply side to prevent the eventual re-emergence of the boom/bust phenomenon in the British housing market. It seems likely that some move to convergence will also take place on the German side as further competitive pressure develops in German mortgage markets. In the medium term there is a strong upswing in the West German housing market led by migration, economic growth, and demography, and held in check by high real interest rates. It is to be hoped that the Bundesbank will be successful in preventing this from gathering speculative momentum. However, there are good reasons for believing that the housing market transmits demand pressures less strongly in Germany than in Britain. With the rate of owner-occupation under 50% and flexible market rents, excess demand for German housing raises both house prices and rents. Since rents are a major inflexible expenditure commitment, tenant households should reduce their expenditure on other goods to compensate. This counteracts higher expenditure by owner-occupiers and landlords, who feel more wealthy. Not only are they likely to have lower marginal propensities to spend, but housing wealth is a less liquid form of wealth than in the U.K. What is common to both countries is that increased housing demand has inflationary
consequences, even though the mechanisms (see Muellbauer and Murphy (1990) for the British case) are rather different. References Biirsch-Supan, A. and K. Stahl, 1991, Do savings programsdedicatedto homeownership increase personal savings?, Journal of Public Economics 44,265-297. Hendry, D.F., 1984, Econometric modelling of house prices &I the U.K., in: D.F. Hendry and K.F. Wallis. eds., Econometrics and Ouantitative Economics (Basil Blackwell. Oxford). Hohnans, Aa,. 1987, Housing policy in Britain (Croom Helm, London). ’ Hohnans, A.E., 1991, House prices: Land prices, the housing market and housing purchase debt in Britain and other Countries, in Milne and Holly (1992). Milne, A. and S. Holly, eds., 1992, International pempectives on housing and the economy, Proceedings of a conference in September 1991 at the London Business School. Muellbauer, J. and A. Murphy, 1990, Is the U.K. balance of payments sustainable?, Economic Policy, Oct., 34&395 with discussion. Muellbauer, J. and A. Murphy, 1991, Modelling U.K. second hand house prices 19564990, forthcoming Tomann, H., 1990, The housing market, housing finance and housing policy in West Germany: Prospects for the 199Os,Urban Studies 27,919-930.
The European Housing Market
Anglo-German differences in housing market dynamics The role of institutions
and macro economic policy*
John Muellbauer Nt#?eld College, Oxford, OX1 INF, UK
1. lIttroduction
Over the last 30 years, there have been large differences in the cyclical behaviour of owner-occupied housing markets in Britain and Germany. The U.K. experienced massive booms in the early 1970s and in the mid to late 198Os, seen in house price/income ratio.’ Germany experienced significant fluctuations also see fig. 1. A remarkable feature of the 1980s has been that the German house price/income ratio has moved like the mirror image of the British: first falling sharply, and rising at the end of the decade, just as the British market turned down. The cyclical pattern of land price to income ratios reveals similar contrasts but volatility was higher in the U.K., see fig. 2. This paper interprets econometric models of house prices in Britain and Germany to throw light on housing market dynamics. Among the various factors which might help account for the different experiences are economic growth, demography, inflation, real interest rates, structural differences in the *Acknowledgements are due first to Alan Holmans for his path breaking work in bringing together empirical material on the comparative international study of housing markets. I am gratehtl for helptitl discussions to Franz Hubert, Konrad Stahl, Horst Tomann and Andrew Ty-rie, and to Christianne Kraus for assistance with German data. Errors, however, are mine alone. This is a condensed version of a longer paper in Milne and Holly (1992). %come is measured by per capita personal disposable income. German house prices come from Holmans (1991) and are a simple average of prices of detached and terraced houses published by the Ring Deutscher Makler which Holmans has carefully chained together. The data begin in 1972. U.K. house prices refer to the Department of the Environment second-hand house price index. This is based on a survey of building societies. In 1967 the index is spliced to an index from the Nationwide Building Society. The series have been adjusted by subtracting a 0.3% per annum trend for quality improvements and also adjusted for temporary distortions in coverage in the 1980s because of the large scale invasion by banks into the mortgage market. 00142921/92/SO5.00 0 1992-Elsevier Science Publishers B.V. AU rights reserved
J. Muelhuer,
540
. .. . ..‘O
An&-&mum
d@rences in housing market dynantks
F
F
Fig. 1. Log house price/income ratios for Britain and Germany (standardized in 1981). ..s.
_
..1.
.
a.,.
,
Britain
Fig. 2. Log housing land price/income ratios for Britain and Germany (standardized in 1975).
provision of mortgage credit and the financial liberalisation which occurred in Britain in the 19809, differences in tax regimes, differences in the provision and regulation of rented housing, and differences in the system of land use planning. Given the role of housing wealth in helping to drive consumer expenditure and the balance of payments, see Muellbauer and Murphy (1990), this analysis helps to explain substantial parts of the differences in macroeconomic behaviour between Britain and Germany. However, a priori, it seems
J. Muellbauer, Angla-German di&rences in housing marketdynamics
likely that these wealth effects are much smaller in Germany, owner-occupation is under 50% and housing wealth is less liquid.
541
where
2. A framework for aaalysis Fluctuations in house prices are best analysed in terms of an inverted demand function for houses given last period’s housing stock. In the short term, the housing stock can be taken as fixed. In our work on U.K. house prices, Muellbauer and Murphy (1991) we use the following key demand shifters to explain variations in the owner occupied house price/income ratio: population relative to the lagged housing stock, the lagged proportion of owner occupied houses (since expansions in the supply of rental housing will have a smaller effect on the price of owner occupied houses), real income, demography, a real interest rate, the lagged rate of return in housing relative to liquid assets, changes in nominal interest rates and the mortgage stock” to income ratio. With 35 years’ data and large data variations, there is good scope for identifying a reasonably robust model. Moreover, the aggregate U.K. model is consistent with regional variations between the South East and the rest of the economy. For German house price data, we have only 17 years and less independent variation. It is impossible to pin down a robust model. Nevertheless, there are some interesting indications which result from the attempt to estimate a U.K. style model. 3. Rates of interest and rates of return Some of the most important differences in institutions and historical experience between Britain and Germany arise with rates of interest and rates of return. There are five major differences. The first concerns mortgage interest rate tax relief. In Britain, mortgage interest costs are tax deductible up to an upper loan limit which was ~25,000 between 1974 and 1983 and f30,OOOsince. In Germany, individuals receive a once only 8 year allowance which allows them to offset against tax part of the purchase price of a home. In 1987 mortgage interest tax relief was abolished in Germany having previously been of limited significance, except during 19831987 when it was extended to stabilize a depressed market. When inflation and interest rates both rise, tax relief reduces the real interest cost of borrowing. This cannot happen in the German system. This is one contributing element to the second great difference in historical ?he mortgage stock is adjusted for equity withdrawal. This occurs when additional mortgage borrowing is diverted into non-housing uses. In the latter half of the 1980s as much as one half of net mortgage advances are estimated by the Bank of England to have gone into non-housing UseS.
J. Muellbauer, AngbGer~
542
diffknces in housing market dynamics
.-
-.I”
Fig. 3. Real mortgage rates in Britain and Germany.
experience which occurred in the 1970s. Between 1970 and 1980 the real cost of mortgage borrowing for a standard rate tax payer in Britain averaged minus 5% per annum. Nominal interest rates remained low compared with general inflation for a decade. This brought about a remarkable transfer of resources to mortgage borrowers, especially higher rate tax payers who faced an even more negative borrowing cost and financial sector employees with subsidized mortgages. Not surprisingly, the demand for loans had to be rationed. In Germany, the real annual mortgage rate for bank loans shown in fig. 3 never even became negative though it too was relatively low in the 1973-1976 periold. However, the subsidized rate of interest charged by German Bausparkassen3 of about 5% was exceeded by inflation in 19731975 and in 1978. Nevertheless, the overall real cost of mortgage borrowing was much less volatile in Germany. The third element of institutional difference lies in fixed rate loans which have been the norm in Germany and in floating rate loans which are the British norm. This is connected, of course, with a post-war history of less volatile inflation and less volatile nominal interest rates in Germany than the U.K. A fixed rate loan system probably entails a lower behavioural sensitivity to interest rates than does a floating rate system. When interest rates are rising, German borrowers have an incentive to lock in before they rise further and an incentive to wait for even lower rates when interest rates are falling. The fourth major difference concerns gearing. In the 1980s average loan to 3SeeBkch-Supan and Stahl (1991) for an analysis of the system, which accounts for about one quarter of housing loans.
J. Muellbauer, Anglo-German d#wences
in housing market dynamics
543
value ratios for first time buyers in the U.K. reached unprecedented levels of 85% as financial liberalization took hold. A large minority of first time buyers in 1988 and 1989 obtained lW/, loan to value ratios, though in practice, transaction costs would have reduced the effective ratio to perhaps 95%. Such gearing enormously amplifies the rate of return in housing. In general this is (d In hp +rate of imputed rate)/( 1- Iur),
rent - lur x after tax mortgage
interest
where lor is the loan to value ratio and A lnhp is the proportionate rate of house price appreciation. This is to be compared with the alternative rate of return of which an interest rate on liquid deposits can be taken as representative. I am not aware of quantitative information on gearing in Germany and how it may have changed over time. First time buyers in Germany tend to be in their late 30s and in their 40s and to have saved up substantal deposits. Gearing in Germany is certainly, on the average, lower than in Britain. This brings us to the fifth big difference which is part cause as well as effect of the different historical experiences in German and British housing markets. Because of the house price rises which have been experienced in the U.K. relatively to the level of interest rates and because of the higher level of gearing, relative rates of return from investing in housing have several times exceeded levels of 60% per annum and on average until 1989 have been systematically higher than saving in a liquid form. This has not been the case in Germany where, for most of the 198Os, the relative rate of return in housing was negative and where, in the last 20 years, it has never reached spectacular levels. The very different British experience over long periods surely is a major cause of the explicitly speculative character of the British obsession with mortgages and owner occupation. These points are illustrated in figs. 3 and 4. Fig. 3 compares the real cost of mortgage borrowing in Britain and Germany: much more volatile in Britain and lower in the 1970s. In Germany, the real cost of borrowing rose steadily from 1976 to 1987. However, the figure overstates the rise a little, since we do not build in German mortgage interest tax relief. Our British measure is for a standard rate tax payer and builds in the declining importance in the 1980s of mortgage interest tax relief as increasing numbers of mortgages exceeded the E30,OOOlimit for relief. This explains part of the increase in the real cost of borrowing, but, of course, real interest rates worldwide have been high in the 1980s. Fig. 4 measures the difference in the rate of return in housing and in liquid assets in Britain and Germany faced by first time buyers. However, we understate the rate of return in housing in each country by around 3 or 4”/,, amplified by gearing, by omitting the
Fig. 4. The geared rate of return (excluding imputed rent) for first time buyers in Britain and Germany.
imputed rent component. We assume an average loan to value ratio for first time buyers in Germany of 0.6 while in Britain we take ratios recorded by building societies.4 Our British evidence suggests that both the current real rate of interest and the lagged relative rate of return in housing have highly sign&ant effects on house prices. The latter suggests an element of extrapolative expectations so that last year’s rate of return influences this year’s demand for housing. This contributes to the overshooting of house prices. The lagged relative rate of return appears to be quite irrelevant in Germany. Since, even after including an imputed rent component, it has always been low and has not fluctuated greatly, this is hardly surprising. Germany is much less prone to speculative fever in its housing markets. In Britain, Hendry (1984) and we ourselves find that we have to build in a ‘frenzy’ affect to capture the cyclical peaks. When the rate of return in housing rises, transactions costs become relatively less important. Thus, an increase from 15% to 20”/, in the rate of return is more important for demand than an increase from 10% to 15%. We find empirical evidence of such a non-linear response in Britain. 4To cOmmmtfurther on the figures for Germany, note that the interest rate series is for variable rate mortgages which the Bundesbank publishes ba& to 1967. The Bundesbank only began publishing interest rates for fixed rate mortgages in 1982. Tht figures exaggerate An&German differences for two reasons. One is that we have made no allowance for the limited degree of mortgage interest tax relief which existed in Germany before 1987. see Tomann (1990). The second is that we have made no adjustment for depreciation allowances. For buyers of new houses with a marginal tax rate of, say, WA, these allowances increase the rate of return by 2.5% before gearing is taken into account or 6.25% adjusting for gearing with a loan to value ratio of 0.6.
J. Muellbauer, Anglo-German di@wnces in housing market dynamics
545
4 T&e evolution of the mortgage stock As in Hendry (1984), the evidence for both countries suggests that both the mortgage stock/income ratio and its rate of growth help to explain changes in the house price/income ratio. In Germany there has been fairly steady growth in the mortgage stock/income ratio apart from the strong upswing that occurred in 19791982. The data unfortunately include mortgages by landlords acquiring property in order to rent it out. The rate of change peaked in 1981, coinciding with the peak in the real German house price. The mortgage stock/income ratio is, of course, endogenous. A substantial part of the phenomenal growth in the British mortgage stock/income ratio from a level below Germany’s in 1980 to a level greatly in excess by 1989 can be attributed to financial liberalization. However, the growth of the mortgage stock has been Mated by the growth of equity withdrawal in which mortgage borrowing in diverted to non-housing uses such as consumption or investment in financial assets. Our final conclusion is that financial liberalization acting through the mortgage stock has permanently raised the U.K. house price/income ratio by around 12% and contributed even more in the short run to the 1980s house price boom.
5. Income, tbe housing stock, population and demography For the U.K. we find, like Hendry (1984) that the steady state demand for housing has an income elasticity of around 1, perhaps just over, given the mortgage stock/income ratio. We can combine the steady state effect on the house price/income ratio of the lagged housing stock, population and per capita real income using the parameters estimated from the British model. For 1962 to 1988, this measure tends to decline in Germany and rise in the U.K., suggesting greater German success in matching the supply of houses with rising income and rising population. There is also evidence of a short term effect in the form of the rate of growth of population either absolutely or relative to last year’s stock, suggesting that when population changes, the short term impact on house prices is greater than in the long term. Similarly to the intluence of demography, the effect appears to be bigger in Germany than in Britain. This is consistent with the view that Germans buy houses primarily as places to live while for the British, the portfolio investment motive is a very important consideration. For Britain we measure demography using data on the proportions of mortgage borrowing by age and using these to weight the fraction of the population in each age group. The average age of the borrowers taking out a mortgage is around 32. In Germany, it is considerably higher, perhaps around 40. From published data on the number of people aged between 25 and 40, we lag this measure by 7 years to give an average age of 40 for the
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ti@mccsin housing mtirkt
d-s
cohort and divide by total population. Thisis a~ fairly-crudemeasurebut it peaks in 1981, coinciding with the peak in the house price/income ratio and the peak in the rate of growth of the mortgage stock/income ratio. Demography appears to be an important part ~of the story of the last German housing boom. Together with immigration into West Germany and recent economic growth, the renewed upturn in numbers in this cohort is surely a part explanation for the new house price boom gathering force since 1988. Let us turn to housing tenure and the supply side. In Germany in 1985 around 42”/, of households were owner occupiers, up about 6”/, from 7 years before.’ There is a flourishing private rental market. Rents have tended to increase relative to house prices in the 19809, probably reflecting a weakening of rent controls which were never severe anyway. In Britain, controls on rent and conditions of tenure are endemic, see Hohnans (1987), and were tightened in the Rent Acts of 1965 and 1974. Housing supply did not grow strongly in the 1980s. In part, this is because the construction of social housing for rent fell, by the end of the decade to about one quarter of its 1979 level and there was not a large expansion of private house building. Why private construction did not rise by more is not entirely clear. There may have been a temporary supply bottleneck in the construction sector with commercial development booming at the same time as demand for houses. One gets the impression that in the areas of the most rapid economic growth, German planning authorities are more amenable to economic development than is the case in Britain but it is difficult to find hard evidence for this. There may also be a temporary land hoarding phenomenon where British landowners hold back from selling in the upswing hoping for higher prices later and then cannot sell once the bubble has burst.
6. conclosiom
German housing markets have operated -in a radically difkent ennironment than British ones. The absence of mortgage interest tax relief, less volatile inflation and real interest rates, in turn reflected in fixed rate loans being the norm, lower levels of gearing and less of an increase in gearing than experienced in Britain are a11important institutional differences. We can escape the past only slowly: a history of a relatively low and relatively steady rate of return in housing contrasts sharply with the opposite situation in Britain. This is i%f@ted in behaviour which is much more Mueneed by speculative rate of return factors in Britain and much more by the . . mlis was paFtly tile Ftsidt of-tile to-~eoadettttltwsas OfFaltad property CllCOUF@Cd by the 1977 cxtcmaionof depmiation allomca to cxistin~ dwellings.
J. Muellbauer,Anglo-Germandiffhnces in housing market dynamics
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fundamentals of demography, population growth and income growth in Germany. The supply side in Germany has been more hostile to house price booms. A large private rental sector offers continuous alternatives to owner occupation and, for whatever reasons, housing supply appears to have been more responsive to demand increases than in Britain. One unambiguous factor has been the sharp cut in construction of social housing in Britain. There are other factors that we have not yet mentioned. Property taxes exist in Germany and will shortly return in Britain. The anticipation of their abolition undoubtedly contributed to the 1988-1989 house price peak. Transactions costs are greater in Germany, in part because of the 2% turnover tax, so that the ‘trading-up’ phenomenon is less prevalent, and housing wealth is less liquid. What of the future? British mortgage borrowers have experienced an unprecedent shock in 1990-1991. It is feared that close to 90,000 homes may be repossessed in 1991. Mortgage interest tax relief on home improvements has been abolished and relief has been limited to one per property as opposed to one per tax unit. In 1991, relief at higher rates of tax was abolished. Real interest rates are at very high levels and are likely to remain so given ERM membership and pressures from German reunitication. The 1988 Housing Act and subsidies to new providers of rented accommodation have probably stemmed the decline of the private rented sector. It seems likely that they mark the beginning of a long term recovery in that sector. More could and should be done in terms of tax reform and the supply side to prevent the eventual re-emergence of the boom/bust phenomenon in the British housing market. It seems likely that some move to convergence will also take place on the German side as further competitive pressure develops in German mortgage markets. In the medium term there is a strong upswing in the West German housing market led by migration, economic growth, and demography, and held in check by high real interest rates. It is to be hoped that the Bundesbank will be successful in preventing this from gathering speculative momentum. However, there are good reasons for believing that the housing market transmits demand pressures less strongly in Germany than in Britain. With the rate of owner-occupation under 50% and flexible market rents, excess demand for German housing raises both house prices and rents. Since rents are a major inflexible expenditure commitment, tenant households should reduce their expenditure on other goods to compensate. This counteracts higher expenditure by owner-occupiers and landlords, who feel more wealthy. Not only are they likely to have lower marginal propensities to spend, but housing wealth is a less liquid form of wealth than in the U.K. What is common to both countries is that increased housing demand has inflationary
consequences, even though the mechanisms (see Muellbauer and Murphy (1990) for the British case) are rather different. References Biirsch-Supan, A. and K. Stahl, 1991, Do savings programsdedicatedto homeownership increase personal savings?, Journal of Public Economics 44,265-297. Hendry, D.F., 1984, Econometric modelling of house prices &I the U.K., in: D.F. Hendry and K.F. Wallis. eds., Econometrics and Ouantitative Economics (Basil Blackwell. Oxford). Hohnans, Aa,. 1987, Housing policy in Britain (Croom Helm, London). ’ Hohnans, A.E., 1991, House prices: Land prices, the housing market and housing purchase debt in Britain and other Countries, in Milne and Holly (1992). Milne, A. and S. Holly, eds., 1992, International pempectives on housing and the economy, Proceedings of a conference in September 1991 at the London Business School. Muellbauer, J. and A. Murphy, 1990, Is the U.K. balance of payments sustainable?, Economic Policy, Oct., 34&395 with discussion. Muellbauer, J. and A. Murphy, 1991, Modelling U.K. second hand house prices 19564990, forthcoming Tomann, H., 1990, The housing market, housing finance and housing policy in West Germany: Prospects for the 199Os,Urban Studies 27,919-930.