Could the government’s planning changes trigger a housing crash?

The government wants housebuilders to build more houses.

House prices in the UK remain too high. Many people blame this on the fact that "we live on a small island with a limited amount of space" - so their solution is to build more houses.

The government has decided to offer housing associations and property developers £10bn worth of loan guarantees in other words, the taxpayer will underwrite loans used for building new houses.

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There is also more funding for the FirstBuy scheme, which helps people to raise a deposit for a mortgage. There will also be a temporary' relaxation of planning laws, including both on building new houses and extensions to existing dwellings.

So, is this going to make a big difference to the market?

Possibly - though not in the way that the government perhaps expects...

There is no housing shortage

If you question the sustainability of Britain's high property prices, someone will always tell you that it's simply because we have too many people and not enough homes to go round.

However, this isn't strictly true. The population has gone up, of course. But the housing stock has risen too. In fact, according to an interesting report from economic research group Fathom Financial Consulting, while the rate of building decreased over the last decade, the quantity of housing per person' has risen by nearly 50% since 1970, and is still increasing.

Fathom also argues that if there were a genuine shortage of homes, then rents would be much higher. That might sound odd after all, there's a general consensus that rents are at record levels.

However, this isn't that surprising. If the supply of rental property was roughly stable, you'd expect rents to rise roughly in line with inflation over time. If there was an actual shortage of property to rent, you'd expect rents to rise more rapidly than inflation.

Yet according to Fathom, if you look at the rate at which rents have risen (using the rental cost' measure from the Retail Price Index), they haven't even kept up with growth in disposable incomes: "hardly an indicator of runaway housing demand".

The zombie housing market marches on

So what's really going on? As we've argued before, the real driver of high house prices was the ludicrous levels of credit available to homebuyers available during the decade-long boom. The problem wasn't too many people chasing too few houses it was too much money chasing an adequate supply of houses.

If this is the case though, why hasn't the market corrected as viciously as we might have expected? House prices have certainly fallen hard in some areas, but on average, prices are still well out of the reach of many, and sales have collapsed as a result.

The problem ultimately boils down to the banks. Banks are heavily exposed to the UK property market through residential mortgages. They have no desire to write off dud loans or repossess homes, because it would expose their balance sheets to massive losses. As Fathom points out, in the US mortgage write-off rates peaked at more than 2.5%, and are still just below 1.5%. However, in the UK, they have so far been tiny not even approaching 0.5%.

This has allowed both homeowners and banks to continue to pretend that their houses are worth much more than they are. However, it also means that there is a huge gap between the prices that sellers are offering and what buyers are willing to pay. This has hammered sales.

In turn that means that housebuilders have no desire to build new homes because no one will buy at current prices. And in any case, banks don't want to lend money for housebuilding projects, because they already have too much exposure to property.

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How the government scheme could hit prices

This means that any attempt to stimulate the economy by building more houses may be a major flop. For example, earlier this year, the government began the NewBuy guarantee scheme, which was meant to lead to up to 100,000 properties being sold with taxpayer-underwritten mortgages. However, just 220 homes have been sold so far.

More to the point, as Fathom notes, there is no genuine shortage of property. In fact, the researchers reckon that in the long term, if the supply of housing rose by 10%, then the fair value' of the average house would drop by 8%.

So given that property is already overvalued on most sensible measures, "a programme of new house building [might] trigger a correction back to fair value, or even below". A publicly-funded house building boom might be good news for housebuilders, but the properties built this way could well end up being sold at big discounts (after all, the builders don't mind what they sell for as long as they turn a profit in the end).

A slide in prices would in turn force banks to start recognising losses, prompting more sales. This could start a downward price spiral.

Of course, this is good news for anyone looking to buy a property. And arguably, a fall in prices is the only way the housing market can begin to go back to normal. Indeed, after significant falls in the US, the market there is finally recovering, with prices and sales starting to rise.

However, it would be a big worry for the fragile UK economy. It's a good reason to continue to steer clear of the British banking sector, for a start. Also, falling house prices tend to make people rein in their spending as the 'wealth effect' goes into reverse. So we'd be wary of the retail sector too.

It's also one more reason why we can probably expect more quantitative easing in the UK before too long which is why we'd suggest hanging on to your gold, too.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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