The Property Ladder

Walking around Croydon it’s obvious that there are a lot of home extensions being built by owner occupiers. This is hardly surprising. Homes are seen by owner occupiers as a form of saving – often their primary form – and a recent report by LSE Professor Paul Cheshire forecasts that house prices will double by 2030. This would represent a tax free return on investment of 4.6 per cent a year. It could be even higher: according to the Office of National Statistics house prices have grown on average by 8.75% per annum over the past 47 years. That is much higher than the return on bank deposits and comparable with long run returns on equity investment – especially so as tax is paid on interest, dividends and capital gains on shares but not on your primary home.

Many extensions have the effect of shifting what in many cases would be affordable homes for first time buyers into a more expensive category. They do, however, represent a great investment opportunity for owner occupiers already fortunate enough to be on the so called ‘property ladder’. Not only will the new investment increase in value in line with the original investment but there is also an immediate tax free capital gain to be enjoyed. As rule of thumb, it’s generally thought that £20,000 of building work, providing it’s not totally unsuitable, should add more than £50,000 in property value.

What’s going on here? There are a number of economic and socio-political forces at play. First, we need to ask what is the source of this exceptional high return to owner occupiers. The answer is straightforward: it is a transfer from those who don’t own homes to those who do. Many in the fortunate latter group think it’s an entitlement justified by their hard work paying off their mortgage and they have a right to pass it on to their kids. The fact that these kids may themselves be unable to get on the “property ladder”, or, on the other hand, may already be much better off than those without homes is overlooked. Also overlooked is the risk that predatory care home operators lie in wait for owner occupiers with every intention of appropriating the bulk of their investment. There is also the consideration that banks do very nicely in providing mortgage finance. Banks are essential to modern capitalism and, as the government’s austerity programme demonstrates, nothing must stand in the way of their profits.

Another interesting question is what is the source of the capital gain when an extension is built. According to neo-classical economic theory – the type they teach in universities, award Nobel Prizes for and regurgitate on the BBC and in the capitalist press – market should respond to eliminate all such predictable gains. They call this ‘arbitrage theory’. Marxist economist, on the other hand, recognise that building workers, like every other worker in productive industries, sell their labour for less than the value it creates. It’s this surplus value that accounts for the average capital gain on building extensions. If building workers were to received the full value of the labour power they sold to owner occupiers, on average there would be no capital gain from building extensions. But then if all workers could do this, capitalism would grind to a halt nd we would be forced to begin constructing a socialist society in which, initially, operate on the principle of from each according to their means to each according to their work*.

The underlying issue here is that, according to neo-classical economic theory, value is created when a commodity (including a house) is sold, or merely revalued in a market. Value is created out of thin air in the form of a “consumer surplus” because the seller and buyer have different subjective valuations. Marxist economists, on the other hand, take a more objective view. They consider that value cannot, on average, be created by exchange or shifting market prices. Exchange is a zero sum game – the buyer’s gain is the seller’s loss and vice versa. These are two fundamentally different ways of looking at how markets work in capitalist societies. It’s a theme we hope to explore when the Communist University in South London is relaunched shortly. Watch this space for news of this development.

* Only under a fully developed communist society would we attain the position of to each according to their need

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Is the Paris Agreement credible?

In the blog last week I suggested that the credibility of the agreement reached in Paris last weekend on climate change should be judged by what happened to the share prices of oil and gas producers following the announcement of the agreement – or at least following the first indication that such an agreement would be reached. If the agreement really signalled a switch away from oil and gas based economy, we could expect to see a significant fall in these share prices. What we actually saw was a fall of only some 3.6%. See the chart below:

oil and gas index

Oil and Gas Producer’s index (NMX0530)

Under capitalism bad news tends to hit unexpectedly[1] – or at least it comes as a surprise to the Nobel Prize winning economists and bank regulators who provide capitalism’s high priesthood. Under capitalism when problems are clearly predictable, they are, however, discounted at the so called “cost of capital”. This is the long run average return investors expect to rake in and is estimated by the priesthood to be about 5% per annum before inflation. Thus a cost, or loss of profits, occurring in 20 years time would be currently valued by markets at only 38% [2]of the eventual cost in real (i.e. inflation adjusted) terms. Thus it could be argued that the observed 3.6% drop in share prices actually represents around a 10% drop in profits in 20 years time. But a fall in oil companies’ profits of only 10% by 2035 is hardly consistent with a target ceiling for global warming of 1.5 degrees centigrade and a new goal of net zero CO2 emissions by the second half of this century.

Conclusion: stock markets think capitalism is incapable of delivering the Paris Agreement. So do I. We need to replace capitalism.

Happy Christmas, everyone!

 

[1] In the past such crises tended to happen every fifteen years or twenty years, but the dot.com bubble bust in 2000 followed by the bank bust in 2007 suggests that such crises are now occurring more frequently.

[2] 1.05-20 = 0.38