The incomplete privatization of the Dutch housing market: Exploding house prices versus falling house-building output

Journal of Housing and the Built Environment (2005) 20:363 378 Ó Springer 2005 DOI 10.1007/s10901-005-9022-5 The incomplete privatization of the Dutch housing market: Exploding house prices versus falling house-building output OTB Research Institute for Housing, Urban and Mobility Studies, P.O. Box 5030, 2600, GA Delft, The Netherlands (E-mail: P.Boelhouwer@otb.tudelft.nl; phone: +31-15- 2781908; fax: +31-15-2784422) Received December 2004; Accepted June 2005 Abstract. This paper addresses the coordination problems in the liberalized housing market in the Netherlands during the 1990 2004 period. In particular, the mismatch between the explosion in house prices and the stagnation in house-building activities during the past six years is under investigation. It is argued that there is still a marked discrepancy between the language used in the policy discourse and the supply and demand situation on the Dutch housing market. One could argue that the Dutch government implemented a double-hearted, incomplete privatization. As a result of the mismatch between actual housing policy and market developments, output is stagnating and the housing shortage is growing sharply. The closing section presents some possible means to overcome these problems. Key words: housing policy, house prices, housing market, housing production 1. Introduction During the 1960 1990 period the Dutch housing market was characterized by a delicate interaction between government intervention and market behaviour. Various governments tried wherever possible to liberalize the housing market and reduce housing subsidies. Their efforts were always subject to the condition that house-building should remain at a decent level so as to reduce the housing shortage, which had never been made up completely. Van der Schaar (1987, p. 238), writing of housing policy in the 1970s and 1980s, noted in this context that it was striking how the behaviour of the market cut right across the political rhetoric. The Den Uyl government in 1973, for instance, started out with the aim of building large quantities of

364 cheap rented housing. Its actual policy had a completely different effect, though: the construction of homes for owner-occupation flourished. Its successor, the Van Agt government, conversely, came into power on a programme with a liberal slant designed to promote home ownership and upward mobility. The severe downturn in the market, however, forced it to adopt a policy diametrically opposed to this, under which unsold homes were even subsidized to turn them into social rented housing. Figure 1 shows house-building over the 1965 1999 period by type of ownership. It is clear from the figure that house-building policy responds to cyclical fluctuations in a highly anti-cyclical manner. The high output of new homes was achieved by an ingenious (from the administrative point of view) planning and production cycle in which the government set the number, price and ownership structure of new-build housing each year. In this respect the Netherlands differs from a lot of other West European countries, most of which renounced this anticyclical house-building policy as far back as the 1970s and have experienced far more ups and downs in output (Boelhouwer and Van der Heijden, 1992). With the introduction of his Housing in the Nineties white paper (Wonen in de jaren Negentig), the State Secretary, Enneu s Heerma, finally broke with the anti-cyclical policy for the first time since World War II. Market forces, consumer sovereignty and the ending of object subsidies were now at the heart of the government s policy. Entirely in line with his market-based housing policy, Heerma 180000 160000 140000 120000 100000 80000 60000 40000 20000 0 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 Number of dwellings Owner occup. non-subsidized Rental subsidized Year Rental non-subsidized Owner occup. subsidized Figure 1. Housing production according to ownership in the Netherlands, 1965 1999. Source: CBS.

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 365 announced that a disappointing economic situation would not automatically mean that the government would maintain housing output with subsidies to properties. Against the background of the change in policy outlined above, this paper looks at the coordination problems in the liberalized Dutch housing market during the 1990 2004 period, in particular the mismatch between the explosion in house prices and the stagnation in house-building during the past six years. Nowadays, this is a highly relevant theme in Europe, where more countries have to cope with unforeseen and unwanted results of their liberalized housing markets (see for instance Ball, 2004). To understand these problems, we will consider the way the Dutch government has organized the privatization of the Dutch housing market in the nineties. In particular, this contribution shows the effects of a double-hearted, incomplete privatization of the housing market. Figure 2 shows the most striking negative result of this situation: the explosion in house prices and the stagnation in house-building during the past six years. Output of new homes during the 1995 2003 period fell by 35%, whereas house prices for existing stock rose no less than 59% in real terms. This justifies the description the disfunctionality of the Dutch housing market : exploding house prices versus falling house-building output. While it is clear from the RICS European Housing Review 2004 that this situation is not confined to the Netherlands, the extent 175 150 Real house price index deflated by buildingcosts Unstable situation 125 100 75 50 Newly built owneroccupied 25 0 1965 2002 Figure 2. Price and production of owner-occupied housing in the Netherlands 1965 2002 (index 1990=100). Source: CBS, NVM.

366 of the phenomenon there can certainly be regarded as unique (Ball, 2004, p. 11). Only the United Kingdom is in a somewhat similar situation, leading the British government to begin a study in 2003 into the underlying causes of the lack of supply and responsiveness of housing in the UK and in particular to consider the role of competition, capacity, technology and financing of the house-building industry. The interaction of these factors with the planning system and the government s sustainable development objectives was also under investigation (Barker, 2004). To interpret this unusual trend we shall first consider some theoretical notions that apply the concept of market forces to the housing market. We then analyse the situation in the Dutch housing market during the 1990 2004 period, in particular housing production policy, planning policy, quality assurance policy and the way demand is boosted. Based on this empirical information, Section 4 describes how the Dutch housing market operates. The results form the input to the last section of this paper on possible lessons for the future. Before we elaborate on these, Section 5 stipulates in short the main conclusions of this paper. 2. Market forces in the housing market: The relationship between prices and output the theory Theoretically, prices are assumed to develop within a neo-classical economic structure in which the core concepts are supply and demand, market forces and the equilibrium price. In neo-classical economic theory, the variation in the house price is the result of the disequilibrium between supply and demand, in which the demand for housing services is a function of demographic factors, income, interest rates and the housing stock and the supply is a function of the price of land, building costs and credit conditions (Chen, 1998). The literature offers two approaches to understand the relationship between house prices and house-building output (Case and Shiller, 1990; Dipasquale, 1999; Meen, 2001). The first approach sees the housing market as differing little from other markets, where prices are determined mainly by supply and demand. Because of the length of time it takes to produce homes, however, the supply and demand adaptation processes are slower than in the case of other goods, which can result in sometimes severe price fluctuations in the short term.

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 367 It is implicitly assumed here that the housing market operates as a supply market. House prices function as a trigger, inducing rapid movement towards the equality of housing supply and demand. Since building a house takes from one to three years, fine-tuning problems can arise so that severe short-term price mutations may occur. With mounting demand, several years may elapse before the required supply is available. Since some housing is already in production, for a period of one or two years more housing is added to the stock than the market requires. As a result, the price of existing owner-occupied housing falls further. The idea behind this supply-directed approach is that in the long term the price of newly-built housing follows the production costs. The factors which determine the costs of new building (including land and construction costs) mark the starting point for a new price equilibrium. We find this pattern most clearly in the United States, where various researchers have demonstrated a strong relationship between trends in building costs and house prices (Case and Shiller, 1990). If we correct for cost and quality changes in the stock, there has been only a modest increase in real house prices in the US over the past 30 years, except in the coastal areas, where the relationship between house prices and building costs is weak or even absent because of the shortage of space for building. It is also the case that major price fluctuations (usually temporary) can occur between urban conurbations in the US. The price trend in the coastal areas of the US can be explained by a second theoretical approach, linking the relationship between house prices and supply particularly to changes in the demand for housing (Abraham and Hendershott, 1996; Hort, 1998; Malpezzi, 1999). Here we need to see the market for owner-occupied homes not as a construction market but as a stock market, where the relationship between supply and changes in demand is highly inelastic. This is particularly the case in countries where the government interferes (sometimes severely) with market forces. The Netherlands is a good example of this, in fact. Often the opposite effect occurs, with new home prices following the prices for existing stock, as it is the latter that determine how much scope a builder has to sell a home of a particular quality at an appropriate price. The international housing market literature also emphasizes how small the influence of the supply (the new construction) may be on price development in the existing stock. Accordingly, the development of aggregated house prices stands largely under the influence of household incomes, mortgage interest rates, and the lag in house prices. Plainly, in this context, it is impossible to discern the effect of supply on prices.

368 3. The Dutch housing market during the 1990 2004 period 3.1. Housing production and planning policy As mentioned in the Section 1, the publication of the Housing in the Nineties white paper can be seen as a turning point in Dutch housing policy. From then on the Dutch government s house-building programme was merely indicative, and the balance of housing types being built was resolutely changed. At VINEX sites (new-build sites designated under the government s planning policy) at least 70% of homes were to be built commercially, whereas until then over half had been built for the subsidized sector. The government did not adopt a house-building policy in line with the market, however; instead it continued to exert a major influence on house-building through planning policy and quality assurance policy and by boosting demand. The VINEX policy was introduced in a planning white paper (Vierde Nota Ruimtelijke Ordening Extra), which strengthened the urbanization policy already being applied. This policy aimed to combat undesirable suburbanization and target house-building at areas in and just outside the major towns and cities. To absorb the expected growth in the number of households and make up the small housing shortage, 650,000 new homes were planned for the 1995 2005 period. On top of this, 14,000 homes a year were to be added to offset the planned demolition programme. Assuming two-thirds would be built before and one-third after the turn of the century, 100,000 new homes a year would be built up to 2000 and another 60,000 after 2000. The output target was increased substantially, however, in the white paper People, Wishes, Homes (Mensen Wensen Wonen) (Remkes, 2001). This was necessary because the government wanted to meet the public s higher quality standards and shape urban renewal. The most far-reaching measure was replacing 30,000 homes a year by demolition and two-into-one conversion over a period of 10 years. This helped to raise the projected housing output over the 2000 2010 period to a target of 100,000 homes a year, over 30,000 more than the 70,000 actually built in 2000. Starting in 2000, however, an imbalance developed between target output and actual output: instead of growing towards 100,000 homes a year, output gradually fell to under 60,000 in 2003, not even enough to absorb the annual growth in the number of households. As another 15,000 or so homes a year are demolished, the housing shortage has in fact been growing again in

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 369 the past few years: from 1.3% in 1998 it rose to 2.6% in 2002, and it is expected to be around 3% in 2005. The housing shortage is defined by the Dutch government as the balance of people who are looking for a new house and the houses they will release as a percentage of the total housing stock. The shortfall in output is explained not only by the strict planning policy, which restricts the number of sites available for house-building, but also by the current rules and regulations. This problem is confirmed by recent research (Van der Heijden et al., 2001). This research identifies problems in (a) the planning phase, (b) the sales phase and (c) the actual building phase. Developers find the problems identified in the planning phase to be the worst, in particular the length of time municipal authorities take to reach decisions. After that the problems mentioned are the lengthy negotiations with municipalities, the inadequate quality of municipal staff, the procedures associated with local plans, and insufficient municipal staffing. Interestingly, the complexity of Environmental Impact Statement procedures, mortgage interest rates, lack of building materials and lack of equipment were considered to be only modest problems. Building firms also experience problems in the construction and sales phases, albeit to a lesser extent. Most frequently mentioned in the sales phase was an unsatisfactory price-quality ratio due to high land prices ; in the construction phase the main problem was rising construction costs. Another reason why prices of newly built houses are not following the trend of the building costs, is the land policy which has been adopted by municipalities in the last couple of years. Especially the large municipalities are using a residual price method to determine the land price. Before that, only the costs of preparing the building plot were charged. Using the residual price of the land means that the price for the land is the difference between the market price for the dwelling minus the building costs. Because of this policy, there is by definition a weak relation between the building costs and the house prices. When the demand for high-priced dwellings is decreasing, municipalities are generally not very willing to decrease the land prices too. This is an important reason for the above-mentioned problem of unsaleable expensive houses. In general it is fair to say that the administrative situation regarding house-building projects has become very complex. While none of the parties involved is now in a position to act entirely independently, there is a high degree of interdependency between both the

370 planning aspects and the participants. Municipalities have lost their dominant status, often trying to organize house-building through communicative planning and without any direct financial tools. Once the parties involved have entered into often detailed, complex administrative covenants, it is very difficult to adapt these quickly and appropriately to changing market conditions. An example is the VINEX contracts signed in the early 1990s, following lengthy negotiations; the ink was hardly dry on the contracts before there was a sharp qualitative increase in housing demand. Now that, at the beginning of the 21st century, after years of debate and at the insistence of the industry, most schemes include more scope for highquality housing, the market for new owner-occupied homes in the higher price range is in decline. As a result, homes in expensive schemes are unsaleable and the funding for house-building as a whole is being eroded. 3.2. Quality assurance policy On top of housing production policy and making new-build sites available (in limited quantities) in and around the towns and cities, the government has exerted an influence on supply and demand in two other areas. Firstly, it has tightened up its quality assurance policy, with e.g. tougher environmental standards, rules on adaptable and safe building and in many cases municipal standards for architecture (in the expensive sector). With the revised Building Decree which came into force on 1 January 2003, the government put in another substantial oar: research by PRC Bouwcentrum indicates that this will cause construction costs to rise by an average of 6%. Consumers will, of course, have safer and more comfortable homes in return (BouwNed, 2002), but the question is whether they see these additional investments the same way the government does. 3.3. Boosting demand Lastly, the Dutch government still interferes substantially by supporting demand, in particular through aid to social landlords, direct government spending and tax concessions to owner-occupiers. The Netherlands proudly leads the field in Europe in the first and last of these aid categories.

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 371 As regards capital growth and independence in the social rented sector, let us turn to the findings of Kemeny (1995). The maturation of the Dutch rented sector can be described as unique in Europe. Not only does the Netherlands have by far the largest social rented sector, accounting for 35% of the total housing stock (followed at a safe distance by the United Kingdom with 21%), the sector has a high degree of independence and it has accrued a large amount of capital in the existing stock. In this context the Central Housing Fund calculated in 2002 that the Dutch housing corporations had combined net assets of 22 billion euros, even valuing the housing stock at its value in use, not the much higher market value, and allowing a certain amount for uncertainty. This figure of 22 billion euros is in fact 10 billion euros higher than the minimum net assets required according to the Fund, and the surplus is expected to rise to 18 billion euros by 2005 (Centraal Fonds Volkshuisvesting, 2002, p. 5). With the scope they have for rent pooling and the freedom to sell off property and thus use capital invested in bricks and mortar for other purposes, the corporations are able to rent out newly built social housing well below cost price. The now common financial gap (the difference between production cost and calculated value in use) of 50,000 euros for building a social rented home is much higher than the property subsidies handed out by central government in the early 1990s. The second way in which the government boosts demand is still in the traditional manner, through the budget of the Ministry of Housing, Spatial Planning and the Environment (VROM). The personal subsidies in both the rented and owner-occupied sector are particularly striking here: in 2002 a sum of 1.9 billion euros was earmarked for affordable housing, 1.5 billion of this specifically for rent rebate (VROM, 2002, p. 3). Compared with the rest of Europe, however, this interference in the market can be seen as modest: Stephens et al. (2002, p. 27) calculated that spending on rent rebate in the Netherlands in 1995 amounted to about 0.4% of gross national product (GNP). Of the seven countries included in the study, only Germany scored lower, with 0.2%; the other five had much higher figures (UK 1.8%, Sweden 1.2%, France and Finland 1.0% and Denmark 0.7%). The third way in which the government stimulates demand is through tax concessions, and this amounts to a lot more than the support provided through rent rebate. In particular, the full deductibility of mortgage interest from taxable income and the low imputed rental income make for a substantial demand boost. The sum of

372 mortgage interest deductions less imputed income amounted to as much as 5.5 billion euros in 2001; 3.4 billion if property transfer tax is included in the calculation (VROM, 2002, p. 11). This generous fiscal support is reprehensible from the point of view of welfare theory, plus it is entirely unique in Europe. This government interference does not serve social justice; on the contrary it aggravates social inequalities, as the amount of aid increases as income rises, because of the higher tax rates. One of the effects of this system is that homes have become unaffordable for first-time buyers in the lowest tax band unless they have substantial capital of their own. Also, as income rises, consumer choice is increasingly manipulated, again causing a welfare loss. As already indicated, the generous tax concessions can be regarded as absolutely unique in Europe: all the other countries have either abolished or drastically curtailed deductibility of mortgage interest. The main argument for Liberal governments was that they wanted to stop interfering with market forces, whereas Social Democrat and Christian Democrat governments tended to stress the harmful social effects. These cutbacks do not mean, however, that there is no longer any fiscal support for owner-occupiers in Europe: the aid is now much more targeted so as to support first-time buyers on low incomes and households with children in particular. The generous tax subsidy to owner-occupiers in the Netherlands made a price explosion in the 1990s possible, which split the Dutch housing market in two. Households that had bought their own homes before 1992 saw a sharp rise in the value of their property, from which they profited substantially, both on the housing market and elsewhere (Boelhouwer, 2000, 2002). This capital growth was made possible by other factors in addition to the rise in prices, such as the economic growth in the nineties, the introduction of fiscally attractive financing systems and an increase in borrowing limits (e.g. the introduction of doubleincome mortgages). As the proportion of owner-occupiers rises with income, the changes in the housing market have also made the existing welfare gaps even wider. The Dutch owner-occupied housing market can be said to have a leveraging effect, which the baby-boomer generation has so far exploited to the full. 4. Output and prices: The empirical data It is clear from the data and analysis above that prices for existing homes have risen partly as a result of the substantial boosting of

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 373 demand. The output of new homes has not only failed to keep up with this, it has even declined in recent years. We can conclude from this that it is the second theory that applies to the Netherlands. This says that the market for owner-occupied homes needs to be seen not as a construction market but as a stock market, where the relationship between supply and changes in demand is highly inelastic. This finding is confirmed if we look at the relationship between borrowing capacity and prices at micro level (Figure 3). These computations take the rules applied by mortgage brokers and banks into account, as well as interest rates and income. Borrowing limits, which had come under severe pressure during the previous period, rose over the 1982 1986 period. Prices, which were also emerging from a deep dip, did not immediately respond to the increase in opportunity, presumably because most households were still mindful of the severe recession. During the next period the difference disappeared again, then in the 1990s prices and borrowing limits kept reasonably in step. Another interesting point is that the gap between borrowing limits and prices has gradually narrowed. This completely accords with the fact that prices of existing houses ceased to be linked to changes in building costs in the period 1966 2002 (Figure 4). 400 350 300 250 200 150 100 50 0 median price 25% 50% 75% 90% 1982 1986 1990 1994 1998 2002 Figure 3. Mortgage borrowing limits for households with a perceived household income of 25%, 50%, 75% and 90% of income distribution and prices in the existing housing stock during the 1982 2002 period (index 1982=100). Source: OTB computations based on data from various Housing Surveys, mortgage brokers, the National Mortgage Guarantee Scheme and the Dutch Association of Real Estate Brokers and Real Estate Experts (NVM).

374 250 House prices Building costs 200 150 100 50 0 1966 1970 1975 1980 1985 1990 1995 2002 Figure 4. Index of house prices and building costs, 1966 2002. Source: CBS and NVM. According to the first theory, if the market were operating efficiently, developments in construction costs and prices would be interlinked, subject to a certain delay. The result of these developments was that prices of new homes followed the prices of existing homes at a safe distance. Research into the 1991 1998 period shows that everyone on the housing market took advantage of this, resulting in overvalue (the difference between market value and selling price) on new homes, property and land (Tauw, 2000). Since 2001, with prices for existing homes stabilized and those for new homes still rising sharply, there has been a marked change. We now have a situation where selling prices of newly built houses are exceeding prices of existing dwellings, especially in the higher price range, causing stagnation in the sales of expensive new homes in particular. 5. Conclusions This paper has looked at the changes that have taken place in the Dutch housing system since the 1990s. It found that there is still a marked discrepancy between the terminology used in the policy discourse and the supply and demand situation on the Dutch housing

THE INCOMPLETE PRIVATIZATION OF THE DUTCH HOUSING MARKET 375 market now, in 2005. Policy revolves around controlling market forces and increasing the choice available to the public, as well as social values. Analysis of the housing market, on the other hand, shows that the government is stimulating demand with a variety of subsidies, causing an explosion in the prices of existing homes. As in many other European countries, the government is not focusing on the weakest groups in the housing market, it is only increasing existing income and wealth gaps, and it is creating major hurdles to house-building through its planning policy, administrative organization and building regulations. The result of this mismatch between policy and the actual behaviour of the market is that the policy objectives are not being met: output is stagnating and the housing shortage is growing sharply. The risks for the public, the government and the building industry are also increasing, and owning your own home has become impossible for people in the low and middle-income groups. More generally we would like to argue that the Dutch government has implemented a double-hearted, incomplete privatization policy. On the one hand, Dutch government has liberalized the supply side of the housing market; since the nineties, the housing production has no longer been planned and subsidized intensively by the central government. On the other hand, the government has not created an environment in which demand and supply could react in a proper way. 6. Lessons for the future and possible solutions If we are to escape from the impasse described in the last section, we need to re-examine the government s role in the housing market. Firstly, we need to cut down the substantial boosting of demand compared with the rest of Europe and target support more at the low and middle-income groups. This would prevent the housing market becoming overheated in times of economic prosperity (as it did at the end of the twentieth century), causing among other things a sharp increase in the volatility, which causes substantial harm to the country s general economic growth. Another improvement could be to iron out the administrative hurdles that the government has created to the housing supply. The first step in this direction would be to apply a less strict planning policy than in the past and make sufficient sites available for house-building: developers could then seek alternative sites reasonably quickly in the event of delays. New-build policy should be applied much more

376 flexibly, to enable developers to respond appropriately to changing market conditions. The relaxation of the strict planning policy should be carried out quite carefully. A lot of consumers are very pleased with the conservation of the open green areas in the Netherlands. Because of that preference, new building sites should be found in and close to the smaller villages. The highly developed rules and regulations on quality assurance in the Netherlands could also be relaxed: at times of low demand it makes no sense for the government to set environmental and safety standards for new homes that are not appreciated by consumers. Lastly, the unique position of the Dutch social rented sector could be used to apply an anti-cyclical building policy, as was the case prior to the 1990s. As already indicated, the social landlords in the Netherlands have enormous assets and by 2005 will own 35% of the housing stock. The surplus of 11 million euros calculated by the Central Housing Fund is more than enough to increase house-building output temporarily during periods of economic difficulty. If necessary, individual housing associations should match their financial reserves. Unlike in the 1980s, quality should not be sacrificed too much when building rented homes. The housing corporations could sell off the better-quality ones to owner-occupiers when the economy picked up. They would then recoup the unprofitable investments and presumably have opportunities to make a profit. This could then be used to improve the quality of the existing stock, which in many cases does not come up to the latest quality standards in times of economic prosperity. In this scenario, however, the politicians would have to make a fundamental choice in favour of a social rented sector that is accessible to the middle-income groups as well as marginalized sections of the population and targets broader social problems in the built environment. In my view the second option would be most appropriate for the prosperous economy that flourishes in the Netherlands. This would take full advantage of the unique position of the housing corporations, compared with the rest of Europe, so as to tackle important social issues such as liveability, social cohesion and safety. Acknowledgements The author wishes to acknowledge the financial assistance of the Dutch government through the Habiforum Programme Innovative

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