The Financialisation of Housing: A failure of the free market and the need for proactive regulation

I wrote this essay for the “Financial Markets” course taught by Nobel laureate and Sterling Professor of Economics, Robert Shiller of Yale University.

Leilani Farha’s statement on the right to adequate housing at the Human Rights Council outlines the implications of the financialisation of housing. She argues that the increasing use of housing as a commodity rather than a place to live is a detriment to society at large.

In this short essay, I’ll focus on three major consequences of the financialisation of housing; wealth inequality, poor urban planning, and an increase in the number of vacant properties. To close things out, I’ll talk about the proactive role regulators can play in addressing these issues.

What is financialisation?

I have noticed two distinct elements of the financialisation of housing:

1. Economic: Entrepreneurial innovation in the finance industry has delivered nuanced products and collective investment vehicles that allow a variety of investors to gain exposure to the real estate market. This has opened up the floodgates enabling trillions to pour into the market from corporations, institutions, and hedge funds. The market cap of US REITs alone has grown from $1.5 Billion in 1971 to $1.25 Trillion in 2020. (Source: NaREIT)
2. Cultural: The fundamental purpose of housing as shelter from the elements and a place for people to live with dignity has become subservient to the investor’s right to maximise profit. We are witnessing a paradigm shift in society — housing is being defended and protected by public institutions as a safe haven for money, rather than a safe haven for life.

What are the supposed benefits of the financialisation of housing?

Wider access to real estate growth: A larger pool of people can now gain exposure to the real estate market without having to put up a deposit for a house. The financial barrier to reaping the benefits of real estate price growth has been lowered. Many people may not even realise that they have indirect exposure to real estate through their pension fund. This notion of wider access extends to geographies too — someone in Kansas can gain exposure to Manhattan’s real estate market with ease.

Accelerated house building (and urban development): An influx in investment through new financial vehicles boost house prices. In an efficient market, these inflated housing prices should encourage developers to build more houses to reap the rewards of the higher profit margins (assuming the cost of construction does not change). In theory this should accelerate house-building, meeting the needs of society faster.

However, these benefits aren’t distributed equitably across society. The key beneficiaries of increased financialisation are:

• Investors: A large portion of which are institutional investors, corporations and HNIs.
• Private Equity Firms
• Hedge Funds
• Large Pension Funds
• Family Offices
• Wealthy Accredited Investors

Despite technically widening access to the market, people in the bottom three income quartiles (the renter class) find themselves with less disposable income due to the high cost of housing. They are also least equipped to navigate the complexities of financial markets.

• Investment banks and AMCs: They are rewarded in the form of fees and commissions for underwriting the financial securities, market-making, and trading. AMCs charge investors for their portfolio management services.
• Developers: Developer’s profits are increasing as they can sell houses for higher prices, and building costs have decreased given advances in construction technology. In the UK, developer’s profit margins have been steadily increasing over the last decade. They are almost back at pre-financial crisis level. (Source: Royal Institute of Chartered Surveyors)

• Real estate agents: Larger house prices mean larger commissions.
• Landowners: Developers are willing to pay higher rates for the underlying land given the higher prices houses can fetch on completion.

So, where is it all going wrong?

It is quite apparent from the section above that the immediate benefits of the financialisation of housing are disproportionately being reaped by those who are already wealthy. But that’s just the start of a vicious self-perpetuating cycle that multiplies many times over.

1. Financialisation propagates wealth inequality at a systemic level:

• Increasing Homelessness

Global investment funds have expanded their asset portfolios greatly in the private rented sector. (Source: Cities Journal) These funds expect greater year-on-year returns from their rental portfolios and actively hike rents at a rate far greater than real income growth. This is plunging low-income households into precarious situations and homelessness.

Source: https://www.london.gov.uk/sites/default/files/housing_in_london_2019.pdf

• Struggling middle class

Over the last 30 years, the middle class has been priced out of the housing market. The graph below shows the UK House Prices as a ratio of the Avg. Income over the last 50 years. There is a clear paradigm shift that starts in the mid 1990’s correlating with the financialisation of housing. At 8.5x the average income, the average person cant afford to buy a house.

Source: https://www.longtermtrends.net/home-price-median-annual-income-ratio/

This is paired with the increased rental prices, putting further pressure on middle income households. In London, rent makes up nearly half of the average person’s income.

Source: https://www.bbc.co.uk/news/business-46072509

The financialisation of housing has ‘monetised’ the middle income demographic to deliver returns for the investor class.

2. The wrong kind of housing gets built

REITs and collective investment vehicles have a fiduciary responsibility to their investors. Their goal is to invest in real estate in a way that generates the highest return. For-profit new construction is overwhelmingly geared at the upper end — the luxury market, so to speak. But it’s lower-income households who face the severest affordable housing shortage.

Most local planning authorities have affordable housing quotas that the developers have to adhere to, but all too often there are loopholes that allow them to make payments to the local authority instead of building the affordable housing in the schemes. These payments are supposed to be used by the councils for building those affordable units elsewhere resulting in segregated communities.

3. Vacant homes: the salt on society’s wounds

A study from Admiral revealed that 22,481 homes in London were left empty for six months or more. Wealthy property owners mothballing homes as investments is a huge problem, and shows that free markets are not efficient nor rational!

Foreign investors make up a significant chunk of this stock, it’s just easier for them to leave them empty — they don’t want the hassle that comes with renting.

A human rights approach and the role of regulation

Being without a home is being without security, equality, freedom.

Home is where we, as people, develop and become capable of claiming and exercising all of our rights. Shareholder profit should not be the end-game, corporate profit must contribute in a positive way to society as a whole. Leilani sums it up elegantly when she says,

The obligations of States in relation to the financial sector have often been ignored or interpreted too narrowly.

The assumption, bolstered by neoliberalism, that States should simply allow markets to work according to their own rules, subject only to the requirement that private actors “do no harm” and avoid explicit violations of human rights, is simply not sufficient to meet States’ obligation to fulfil the right to adequate housing “by all appropriate means, including legislative measures.

It is the role of the state to develop the regulatory framework that optimises for equitable societal outcomes, not just the private gains.

Outlining specific policy solutions is beyond the scope of this essay. For those interested in guidelines and policies for the implementation of a human rights-based housing strategy, check out the UN Special Rapporteur’s site.