THE HOUSE-BUILDING SPEC-DEVELOPERS

Not a normal industry

How would the housebuilders (one arm of the Iron Traingle locking down the housing market crisis )react to the imposition of LVT? 
 Before answering that I have to explain the strange beast that is the house-building industry.
We rely on the house-building industry for our supply of new houses, but we blame them for vastly under-supplying our needs. Perhaps if we understood the production methods which they are forced to follow we could see what is preventing the housebuilders from doing more. Understanding the peculiar characteristics of the spec-builders is essential if we are to find ways to help the housebuilders do better, build more and most of all get prices down.

Liam Halligan does not pull his punches in his insight-full book ‘Home Truths’ when it comes to the Spec-Housebuilders. He’s even done a Channel 4 Dispatches programme which shows what a raw deal the buyers of Persimmon and other new housebuilders suffer.

And Liam has a much better idea than most commentators about the ‘Business Model’ of the spec-builders, and why it inevitably leads to poor quality, and why too few new houses are being built and sold. Worst of all, it is a business model which reinforces the steady upward march of house prices, too.

Economists are wrong when they say “Increase Supply by building more dwellings; that’s the way the market ensures lower prices”. Housebuilding is not a normal industry, it has its own peculiar means of operating – or business model in the jargon. I’ve shown this here,here, here and here

But what is this “Peculiar Business Model” that the Spec-housebulder-Developers follow?

This is how I picture the process by which most of the new houses built today. In the main they are built by a small number of firms known as the ‘Volume Builders’. It is they who acquire tracts of land and develop the estates of new houses.

THE BUSINESS MODEL OF THE VOLUME HOUSE-BUILDERS

As I described above: The process is that the spec builder gets hold of a tract of land, maybe tens of acres with a view to developing it for house-building. Plans for the layout of the estate can be drawn up, and individual house types designed. The next stage, which can be quite lengthy, is Planning Permission, and often results in major changes to estate layouts and housing densities – in other words, massive uncertainty about possible future expenditure and revenues from sales.

Eventually the actual building work can start.  First off is the building of roads, connecting to services, laying out plots. Then they start building houses, first the show house, then the batches of houses sold off in stages.

Finally, after many years, all the new houses are sold, and the spec-builders can calculate their profit (with a contingency for after-sales fault fixing). It’s been a long time coming, and you might wonder what makes the difference between a highly profitable and a not-so-profitable development?  

This may look like a crazy way to organise production, but the developers have had to adapt to their circumstances. They are businesses after all, not social services or charities. Do you remember what they told you about the objectives of any Firm in our great capitalist economy?

Objective 1. Stay in business

Objective 2. Make money, profits, as much money long-term, as you can.

[Nothing here about morality, honesty, altruism, benefiting Society or even Pride in the Job (to quote the NHBC slogan). Just Greed, but it helps if you can build a reputation for these positive virtues.]

Looking at the stretched-out time scales, and the huge up-front cost of land, it’s no wonder the developers are cautious. When the returns will not be made for years (up to 12 years on the picture above) you have to tread warily to stay afloat.

But what of making a profit? How do the developers make money from this long-drawn out process? In capitalist ideology through fierce competition to cut costs you make most sales and profits by supplying the cheapest product at the market price. Less ideologically, in modern corporate capitalism you outcompete your small number of rivals by producing better quality branded products (I am a firm believer in Galbraith’s theory of modern capitalism.)

From what we see of the products of the spec-builders, they do not engage in the benign Galbraithian competition that drives up quality. Newly built houses are built and sold as commodities. It is rare to find any corporate branding anywhere on the building. Although there are a handful of ‘volume builders’ – an oligopoly in the jargon – the peculiar conditions of the construction industry (see Michael Ball) means that their relative dominance results in other benefits for the firms, NOT in better cheaper houses.

So oligopolisation is more about 1. Staying in business. It also explains why house-builders  build down to the minimum standards (on thermal insulation for example) and use the cheapest of materials. It’s the only way to cut costs.

As Liam explains, the only place that competition between firms prevails is land purchase. (p80)

“The UK’s housebuilding model is competitive only in the sense that the market for land is competitive– but the benefits of such competition accrue not to the millions of potential homebuyers, or even those trying to access a rental property. They accrue, instead to the massively powerful vested interest of landowners – whether individuals, developers or land agents – who are able to sit on land and extract windfall returns.

He then goes on to explain why this land-nexus, by tying up large amounts of capital for long periods of time re-inforces an “unhealthy over-concentration within the housebuilding industry.” (Liam has a thing about oligopolies, but in the right circumstances, eg Galbraithian they can be hugely beneficial to the consumer interest)

The market dominance, especially in the local market enables these spec-builders to produce houses slowly so as not to slow down in price rises.

“It would be hard to conceive of a system .. [so much] to the detriment of ordinary homebuyers.”

That explains why so few houses are built, and why the lack of effective competition has the result of  ever rising house-prices. It also explains why new houses are getting smaller and why they are badly built, a subject Liam is expert on, having produced his Channel 4 ‘Dispatches’ programme.

The shrinking size and poor build quality are a result of the drive for profit. Only by making the build cost smaller can the profit margin be enlarged. All the major costs have already been committed. Various tricks are used to reduce cost:

--Use of the cheapest materials and components (compliant with standards), using tenders

--Reducing room sizes reduces material costs

--Sub-contract labour on piece work cuts costs, but results in rushed, often bodged work.

In summary: The existing model for the production of housing gives no incentive for the spec-builders to produce large numbers of houses or to produce better quality houses than their competitors. The focus of profitability lies in the land-purchase activity. Sitting on a landbank and waiting for its market value to rise is much more profitable than finding ways to build better houses more efficiently.

A couple of notes

(i)                  Housebuilders, Spec-builders or Developers? These names for the production side of the Housing Market are somewhat interchangeable. They like to call themselves ‘Developers’ because this sounds respectable if not very specific. ‘Spec-(house)builders’ indicates that they speculatively produce houses ahead of demand, but spec(ulator)  sounds a bit sleazy. Even ‘Housebuilder’ doesn’t cover the whole range of activities necessary to get a key to the front door into the buyers’ hands.

(ii)                The standard image of housebuilding is of a large ‘estate’ development. The big boys, known as the Volume Builders get hold of a tract of land, maybe tens of acres and develop it, building roads connecting to services, laying out plots. Then they start building houses, first the show house, then the batches of houses sold off in stages. There are also small firms in housebuilding, but they only produce 12% of all new houses (Liam p.87) so I’ll focus on the big boys for now.