The Overall Benefit Cap — a little time bomb under UK buy-to-let housing

As a part time analyst of (and indeed investor in) the UK rental property market, I try to keep an eye on anything that might upset the market. Because of this, I try to stay aware of developments in housing benefit and social housing, because problems which start there often tend to spread to overall house prices. And at present, it seems to me that sensible analysts of the sector like Joe Halewood and Nearly Legal are kind of tearing their hair out over the fact that nobody seems to realise that forthcoming changes to the benefit system are going to seriously undermine the viability of a fairly important part of that market — namely, the renting of houses to people who claim housing benefit.

So what is it then?

The Overall Benefit Cap (OBC) is one of the Conservative governments signature policies, and one of its most popular (particularly, to the understandable chagrin of left wing opponents, with the working class). It’s quite a simple policy to understand — the principle is that no household should receive state benefits which total more than a set ceiling — currently £25,000 for most households subject to the cap, but with a proposal to reduce it. You can see the idea — it’s meant to cut out the relatively small number of high-profile cases where large families in specific situations end up getting state benefits which are significantly larger than average working incomes. It doesn’t actually do much a job in cutting out those situations, because most disability benefits are not subject to the cap, but it’s a good piece of politics to deal with the perceived problem.

On the other hand, like many measures which combine “good politics” and “simple principles”, it could have some unpredictable effects when it interacts with a complicated world and with a benefits system that wasn’t drawn up along the same political lines. In particular, the way that the cap works has the effect of turning the UK benefits system into something like a CDO, with housing benefit as the first-loss tranche.

What do I mean? In the chart below, I’ve dramatised it a bit by using a family in Haringey (an expensive place to live, and therefore one with high housing benefit rates), and assuming a two-adult, three child family with no employment income and no disability benefit. That means they hit the benefit cap harder and faster, but I’m not playing games here — the revised cap will catch a lot of people.

Basically, the total benefit sum is capped. But most welfare and child benefits and tax credits are fixed sums. Housing Benefit, on the other hand, is variable — it’s meant to cover the actual housing cost, and so it varies depending on the rent that the household actually pays. The effect of this, though, is to mean that all the effect of the OBC has to come about through a reduction in Housing Benefit.

Squeezing the housing costs

This already has a strong sense of “what could possibly go wrong?” to it. As it happens, with the cap set at its current level, there was not all that much in the way of practical consequences, as it really did only catch a small number of unfortunate corner-cases. But the current intention, which is likely to be put into place in July, is to reduce the cap from around £25,000/year nationwide to £23,000 a year in London and some lower figure, to be determined, outside the capital. (This London-weighting, of course, is a partial recognition of the bias toward Housing Benefit in the way the cap operates). And at the lower level, things start to happen — credible estimates suggest that as many as 200,000 households might be subject to the cap.

Taking some figures from Joe Halewood and cross-checking them with a publicly available benefits calculator and a list of housing benefit rates, you can see how bad things could get. In the Inner North London on my chart above, a family with two non-adults and three children would be receiving £335 in welfare and tax credit. That means that as the cap changes, their maximum Housing Benefit payment would go from £165 to £105. Effectively, by removing 36% of their subsidy, their cost of housing has gone up by a very large percentage — if, say, they were paying £180/week rent beforehand (which itself would take some doing, as the standard allowance for non-capped households for a three-bedroom house is £315), the amount of money they have to find from their benefits to cover housing costs would have gone from £15 to £75 — from a relatively minor expense to more than a fifth of their income.

Outside London, the sticker shock could be even worse. Assume that the non-London benefit cap is set at £400/wk, or 90% of the London figure, and take the example of a similar family in Liverpool, where the local housing benefit rate is £120/week. At present, it’s very likely that the entire rent would be covered by housing benefit. But if the cap falls from £500 to £400, then the maximum housing benefit this family can receive is now £65/week. From the landlord’s point of view, he has gone from receiving an income that is entirely guaranteed by the state, to one where half of his monthly rent is dependent on the ability of a family on state benefits to find £55 a week that wasn’t previously in their budgets.

Reducing the landlord subsidy

Indeed, the big question here is how the incidence of this change in the benefit system will fall on tenants compared to landlords. At a stroke, families receiving housing benefit become vastly less desirable tenants for private sector landlords, and you’d expect social landlords like housing associations to run into big arrears problems. My guess would be that you’d see particular problems in South Coast towns, where there are a lot of properties owned by amateur buy-to-let investors, who really aren’t set up to handle arrears problems at all — that’s why they got into renting to housing benefit claimants in the first place.

Which is slightly odd, as if anyone could be seen as a core Tory/UKIP voter, I would have thought that a small landlord in a southern coastal town would be. It’s not often that you see a government attacking its core supporters in this way.

The best possible outcome would be for the change in the benefits cap to put downward pressure on rents. Ironically, in the limiting case in which rents fell by the full amount of the cap change, this would mean that the benefits cap had no effect on claimants at all — it would be experienced by the economy as a reduction in the subsidy provided to buy-to-let landlords and to housing associations.

But that best case is unlikely. One thing we do know about the British economy is that rents are sticky. I would guess that the frictions in the housing market would be significant enough to mean that we saw plenty of evictions (which destroy the cost-effectiveness of the scheme, as the evicted families have to be housed in expensive temporary accomodation), plenty of arrears, downward pressure on house prices and real danger of a meltdown in the social housing sector. I’m not sure this one has been brilliantly thought through.