Pauline and Derek live together. This statement says where Pauline and Derek's house is in relation to the speaker's house.
The 'next house' is the house next to the speaker's house, and the 'next house but one' is the house next to that one. In other words, there is one house between the speaker's house and Pauline and Derek's house. If the houses on one side of the road are numbers 1, 3, 5, 7 and so on, we could imagine the speaker living in house number 3, and their neighbours Pauline and Derek living at number 7. Another informal way of saying this is "next door but one" or " two doors down".