Stop being overly optimistic
Double, double, toil and trouble;
Fire burn and London property bubble.
Prices are rising, demand is growing
There seems no chance this jovial mood will soon be slowing.
Asking prices are back to an all-time high,
With no one thinking that their time might be nigh.
But be wary fellow Londoner,
For we may all soon find ourselves regretting our housing blunder.
As exciting as rising London property prices have been for homeowners and investors – and we should know, we have written about them enough over the last couple of years – there are various signs that the London property market may be heading for a readjustment.
On the surface, things have never been so good for many homeowners. Not a week goes by that we don’t hear about more supposedly good news that will further raise prices.
Prices are on average back to pre-2008 highs, with some boroughs more expensive than ever, and rising. In the last 12 months Prime Central London prices have gone up by around 5%, with certain pockets within Mayfair, Kensington and Chelsea seeing up to 20% increases. The investment circle has long been spreading: Richmond, Barnes, Clapham and Battersea all saw price hikes of almost 8% last year.
A typical London home is now on the market for a mere 34 days before it gets swooped up at 95% of asking price. Nor is the trend expected to taper off anytime soon. Savills estate agents estimate that by 2017 prices will soar by 25.6% in Central London, 22.1% in Prime Outer London and 22.2% in the Prime Outer Suburbs, while London as a whole will rise by 21%.
Other predictions have been even more optimistic. Realtors Chesterton Humberts prophesises Prime London prices to grow by 40%. Knight Frank, meanwhile, foresees specific pockets like Nine Elms growing at up to 40% annually over that period.
We are constantly told that such dizzying growth is possible, and perhaps even inevitable. With a chronic homes shortage in London that caused demand to outpace supply threefold in the first quarter of this year, Knight Frank believes that demand during the next decade will outstrip supply by 50%.
This all sounds pretty tantalising as an investment – as safe as houses, if you must – but in a decade dented by one bubble after another, is it really so impossible to imagine that we may be in the midst of yet another?
Buried between the elated forecasts, you can see signs of hubris that indicate we have already laid the ground for our inevitable fall. Even estate agents and property analysts hint at this in private – though it’s one thing to let your doubts spill over during a coffee, and quite another to become a lone voice sowing the seeds of your possible downfall in public.
So here are some of the top reasons why you should be taking all the seemingly good news with a hint of scepticism:
1) Foreign buyers
Foreign buyers are a small but integral part of the London property market. Their appetite for new homes has spurred much of the recent construction in luxury developments. However, fluctuating global economic conditions and tighter government controls on things like visas in the UK could mean that London will stop being the second-home capital for the world. And if the world’s rich stop buying London property, there will be significantly less demand at the top end to keep pulling up prices.
Foreign buyers have been propping up the London property market for years, if not decades. Their interest in London is certainly nothing new, but their proportional share of the market has been growing. Overseas buyers now account for anywhere between 50% to 85% of all prime London property purchases and almost all of the new developments that are bought off-plan. It’s largely thanks to their demand, and the interest of foreign investors, that landmark projects like Battersea Power Station have been able to get off the ground.
But the foreign market is not as concrete as it seems. For one, the sell is getting harder. The large trade shows now have to go to a whole collection of countries, from former Soviet Republics to the Arab states and South-East Asia, in order to sell apartment blocks. It is no longer a matter of just showing up in Hong Kong or Dubai and watching your project get lapped up over a bellini.
After a decade of bombastic growth, China’s economy is beginning to slow. The US, which remains the biggest foreign market, has just posted lower-than-expected growth figures. The Qatari royals may be richer than ever but they are all rumoured to own dozens of properties across the capital that largely lie dormant and have just publicly said they have grown tired of overpaying for trophy projects.
Those that are looking to buy have begun looking elsewhere. Arab countries have increasingly been turning to Turkey for their second homes, as foreign relations between the republic and its regional monarchies has improved, while Chinese buyers have reportedly started flocking to Thailand.
In turn, the countries that many insist will plug this demand gap have been slower to rise up. Turkish buyers are seen as a big up-and-coming source of investment. They already account for 11.5% of the London overseas market, with Knight Frank reporting a jump in demand since the outbreak of political unrest last month. But in comparison to other large foreign markets that have come before it, Turkey remains small. Its middle class may be growing, but with 50% of the country’s 73 million citizens below the age of 30, it will be some time yet before we see high numbers of possible investors to rival giants like China.
Even if purchasers are interested, they can be put off by complications like getting visas. These are already hurting Chinese interes, alongside that of many other foreign buyers – foremost among them Indians, widely touted as the next big London property-market inflating force. Instead of bringing the barriers to entry down, George Osborne’s latest budget review only increased restrictions. Hardly a sign of good changes to come.
And it’s not just UK regulations. Foreign buyers are often stifled by scores of regulations in their home countries too. India, for instance, is subject to firm restrictions on the movement of capital abroad. All investments over £200,000 remain subject to stringent checks, while taxes also discourage investment. In addition to all UK property taxes, Indians are left paying 30% corporation tax back home if they sell quickly, and 20% if they sell later on.
Fact Box: Exchange rates
Currency fluctuations can have a potentially good or devastating impact on foreign buyers. Knight Frank says buyers using US dollars will find prime London properties 7% cheaper than in 2008 because of sterling’s decline, while buyers using pounds pay 17% more.
This has helped to fuel interest in London and make it more attractive to international buyers, but also makes the market sensitive to external shocks. If the dollar depreciates or Asian currencies stall, London will look far less attractive.
But it is also a common mistake
to assume that all foreign buyers buy with foreign money. According to Savills’ estimates, three quarters of new builds were bought by foreign buyers – but half of those were UK-based foreigners, many of whom work in London’s financial services. These buyers have long used their annual bonuses to buy homes, but with bonuses down 10% this year, they are bound to be affected, alongside a large chunk of British prime property purchasers.
2) New no more
New builds account for the overwhelming majority of new housing stock, but they have a shorter shelf life and will, on the whole, appreciate less quickly than their classical counterparts. However, new builds tend to be more expensive than older homes per square meter initially. An increasing amount of new build property is expected to come on market in the next few years which will help to elevate London property prices in the short term, but could lead to a longer-term tapering off of prices.
Much of the greatest price appreciation we have seen has been in areas where new builds have promised to revamp previously run-down areas. Overnight, Battersea has turned from a “isn’t that on the wrong side of the river?” destination to the “it” part of town.
But what comes up usually comes down. Past experience shows that new-builds tend to have a shorter shelf-life than their period partners.
Even the most bullish of London property pundits admit that almost all new homes – especially purpose-built apartments – tend to spike in price upon launch, before either depreciating or appreciating less quickly than their period rivals. The last year has seen an upswing in construction, as will the next few years, but that means that much of London’s new housing stock is near to reaching its relative peak.
Within a few years, new becomes dated, subsequently driving down demand – at least until a large-scale refurbishment is enacted. Even when it is, in relative terms prices are unlikely to return to their original highs.
More iconic projects with direct river views may be able to escape the new-build curse, but many cannot. In Canary Wharf, the epicentre of contemporary new-builds, prices have failed to recover from their post-recession lows. The demand just isn’t there. What demand there is happens in neighbouring areas, because foreign buyers are scooping up new projects, rather than old new-builds.
This isn’t necessarily sustainable. These properties may be still seen as the safe choice of the “unsophisticated” buyer. Once foreign investors are in the London property game for a while, they tend to diversify away from new builds into more classical properties, where the floorboards creak and the roof leaks.
The result will be twofold. Older properties may end up going up in price, but the price of new-builds will fall as a large chunk of them age and as more new-builds are erected to try to ease the property crisis. As new-builds are more expensive than older houses (£542,000 for the average new and just north of £500,000 for an older home) average prices will fall, at least in relative terms.
3) Political fallout: Generation rent
After many years of declining home-ownership, there is mounting public pressure to build more affordable homes. When politicians and developers eventually buckle to it, the surge in reasonably-priced housing stock will bring supply more in line with demand, so bringing down prices.
If we accept that an Englishman’s home is his castle, then we are fast becoming a country of landless surfs. Home ownership has been declining over recent years. According to the government’s Office for National Statistics, from 2001 to 2011 the percentage of home owners in the population has fallen from 69% to 64%, while the number of renters soared from 1.6 million to 8.3 million. The average house price for first-time buyers has jumped by 96% over the same period.
New research from Halifax suggests that even the dream of owning our own home now escapes us. One in three 20 to 45 year olds have outright stopped saving to buy a home, resigning themselves to leasing purgatory. The bulk of those that do think they will become homeowners, only expect to do so following a large bonus or an early inheritance cheque.
At present, the political balance is in favour of the owners (In London 25% of residents were private renters in 2011) who cheer price growth. But as the baby boomer generation ages and starts to die out, or downsize, the rent-ownership gap could widen. With London prices where they are, ordinary families will not be able to afford to buy up that same housing stock. Investors will instead snap up the property and rent it out, further skewing the rent / buy ratio and escalating pressure for change.
Eventually, public pressure for more housing at widely accessible prices will force a change of policy to create more homes. This shift will intensify in the coming years – we have already begun to see signs of the political reaction from just about every corner. London Mayor Boris Johnson wants more homes, George Osborne wants more homes (just look at his Help to Buy scheme), UKIP wants more homes, and outspoken LibDem MP Simon Hughes who wants to stop properties being sold to overseas buyers definitely wants more homes.
It’s only a matter of time before something gives and we actually get more houses – which ultimately will bring overall prices down, as supply will be brought more in line with demand in London.
4) Government fiddling: Taxes
There is plenty of evidence that suggests how susceptible to tax shocks the London property market can be. Not enough has been done to introduce a system of clarity and consistency which would underpin steady growth in the property market, and high taxes risk putting off buyers.
The HomeOwners Alliance, an organisation of homeowners, estimates that while house prices have risen fivefold between 1995-96 and 2011-12, the amount of tax paid on property purchases had increased 11-fold.
The average stamp duty tax bill now stands at close to £6,000 nationally but a whopping £17,529 in London.
If a mansion tax is introduced, Whitehall estimates that wealthy households will end up paying £36,000 a year. This could cause a mass sell-off of London homes and drive down prices.
All these taxes are a deterrent to buyers, and risk putting them off. The risk factors could cause a mass sell-off of London property. That would lead to a double whammy of increased supply and dwindling demand (as buyers are put off by higher taxes). Result: lower prices.
5) Mortgages, interest rates and whole lot of market distortion
The price of mortgages is too low and government lending is not sustainable. When this readjusts to more realistic levels, the housing market will have to react.
The rising costs of buying a house and then selling it on have encouraged further market manipulation, geared at making voters feel like they are not on the edge of a fiery precipice. Keeping the Bank of England’s base rate consistently at
300-year lows has been a lynchpin of this policy, and has had a corresponding impact on mortgage rates, keeping them cheap, for the most part.
If the base rate is eventually hiked up – as it will inevitably have to be – mortgage rates look likely to rise, possibly even double in just a few months.
The situation has been further aggravated by ventures like Osborne’s Funding for Lending. It may have not eased up bank lending to small businesses as had been hoped, but it has helped banks drive up mortgage lending. (Mortgages are considered relatively secure investments and so require banks to underwrite less capital for these kinds of loans.) This has come in handy at a time when banks are being encouraged to hold onto ever more capital reserves. Since Funding for Lending got underway, the cost of a two-year fixed mortgage at 90% of the value plunged from 6% to more like 4.5%.
But what happens when government subsidies stop and the Bank of England’s monetary policy tightens? The likelihood is that tens of thousands of Londoners – and at least 700,000 Brits struggling to repay their home loans at the moment – will find it even harder to do so. Those looking for a mortgage, meanwhile, will not be able to get one, driving down demand.
If the veneer doesn’t crack before then, some foresee a point of no return in about five years when Osborne’s latest scheme, Help to Buy, starts demanding chunks of its taxpayer-guaranteed home loans back from recent home owners, stuck in their now ageing and hence depreciating new-build homes.
So next time you wake up to news that London property prices have been magically impervious to decline, think again – because there could be some powerful trouble boiling away and looking to bubble.
You need to read: