A MoneyWeek Special Investment Report

Money Morning
Londons Pending
Property Crash

MoneyWeek

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A MoneyWeek Special Investment Report

Editors Letter
The 2008 financial crash saw UK house prices which had been rising
inexorably since the late 1990s finally suffer a blow they couldnt keep
rising through.
All told, prices were hit hard, and despite the recovery, in some parts of the
UK, prices are still below (certainly in inflation-adjusted terms) their 2007
peaks.

John Stepek

Not London. Prices in London have ballooned since the financial crisis, fuelled by factors
ranging from sterlings relative weakness after 2008, the safe haven status of the UK
during the eurozone crisis, Londons general attractiveness as a global city, and the
generally favourable tax regime.
But is the bottom about to fall out of house prices in London? Betting against prices in the
capital has proved a losing bet over and over again. But we believe strongly that prices
have risen too far, too fast and a nasty bump lower from here is not only possible, but
likely.
This report explains why.
Were not predicting a full-blown, UK-wide house price crash (much as we suspect many
people would be glad to see property becoming more affordable). At the end of the day,
prices in many parts of the UK look perfectly reasonable particularly the more distant
you get from the southeast of England and the London commuter belt in particular.
However, in London, prices as many people who live there would no doubt concur have lost touch with reality. In the following pages well explain why we think prices
have come too far and a correction is on its way.
I realise that property is a divisive issue and our readers often contribute some of
our most interesting insights into Londons housing market. As my colleague Merryn
Somerset Webb puts it, half of MoneyWeeks readers think that London is so fabulous
and so much in demand that prices cant ever fall much or for long.
But the other half agree with us that a crash is on its way. (A recent poll we did on this
online shows that 67% expect prices to fall from here).
So please email in your questions and any views to me direct at john.stepek@
moneyweek.com. I cant promise to answer every individual email, but well address the
issues that are most urgent and pressing in the magazine.
Thank you!

John Stepek
Editor, MoneyWeek

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London is far more expensive than the rest of the UK

Londons property market is a topic we follow closely at MoneyWeek and right now the
alarm bells are ringing. Lets start with the following chart, from Nationwide.

Nationwide provides some of the most comprehensive house price data available in the
UK. The chart above shows prices both in London (in blue) and for the whole of the UK
(in red). London property has always been more expensive than the rest of the UK, but
plotting the two against each other shows just how significant the gap between the two
has become.
Indeed, last year the premium paid for the average London property compared to the
average house in the UK hit a record level of around 140%, according to Nationwide.
In 2007, prior to the last housing bust, the premium hit a peak of around 70% before
falling back to around 50% at the trough of the market in 2009. This cant go on. Even
Nationwides chief executive, Graham Beale (while hastily adding that he wasnt
predicting a crash), warned in November last year that there will come a point when
people in London cant afford to buy.
This gap might be understandable. In the wake of the financial crisis, in many ways,
housing in London looked like the perfect investment. A weak pound and a stable, lighttouch tax regime encouraged foreign money to flood into the capital, snapping up the
most tangible of assets: bricks and mortar. Limited supply and a more general sense of
buyers panic (when rising prices create their own momentum, with people rushing to
buy before they rise even further) saw prices shoot up.
However, anyone who believes in reversion to the mean (the phenomenon whereby
prices that get out of whack with their long-term average tend to return to it, often
rapidly) will already be wondering when that gap might close either by the rest of the
UK catching up, London prices falling, or both. We think theres a good chance that the
time has already arrived.
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Demand creates its own supply

Firstly despite all the protestations about a mass housing shortage high prices are
already encouraging a response from developers.
In some ways, the extent of the over-supply is difficult to overstate. Take, for example,
data published by London housing specialist LonRes, research company Dataloft and
estate agent Property Vision last year. According to their research, there are more than
50,000 new homes planned or under construction in London in the million pound plus
bracket. The majority are two-bedroom flats.
That is a staggering glut. To put it into context, in the same areas of London in 2014, only
3,900 homes were sold in the same price bracket. As my colleague Dominic Frisby pointed
out when he first read the statistic, that potentially puts supply at 14 times annual
demand. New build property in London is, as he says, a train crash about to happen.
These new, high-end developments being flats are largely unsuitable for families.
Topping it off are the prices: the average London house price is around 580,000, but the
average wage in London is only just above 40,000. That means the market this end in
particular is firmly out of reach for average Londoners.
Perhaps unsurprisingly, as more of this supply comes to market, our readers have
been telling us about problems in the new-build sector. As Merryn points out on her
blog, readers with knowledge of the new-build sector in London keep telling her that
too much is coming on too fast (this round of supply will peak later this year) and that
sales (both first and second hand) are running into trouble at a good number of new
developments.
One problem is that many of these properties are being sold to foreign off-plan
purchasers. Many of these bought when emerging market currencies were strong against
sterling. But the commodities collapse has put paid to that.
As one reader points out: When the flats are finished they will have to pay the bulk of
the purchase price. With the collapse of emerging currencies that final payment will be
much higher than they expected. So theyll be selling up before they have to pay the
balance of the price.
Notes Merryn: The Sunday Times has picked up on the story too. Cross the river from
Pimlico to south London, turn on to Nine Elms Lane and you will find yourself in a mile
long building site, says Oliver Shah in the paper. What you wont find is very many
people.
Five years ago, Nine Elms or Singapore on Thames as Charlie Ellingworth of Property
Vision calls it was held up as the brightest spot in Londons construction boom. Now
its 18,000 homes and two new tube stations exemplify a glut of supply and shrinking
demand. Selling prices in the area (SW8) fell 7% last year (LonRes) and some 28% of
unsold properties have been on the market for over a year. At the same time, the UKs
property websites are awash with unofficial resales in developments including Battersea
power station and Embassy Gardens.

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Battersea Power Station, meanwhile, is being converted into a sprawling new housing
complex, whilst the recently completed Vauxhall Tower, overlooking Vauxhall Bridge, is
Britains tallest residential building. 50 storeys high, it has 223 flats. According to LonRes,
the number of properties for sale in SW8 has rocketed from around 400 per month
two years ago to as many as 2,000 per month at the moment, an increase of five times.
Meanwhile, Crossrail will make once uncommutable areas of London more feasible,
bringing more supply into the market.
In that sense, the current bubble we are seeing in Londons property market very much
resembles the pre-2008 period. Back then, a buy-to-let mortgage bubble pushed up prices
in central Manchester, Birmingham and Leeds. Developers cashed-in by throwing up
blocks of flats and buyers, in the main, were investors (not locals) coming into the market
from the outside.
In short, house price rises were essentially speculative. They were not built on increased
local demand, but on the wishful idea that prices would carry on rising. That is exactly
the dynamic we have seen in recent years in new build property in London. And for that
reason, Londons house price bubble is alarming.
Many of the factors that drew foreign investors into the market have now gone into
reverse. High commodity prices and strong currencies in emerging markets, which
helped to push foreign buyers into London property, are a thing of the past. Chinas
economy is also slowing and its stock market has crashed. The bread and butter of the
high-end residential market isnt nearly as well off as it was: no Russian oil billionaires
are going to spend 60m on a penthouse apartment in Hyde Park this year. Quite the
opposite: they are more likely to be distressed sellers. The great unwinding of the global
credit bubble can take London houses down with it just as easily as it has taken down
steel mills.

A less welcoming tax haven

But this is about more than just supply. The incumbent Conservative government has
also taken aim at house prices in London, which are politically unpalatable, especially
ahead of the mayoral elections this summer. The current government has introduced
an annual tax on so-called enveloped dwellings, which applies to houses bought by
companies, typically held offshore. It has also hit the market with higher rates of stamp
duty for houses worth 1.5m plus and has said that anyone buying a second home will
pay 3% extra, beginning in April.Both measures are designed to discourage buyers from
overseas.London used to be lightly taxed by international super city standards. Add the
nasty cuts in tax relief on buy-to-let interest and that is no longer the case.
So you have plenty of supply on the one hand, and on the other you have various
factors weighing on demand. It strikes us that this bubble may be about to find its pin.
And when it does, it will have a nasty ripple-on effect for house prices across London, as
false perceptions of housing scarcity begin to unravel.
Evidence suggest that prices may have already peaked. According to a report last
September by LonRes and Bloomberg, almost a third of all properties on the market in
Londons Nine Elms district had been on the market for more than a year. That compared

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to just 12% in the best parts of London, the clearest possible sign that new developments
are already beginning to fall flat.
Some developers are meanwhile offering to pay stamp duty taxes for buyers, while others
are offering deals on furniture packs. That is hardly a sign that demand is rampant. In
fact, it suggests the opposite: the construction boom has overtaken demand and real price
falls (rather than just gimmicks) will surely follow.

Sell London, Buy Birmingham?

Is there any way to profit from this? Several of our columnists have said they would short
the London property market if they could (ie try to profit from price falls), and hedge
funds have been shorting shares in the likes of London-focused estate agent Foxtons
or housebuilder Berkeley Group. Unfortunately however, shorting property in London
directly is not an option available to investors (some companies have tried to launch
investment products to do this, but theyve never worked). There is though, one trade that
investors can make.
As we noted in the chart at the start of this report, its clear that London property is more
expensive, versus other property prices in the UK, than it has ever been before. History
doesnt repeat itself, but as the chart shows, it does rhyme. And that in itself suggests that
London prices have been over-hyped and are due for a bump to the ground.
However, that doesnt necessarily apply to the rest of the UK. So for anyone who believes
in reversion to the mean Sell London, buy Birmingham (or a place in the country) might
be a sensible maxim. If you live in London and were already thinking of moving out of
the capital, now looks like the time to do it.

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