Boom or Bust – What next for London Property?

Dow has worst start to the year since 1928” scream the headlines and life is about to get harder.

QE has stopped, companies’ earnings are weak and property taxes are rising.

This is the perfect storm that many have been anticipating.

Economists and city analysts are predicting that prime central London property prices will crash.

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Of course this will not stop many estate agents from making bullish comments in the press and they will fall back on their default argument “demand is greater than supply”. But that was the case in 2007/2008 and the market crashed…. And not because hundreds of thousands of properties had suddenly been built. So that argument doesn’t actually hold up to any scrutiny.

Of course the agents (and developers) remain upbeat because they are trying to sell their clients’ property.

Conversely, the more pessimistic commentators, who tend to be highly regarded economists, also get it completely wrong. For example, in 2003 Roger Bootle, managing director of Capital Economics, formerly chief economist at HSBC and one of the Bank of England's 'wise men' said:

“House prices could fall by as much as 30 per cent over the next four years”

If you had followed his advice you would have missed out on some of the largest house price gains in history.

Unfortunately none of the people who comment in the press have studied the history of the London property market in any detail. Which is why the lengths of the trends confound them and then the dramatic shifts surprise them. But history provides very clear indicators that help predict what the market will do. This is why in 2005 I was able to predict that the market would crash in 2007/8.

So is it Boom or Bust for the market now?

Well there are numerous issues:

I have mentioned the stockmarkets and the end of QE, but that is the tip of the iceberg:

1. The savage increase in Stamp Duty Land Tax

2. The changes to the non-dom rules

3. The reduction of mortgage interest relief for buy-to-let investors

4. Weakness in the fabric of the Eurozone, problems in Asia, Russia, South America, etc.

5. House prices that bear no relation to earnings

6. An extraordinary number of new-build, highly priced, identikit developments in the pipeline

7. Prices have increased 61% in the last 5 years which mean that most if not all the gains have already been had

You can probably add a few more. So it would seem obvious that now is not a prudent time to buy a property in London and that a large crash is likely.

But the differences between now and 2008 or any of the other property crashes is huge.

Has there been a mad frenzy? Have people been buying indiscriminately because they thought they would be priced out otherwise? No.

In 2007, just as in every previous property cycle, London and the UK went mad. Everyone was in the market. Sealed bids were the rule rather than the exception. Prices were going up 25-30% per annum. That simply hasn’t happened.

In my opinion we are much closer to 1998 than 2008. Indeed after every crash people say the market can’t recover. In the last cycle the market was too high in 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005. Here is a selection of quotes taken from articles over that time period:

2000 – “Housing-market experts, from estate agents on the ground to analysts in the high-rise city banks, are agreed on one thing: this is more than the annual summer slowdown. House-price inflation has dropped considerably and, in some pockets of the capital - usually areas on the fringes of more fashionable addresses - where people were paying silly prices for bad houses, properties are indeed worth up to 10 to 15 per cent less than they were six months ago.” The Daily Telegraph

2001 – “The house price indices are for once agreed: prices are slipping as the effects of recession take hold. Suddenly, the telephone-number price-tags of rather ordinary two-bedroom flats are beginning to look ridiculous.” The Daily Telegraph

2002 – “The top of the property market has been in trouble for some time… Property in some outer London boroughs now changes hands at phenomenal multiples of average local earnings - the prices being pushed up by a relatively small number of people driven out of expensive parts of the city.

In Bromley, for example, house prices are now 10.4 times local earnings” The Daily Telegraph

2003 – “He [Roger Bootle] said: 'The message is clear. Houses are now so over-valued that a prolonged period of falling prices is on the cards.' … Some London 'hot spots' have already seen prices marked down in recent weeks, which has been attributed to lower City bonuses and Stock Market uncertainties.” The Daily Mail 1st March 2003

2005 – “After five years of unstoppable price rises, the housing market has been showing signs of jitters.” BBC

Which just goes to show that you cannot and must not rely on or be influenced by commentary in the press.

The real problems began in 2006 when the majority capitulated and decided that there was a new paradigm: this time property really only did go up! Of course, it is when the consensus turns
that you know there is trouble ahead. If I had time I would show you idiotically bullish headlines! We all know what happened next.

Meanwhile the cycle continued to unfold as expected. London recovered first and fastest – after a liquidity crisis the only people who can afford to buy property are the rich and they want to buy in London. Then London takes off further as the banks tentatively start to lend, because the rich are the only people the banks will lend to as they are the best credit risks. Then London plateaus or dips slightly while the rest of the country catches up.

But at this stage of the cycle the consensus says that the market must crash: prices are now “high” and no-one can see value. Indeed how can prices go higher when the banks’ ability to lend has been curtailed and Londoners’ earnings are so completely detached from property valuations?

But this is exactly what people were saying 18 years ago:

There was the Asian crisis of 1998 that some had predicted and viewed as a danger to the world economy. Indeed stock markets tumbled but that did not affect London property prices. Likewise debt problems in Russia and the collapse of Long Term Credit Management was a disaster that people thought would destabilise the banking world. Again there was little effect on the upwards trajectory of house prices.

The same can be seen after the dotcom crash. House prices do not track the stock markets as much as people, especially those in the City, think. There are numerous reasons for this but consider these two facts. The total value of the world’s stock markets is roughly $55tr while the total value of the world’s real estate is $217tr. The banks are far more exposed to land. It is only when land price induced crashes take place that housing and stock markets tend to correlate.

Chart of the FTSE 100

FTSE Chart 88-2015

Chart of the Knight Frank Prime Central London Index

HousePricesChart 88-2015

In 1998 through to 2002 most people were still reluctant to buy property because the previous property and financial crash of 1990 was still a painful memory and the tribulations in the world’s various stock markets was seen as a clear indicator that problems still existed.

But history shows us this was actually a very good time to have bought property

It is no different now which means that there is still huge potential upside despite the gains of the last few years and the current, obvious issues. Why?

1. The changes to the tax regime are not a disaster. The uncertainty has been more damaging than the actual increases. Yes, some buyers will be deterred but this will make little difference to overall demand – London is still highly desirable. Indeed prices on average have only dropped a little in excess of the SDLT rates.

The exception is the new build market which is overly reliant on international investors, especially from Asia. Savills reports that “Overseas’ buyers purchasing property as rental investments only account for c. 7% of all greater London residential transactions. The percentage seems much larger due to high investor activity in the new build sector which accounts for less than 10% of all London transactions”

If you have not received my report The Properties To Avoid Buying in 2015 and 2016, email veronika@mercuryhomesearch.com and mention that you were at the Royal institute Talks. Written in January 2015 this shows the predictive power of the indicators I use. It is advice that was available to my clients in early 2014 which has helped them avoid making poor acquisitions and expensive mistakes.

2. SDLT will soon be absorbed and accepted as the (irritating) cost of transacting. Sellers are already accepting lower prices in line with the price hikes

3. Analysis by Savills shows that for properties over £1m between 2011-2013 “54% of buyers acquire their property with no debt whatsoever, with a further 25% taking a mortgage of less than 50%.

The mortgages that have been raised since 2010 are rock-solid and bear no resemblance to the debacle of 2002-2008. However, these lessons will soon be forgotten – they always are. Interesting fact: According to Savills – “Six Trillion, one hundred and sixty five billion is our best estimate of the total value of housing stock across the UK at the end of 2015… There is £1.32 trillion of debt.”

4. Earnings are irrelevant – UBS produced a note in November 2015 which said that house prices would crash because the house price to earnings ratio was above 10 and the market in the past has crashed when the ratio has gone above ten. This is true to a degree. EXCEPT, there is far more evidence to show that mostly house prices are not affected by a high price to earnings ratio. For example, see the quote above from 2002. House prices were over 10 times earnings in 2002 but house prices didn’t crash or just tread water, they increased massively for five years

Now what I am about to say is hugely unpopular with the mainstream but then the truth often is.

The fact that most people up to the age of 37 cannot afford to buy property or that the house price to earnings ratio is high is irrelevant for house prices, especially in London. It simply doesn’t matter…

… Is it unfair? Yes but:

THIS IS TOTALLY IRRELEVANT FOR PRIME LONDON PROPERTY PRICES RIGHT NOW

Why? Well just because first time buyers don’t have the means to jump on the housing ladder doesn’t mean that the money has disappeared into a vacuum or isn’t being produced. The money to buy property is there it is simply coming from a different source.

Indeed earning money is dreadfully 20th century. Why earn it when you can simply print the stuff!? The major effect of QE has been to boost asset prices. Those with a lifetime of savings and assets have made out like bandits.

Meanwhile the young are struggling. Indeed in prime central London you can have an excellent career as a lawyer, banker or stockbroker and still be completely inadequately funded in terms of buying a house.

Unless of course you have the best bank in the world.

The bank of mum and dad are now the middle men between the central banks and the younger generations.

The over 55’s have huge disposable wealth and are the richest generation in the history of mankind. There is also now greater flexibility on how they can use the billions of pounds stored in the UK pension pot not to mention the impending changes to IHT thresholds which will allow them to pass down more of their wealth.

A large percentage of this money will now enter the property market – this is likely to affect the lower end of the market more than prime central London so expect to see first time buyers priced out of even fringe areas. Don’t worry, they will not be homeless, they will simply move further afield as has always happened in the past.

Let me give you a couple of examples:

1. When my best friend’s father moved to London in 1950 he had a place in Pont Street, Knightsbridge. When he visited his grandmother in Mayfair and told her where he was living she retorted “Why on earth are you living so far out?”

2. In 1989 I rented my first flat in London in Notting Hill. It transpired that nearly every other house was a “crack house”. Yes a slight exaggeration but also closer to the truth than many realise. Shepherd’s Bush, Shoreditch, Queen’s Park, Brixton were absolute “no go” areas. In 1989 taxis did not go south of the river. Northcote Road, the epicentre of what is now called “Nappy Valley”, was where you went on a Saturday night to get stabbed

No-one in 1989 would have believed that these areas would have become thriving hubs. It is rather derogatorily referred to as “Gentrification” in the press. Actually it is the sign of a healthy city that is thriving and evolving. The alternative is a situation like Detroit or some of the neglected towns in the north of England where industry has died and we have failed to invest and reinvent ourselves.

But money from the older generations isn’t the only source of wealth replacing first time buyers: international wealth is now more fluid than ever before. This is creating a completely different world; a world in which a few “global super cities” are attracting a disproportionate amount of investment in terms of infrastructure. London is obviously one of these.

Those who own property are the biggest beneficiaries of these improvements. Crossrail is an obvious example.

But then this has always been true: those who own the land always take home (excuse the pun) the largest share of increased economic activity and profits.

This is why, historically, house prices have increased at substantial multiples to earnings’ increases.

So London will continue to expand as more money is attracted to it.

The influx of capital will lead to infrastructure improvements which in turn will feed into land prices. For example, Crossrail will mean that towns like Slough will effectively become part of
London. In 20 years’ time it will be the equivalent of Acton today, just as Acton today is the Notting Hill of 30 years ago.

When you truly understand the implications of this you can acquire property astutely.

And remember the government has a vested interest in higher house prices as it is virtually impossible for a government to be re-elected when house prices are falling.

In addition, the margin the banks are making on property lending is huge and they will want to be able to lend more and more. In America they are already relaxing the rules on who can and cannot borrow.

It is a racing certainty that the laws on lending in the UK will be relaxed too. Indeed the first sign that this is happening was the effective dismissal of Martin Wheatley, the Chief Executive of the Financial Conduct Authority. Apparently he was regarded as being “too harsh on the banks”.

But the way credit rules will be relaxed will be different from the last cycle – at least to begin with. For example, The Times recently was proudly announcing a victory in the battle against ageism as they push for mortgages to be granted to those over 60. This will happen as people are living longer, working to an older age and pension income is also far safer than wage income as you can’t get sacked from your pension. This will allow more money into the market which has to lead to higher house prices.

More importantly, the obvious extension of this will be for banks to start offering 40 and 50 year mortgages to those aged 25-35 which they already have in Japan and the US (in Japan they also have mortgages which you can pass to the next generation). This can only drive house prices higher.

But what else will drive the market higher?

Well as is often the case the important facts are not always so obvious. The Budgets last year were seen by most commentators as being distinctly negative for London property. However, the most important announcement for London and UK property prices did not appear in the housing section of the budget. 

No, the key point was the news that corporation tax will be reduced to 17% - the lowest rate in Western Europe with the exception of Ireland. This will encourage a vast amount of investment, which can only have an upward effect on land prices which in turn will feed into higher house prices.

This inflow of money will dwarf any outflows caused by the changes to the non-domicile legislation and the reduction in mortgage interest tax relief for buy to let investors.

In fact fears over non-doms leaving London are unfounded. A small number will certainly leave, but for many the tax breaks were the icing on the cake. They choose to live in London because it is a fantastic city. If you don’t believe me, think of all the hedge funds that were going to flee London for Switzerland. Almost all of them returned because life is too short to be that bored (especially when you are that rich).

The economy is already outperforming the rest of Europe and if you have tried to buy or even rent office space in London you will know that prices are rising rapidly because competition is fierce.

Also remember house prices have been going up while the amount of mortgage debt has been going down.

But there are other disruptive technologies and businesses that will also change the market:

You can expect crowdfunding to play a large role in the next boom. Although people may not be able to afford a home they will certainly want to participate in the price increases, so will invest in property through crowdfunding platforms focussed on property, e.g. PropertyPartner (this will ultimately be a disaster for many). This is what Property Partner achieved recently:

“Forty-two flats in a converted mill sold yesterday in ten minutes 43 seconds via crowdfunding. There were 318 investors, piling in at the rate of £1,405.17 per second. Representing the largest offering yet to list on property investment platform Property Partner, the property is in Gainsborough, Lincolnshire. It was put on offer with a funding target of £843,000 and a 60% mortgage. The property was purchased for a total of £1.82m – said to represent a 7% discount on value.” (Property Industry Eye)

The value of the properties is not of interest and nor is the speed although it is staggering. The really interesting point is that the smallest investment is £50. Therefore people who were effectively locked out of the market due to a lack of funds can now invest. This will mean that hundreds of thousands of people, if not millions, will now be able to “access” the property market allowing vast sums into the market that was impossible before (such people would never invest in REITS as the average man on the street is unaware of them, thinks they are too complicated or simply didn’t have the minimum investment).

It is likely that peer-to-peer lending companies like Ratesetter will start to offer larger loans/mortgage products. They will undercut the banks and in turn the banks will be given greater leeway by regulators to lend so that they can be competitive.

AirB’n’B, Vrumi, Roomflick (Tinder for property) and similar ways of using property more efficiently will generate additional sources of income from property – you can expect banks to take this into their mortgage calculations in roughly 7 years’ time. Indeed Bath Building Society has just launched a product for this very purpose.

It is inevitable that this will drive prices higher than ever before. Unfortunately it will also mean that the next crash will be the biggest we have ever seen.

But that crash is not imminent and in years to come people will look back on the next few years as an excellent time to have bought property just as we look back on 1998 to 2005.

Unfortunately I don’t have time to go any further and we have only really scratched the surface on what will happen and how there are very clear indicators that will flag the next crash which are oddly ignored by the economists and city analysts.

To discover more or if you would like to receive regular market updates and information that is simply not available in the mainstream press. Or if you wold like to receive complimentary copies of my book for you or your clients then simply email me at jeremy@mercuryhomearch.com or call 0800 389 4280.

Please send me further reports on the London Property Cycle