Boom or Bust – What next for London Property?

Everyone laughed when I said I was founding a property consultancy in late 2001.

“It’s the wrong time to be doing this”

“The dotcom boom has bust and events of September 2011 have changed the world”

“London property has peaked. It’s far too expensive”.

Nevertheless, I was convinced that the London property market was not about to crash at that stage, which is why I continued to buy property for myself. And here I am today and the worries about the London property market continue.

And this time there really are some major issues. As I write the Dow Jones has just plummeted a 1000 points!

Of course this will not stop many estate agents from making bullish comments in the press. In fact it irritates me how permanently bullish on the London property market many are. They simply rely on their staple argument “demand is greater than supply”. That was the case in 2007/2008 and look what happened!

Quite frankly such commentators have little idea what they are talking about and remain upbeat (in public) 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 dramatic shifts surprise them, when there is actually a very clear and reliable indicator.

I have been using this indicator for years: in 2005 a client whom I helped buy a £7m house in Kensington said to me that “he was ringing the bell at the top of the market”. I told him that he was fine but that the market would probably crash in 2008. Indeed in 2007, when the market was literally fuelled by panic buying, I was advising clients that the probability of a crash was high and that waiting and watching was probably a good idea.

None of the agents forecasted that because they were unaware of what was happening.

But after 2008, I urged caution for too long despite the fact I should have known better (more about this later).

So is it Boom or Bust for the market in the next three years?

Well there are numerous issues:

1. The savage increase in Stamp Duty Land Tax

2. The changes to IHT rules that will certainly concern Middle eastern owners and buyers

3. The changes to the non-dom rules

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

5. Weakness in the Eurozone

6. Economic problems in China, Russia, South America and Asia

7. House prices that bear no relation to earnings

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

9. Low yields

10. Large price increases in the last 5 years which mean that most if not all the gains have already been had

11. Stock markets across the globe that look decidedly sick

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, whether it be a home or investment. In fact you may well have been thinking this since 2010 and are just waiting for the crash to fully play out.

Except how often do markets crash when there are “obvious” problems and when so many people are sitting on the side lines like today? Corrections – absolutely. But long, painful crashes - no. It is the unexpected that crushes markets when the consensus is that everything “must go up”.

In fact the difference in the London property market between now and 2007 (or 1989 or 1971) is huge.

Is there a mad frenzy? Have people been buying indiscriminately because they thought they would be priced out otherwise? No. The only segment of the market where this may have happened in the last year is the new build market.

And if you absolutely want to buy off-plan or in a building that has just completed then I strongly recommend you wait as there is likely to be further weakness due to the economic problems in Asia. This is something I predicted over a year ago and have been actively discouraging my clients from buying in most developments (there are always exceptions).

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.

Some of my clients decided to buy properties in 2007 despite my advice and entered sealed bids. I would tell them what I thought was a sensible price, then the likely level of the actual winning bid and why they should wait. In some instances we were 15% under the winning bid despite the fact that we had bid 5-10% over the asking price.

These clients are still with me today and recommend me to their friends because they experienced first-hand the importance of understanding not only market conditions and prices but also where we are in the property cycle – yes that is a horribly blatant plug! But it is true and you can speak to these clients if you so wish. But I digress.

Why am I telling you about 1998 and 2008?

Well it all has to do with the UK property cycle. A cycle that has proven to be reliable for nearly 500 years in the UK – dating back to the first really big sale of land in 1536 – the Dissolution of the Monasteries under Henry VIII (there were no house price indices back then but you can study timber and brick prices).

There is a clear cycle which has only failed twice – during the two world wars.

Now you may be sceptical about a predictable property cycle and I certainly had my doubts even though I had spotted a pattern. After all nothing in life is that easy and if it was everyone would know about it. But I dug deeper and discovered that there had been plenty of research on the subject. Fred Harrison’s book Boom & Bust is essential reading (he wrote an open letter to Tony Blair and Gordon Brown warning them of the 2008 crash years in advance).

But he is not a sole crusader; Henry George, Fred Foldvary, Homer Hoyt, Philip J Anderson (The Secret Life of Real Estate & Banking is excellent), Joseph Stiglitz and others have studied these cycles which are evident across the globe and not just in London and the UK.

And the more I read, the more I realised that the cycle really does exist. The reason why so few people recognise it is because, although the timings repeat with extraordinary precision, the reasons for each crash, superficially, seem to differ. Add into the fact that each new generation needs to learn the lessons themselves and you can see why history rhymes if not repeats (as an example, one of my clients has recently pointed out that in his firm there are desks and desks of bond traders who have never seen a rate rise).

So although the information on the cycle is free for all to see, it is in fact one of the best kept secrets. Literally hiding in plain sight.

So where are we now?

We are much closer to 1998 than 2008 in the UK property cycle. Why? Well, think of the last 3 major crashes in London property prices: 1972, 1990 and 2008.

After each crash people said the market couldn’t recover. The market was too high in 1997,1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005. Here are a selection of quotes taken from articles over that time period:

1998 The Budget – “Mr Brown said: "I will not allow house prices to get out of control and put at risk the sustainability of the future." He said he was determined that the UK should not return to the "instability, speculation and negative equity" of the 1980s and 1990s.” The Daily Telegraph

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 do not want to rely on or be influenced by commentary in the press.

The real problems began in mid 2006 when the majority capitulated and decided that there was a new paradigm: this time property really only did go up. Of course, it it is when the consensus turns that you know there is trouble ahead.

This is where I was an idiot.

Against my better judgement I felt in 2010 that there were still too many dangers and was not confident of investing DESPITE THE FACT THAT I WAS PRETTY SURE THE MARKET WOULD RECOVER because I had studied the history. Of course studying the history and experiencing the reality are dramatically different things.

I still kick myself for not taking advantage of the situation in 2010 and 2011. What a missed opportunity especially as I had the blueprint for what is happening. But fear can do that…

Meanwhile the cycle continues to unfold as expected. 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?

Well, as mentioned, this is exactly what people were saying from 1997 after prices had risen above the levels of the previous peak in 1990. Indeed there were major problems brewing in the world then:

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. It is only when land price induced crashes take place that housing and stock markets tend to correlate.

HousePricesChart 88-2015

The FTSE 100

FTSE Chart 88-2015

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

It is no different now which means that if you act now 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 an inconvenience 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.

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”

2. SDLT will soon be absorbed and accepted as the (irritating) cost of transacting. Indeed it is possible that the SDLT rates at the higher end will be reduced or even returned to the same levels as pre December 2014, because the tax receipts have fallen so dramatically (this is a big “if” but it is early enough in the new government’s term to change the rules especially as they can prove the negative effect of the policy)

3. The banks will start lending again. The increase in prices over the last five years has been on the back of a higher than normal percentage of cash purchases. Analysis by Savills shows that “54% of buyers acquire their property with no debt whatsoever, with a further 25% taking a mortgage of less than 50%. This would indicate that of the average £31.5 billion spent on property worth over £1m in the period 2011-13 across the UK, £6.2bn was funded by borrowing.”

The mortgages that have been raised are rock-solid and bear no resemblance to the debacle of 2002-2008. However, these lessons will soon be forgotten – they always are.

4. Earnings are irrelevant

This last point seems mad but it’s not.

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:


Why? Well just because FTB’s 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. This is why the young are struggling. They rely on income rather than assets.

Meanwhile those with a lifetime of savings and assets have made out like bandits. Consequently there is such a huge disparity in wealth between the older and younger generations and those with assets and those without.

Trying to earn money as a youngster in a typical job to buy a property is futile as you will remain behind the curve. 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 “core areas”. Don’t worry, they will not be homeless, they will simply move further afield as has always happened in the past.

But that isn’t the only source of money 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 huge amounts of investment in terms of infrastructure (digital as well as physical).

So we have a situation where there is:

1. A huge expansion of money through QE in several jurisdictions

2. A transfer of wealth from West to East

3. Money can transfer between jurisdictions at the touch of a button

4. The return on cash is abject if not negative

Consequently, it is madness for those with huge sums of excess cash to stay in cash. This is set to continue as the UK, US and European governments literally cannot afford for interest rates to rise significantly. They have too much debt. This may be cynical but it’s true.

If rates rise it will only be because the economy continues to recover. But then earnings will rise, which in turn will mean that rents will rise (they are already up 13.7% compared to June 2014), which will attract more people to invest in property – including large institutions who will see residential property as a serious mainstream financial asset (as opposed to their previous focus on commercial).

So this is pretty miserable news for those whose families don’t have assets. But then this has always been the way and is the secret that politicians don’t want highlighted: those who own the land always reap the gain of increased economic activity and profits.

This is why, historically, house prices have increased at substantial multiples to earnings’ increases. It is also why such a high percentage of individuals who feature in the various “Rich Lists” made their money in property and why the vast majority of wealthy families have substantial property portfolios – it is a proven strategy for generating and preserving wealth for generations, if done correctly.

The question is how long can this last?

Well London will continue to expand as more money is attracted to it. And it will be attracted because of the unique combination of advantages that London has – politically stability, the clear rule of law. It is a global financial, tech and education centre as well as having excellent culture, shopping and nightlife (London is now the number one tourist destination with 18.7m visitors in 2014). I could go on. Quite simply London is an exceptional city.

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.

Perhaps a better example of this is a story that my best friend’s father used to tell. When he first came up to London in 1953 he moved to a flat in Pont Street, Knightsbridge. He went to visit his grandmother in Mayfair and when he told her he was living in Pont Street she responded “Pont Street! Why on earth are you living so far out?”

When you truly understand the implications of this you can acquire property astutely, just as I do for our members at Mercury Homesearch.

We are only in the early years of this property cycle. The trajectory will not be straight up and there will be corrections upon the way, but over the next 10 years the probability (there are never any guarantees) is that prices will increase.

Indeed 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. Why? Because humans are forgetful, fearful and greedy. Once it appears that we have stability people will want to make more profits and money, buy more houses and will require the credit to do so. As the risk of default diminishes (in the eyes of the crowd/popular consensus) then the rules will be relaxed. It happens in every cycle and will result in another almighty property crash; that I can guarantee.

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”. This does not mean that loose lending will happen overnight - the memories of 2008 are still too fresh, but lending criteria will be loosened.

Then prices will increase, which will lead to further relaxing of the lending criteria as we enter the age of a new paradigm. This in turn will lead to another frenetic surge in prices as people panic that they will never get on the housing ladder. It has happened time and again because although we may have become technologically more advanced we are still, by instinct, herd animals.

That is why there will be another massive property boom… and the inevitable catastrophic crash thereafter - except the crash is years away.

I know it is hard to believe with the large mortgages people require already and the seemingly high prices we already have that prices can increase much further. However, if you had said to anyone buying a house 40 years ago for £30,000 that it would be worth £4m today, they would have laughed at you.

It sounds ridiculous doesn’t it? But actually this equates to an annual return of under 12% per annum. Not quite so mad after all. That is the magic of compounding.

So what else can drive the market higher?

We know that pension funds from the UK and abroad, sovereign wealth funds, private equity and the “Global Rich” are all buying property.

But as is often the case the important facts are not always so obvious. The Budget in July was seen by most commentators as being distinctly negative for London property due to the proposed changes to the non-domicile rules and buy to let investing in addition to the SDLT changes in the December budget. 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 19% and then 18% - 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.

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. Indeed banks, law firms, asset managers and the like are all reporting how difficult it is to recruit the right standard of people and are having to offer higher remuneration packages. This in turn will lead to greater credit generation in time.

Remember house prices have been going up while the amount of mortgage debt has been going down. This is a positive signal although the effect of SDLT increases should not be underestimated at the very top end of the market.

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 (this will ultimately be a disaster).

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 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 c. 7 years’ time.

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.

So is now a good time to buy when we know a big crash will happen?

Well, I have just bought a bigger house to put my money where my mouth is. I expect steady, not massive, growth in the next three years and there is a reasonably high probability of a minor mid-cycle fall in prices in about four years’ time.

However, the likelihood is that we will see 5-6% growth in house prices per annum across the UK for the next few years – this figure will vary massively depending on the area and price range, so you need to understand what will drive prices higher in each area.

Quite simply, I don’t want to miss out on the major gains that are still to come and you don’t want to be kicking yourself because you didn’t act now.

You might be wondering “Should I really go ahead and buy a home or investment in London now or should I wait for a better opportunity?”

Well there are tens of thousands of people around the world sitting on the side lines waiting to see what will happen to the London market because they are worried about all the issues I have mentioned.

Do you remember what I said about us being herd animals? It will be very hard for the property market to crash while there are so many people not in the market. When the side lines are virtually empty, because everybody has dived in, then it will be time to sell.

And I totally understand if you are reluctant to buy now. To be honest I am slightly nervous about my latest acquisition when I look at the stock markets, but actually that is a good sign because when I am overly confident about an investment and following popular opinion, then that is normally when I am making an average, if not poor, decision.

So if you are rueing the fact that you didn’t buy in 2009-2010, do not make the same mistake now as you will find it even harder to buy until the next boom is already well under way. Because then you will decide to buy just as commentators on television start to tell you “it’s different this time” and that house prices will never fall again. By then it will be too late.

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Best regards,

Jeremy McGivern

p.s. Although the stock markets currently look anything but promising don’t be fooled into thinking that this will severely impact the London housing market. History has proven that this is an opportunity.