The London Housing Crisis

by George Hatjoullis

Reflecting on 2015 and looking forward to 2016 I find myself most concerned with London housing. This may seem odd given what is going on in the world but it is the pressing problem for Londoners. I have two grown up sons living at home because they cannot afford to move out. I am aware through them of the appalling living conditions and exorbitant rents that young people in London must endure. I am aware of the work of housing associations to accommodate vulnerable Londoners and how government cuts will make this work much more difficult. Expect a rise in homelessness especially amongst the most vulnerable. There is a crisis.

London’s population has grown back to previous highs and is still growing. Much of this is through migration. This is not new for London. It is a magnate for people from within the UK and from abroad because it offers jobs. The crisis is, in part, a direct consequence of a successful economy in terms of employment and jobs growth. It is easy to say it is all the fault of immigrants and just stop immigration. This rather begs the question of who will fill these jobs. There is, I am reliably informed, a shortage of bricklayers. How does an immigration control help relieve such a shortage? In any event, as long as we are in the EU such limits are not possible. London house prices may thus suffer if Brexit becomes a high probability.

The crisis does have a foreign component. It is not so much people as capital. Foreign investment has boosted London house prices. It has brought in much price-insensitive cash. There have been reports that much of this cash is laundered money. Such cash is very price-insensitive. Indeed, perversely higher prices attract more cash from such sources. Bubble dynamics by any definition. Legitimate sources have also seen London housing as a safe home for wealth. Following the crisis of 2008, safety has become an important characteristic for the location excess wealth. Finally, there are the speculators. They buy off-plan hoping to flip the investment for a capital gain. These sources have not been buying traditional starter homes but the trickle down has been quite severe. Moreover, much of the building activity has been directed to meeting the needs of the foreign buyer rather than the local. The result is many overpriced flats left empty.

The bubble element of London housing is definitely sourced overseas. It has been helped by the relative strength of sterling. For the bubble to burst foreign investors must liquidate or rather try to liquidate. In a collective liquidation who will buy? Locals want the properties but cannot conceivably pay the present level of asking prices. Prices relative to income are beyond very high and deposit requirements unattainable. So in a liquidation we can safely expect some severe market indigestion and drop in unit prices. They will drop until marginal buyers are found. If the marginal buyers are to be locals, then this will be much lower than prevailing.

During the bubble phase such talk sounds alarmist. It always does until the proverbial hits the fan. Ask British property investors in Spain and Cyprus how a bursting bubble works. They know. It is not a pleasant experience. The question is what will trigger a bubble burst? In Spain and Cyprus it was a banking crisis but this is not a relevant risk factor for London housing. Domestically generated risk factors include Brexit and sterling. The domestic situation of foreign investors is also a risk factor. Oil and commodity prices have collapsed and China is having some domestic adjustment problems. These factors may weigh on foreign investors and force some liquidation. Alternatively it may simply require a conviction that the upside is now limited and profit taking in an illiquid market may do the work.

Is it indeed a bubble? It does have the characteristics of a bubble. Importantly, prices cannot be supported by the local personal buyer. The price to income ratio is too high. Local buy-to-let investors may seem to provide an alternative and more sustainable source of demand. This is however somewhat illusory. The buy-to-let buyers are constrained by rental yields. If prices are too high then yields may be too low. The constraint of the local economy still bites. Moreover, local buy-to-let investors are sensitive to interest rates. If interest rates go up then BTL investors will feel the strain.

The single most likely trigger for a bursting bubble (apart form Brexit) is a rise in mortgage costs. It may a be a long time before this will be achieved through monetary policy. It may need to be effectively engineered through regulation and tax policies. This process is already evident. It may also need some significant shift in unit supply. Once again this may require official action and there are some tentative signs that action will be forthcoming. There are many land pockets that can be used if released. It may also require some relaxation of planning controls especially with respect to height. The London skyline is very well protected. It is a great skyline but Londoners may need to accept that we cannot have everything.

There are tentative signs that price momentum at the higher end of the London market is now slowing. This may be the first signal that some divestment is happening or is about to happen. Once this process begins it can be very and very ugly. We locals can only hope…