My view is that London house prices will continue to fall in real terms within the next 12 months. If the Brexit transition is not as smooth as anticipated, prices could significantly fall in nominal terms.
As a first-time buyer, I continually monitor the housing market in London because this is where I am located. It’s not just a matter of viewing places in the hope of finding a bargain. I am seriously considering a purchase and I have the advantage of having plenty of times to make the big move. As time is on my side and I do not need to sell an existing property to finance the purchase of a new one, I have no reason not to try to find the best deal out there. It might take me an extra-year but I am fine with this.
House prices have outpaced wage growth for many years
Based on data from the Land Registry, the average price of a property in London in January 2009 was £253,093 compared to £482,241 in September 2018. That’s a 90.54% increase in only ten years.
Wages did not grow as fast. According to the ONS, wage growth suffered declines of -2.6% in March 2009 and -0.3% in June 2014.
As a result, affordability has been the number 1 constraint to jump on the property ladder.
Based on data from 2007, the ONS notes that on average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, an increase of 2.4% since 2016.
The situation is worse for households based in the Southeast of England and those purchasing a newly-built property. In 2017, full-time employees in England and Wales could typically expect to spend 9.7 times their median gross annual earnings on purchasing a newly-built property. Housing affordability worsened significantly in London, the South East, and the East.
According to the ONS, in 2017, seven of the 10 least affordable local authorities were in London. All but five London boroughs had significantly worsening affordability since 2012.
Kenginston and Chelsea – one of the priciest boroughs in the country, if not the priciest – was the least affordable local authority in 2017. Median house prices were 40.7 times the median workplace-based annual earnings. To put some hard numbers on this, the median house price was £1.3 million for a median gross annual salary of £31,950. To explain such a massive gap, it is likely that many homeowners in Kensington and Chelsea work in other areas where earnings are higher, and that those people have additional income that does not count as “workplace-based annual earnings.” Work-place based annual earnings would not typically capture capital gains, dividends and rental income.
The London housing market is slowing
According to the website Rightmove, house prices fell by more than £5,000 on average in November. The slide was even worse for the county’s wealthiest boroughs. House prices in inner London are down 2.5% year on year. Bexley and Bromley are the exceptions as they are up by 2.8% and 2.1% respectively.
Note that Rightmove’s price figures may differ from the prices recorded in the Halifax and Nationwide indices as they reflect asking prices instead of mortgage data from lenders or sold prices from the Land Registry.
Nonetheless, the data point in the same direction: the London housing boom is over. According to the upmarket bam Coutts, price central London remains “in limbo” with prices down 14.7% from their peak in 2014. Transaction activity has also fallen about a third.
It, therefore, appears that London property prices are decreasing at least for now. It remains to be seen if the trend can last. I think it will.
So why is the London market slowing?
There are a couple of reasons why house prices are no longer increasing.
The affordability issue: people just don’t earn enough to pay that much money for a house.
As mentioned above, house prices skyrocketed over the past few years while salaries overall stagnated. For civil servants, salaries actually decreased due to a freeze on salary increases due to austerity and an attempt from the Government to balance the books.
As a reminder, public sector pay was frozen for two years in 2010 (except for those earning less than £21,000 a year) and rises have been capped at 1% since 2013. A few months ago, the government announced that pay rises would be implemented but those still hover around 1% (police) – 1.7% (prison officers) only depending on the sector.
According to the ONS, the Consumer Prices Index (including owner occupiers’ housing costs) 12-month inflation rate was 2.2% in October 2018, unchanged from September 2018. The Consumer Prices Index 12-month rate was 2.4% in October 2018, unchanged from September 2018.
Therefore, even if we take into account the recent pay bumps, the public sector workers have seen their salaries decrease in real terms as the inflation rate exceeds their pay increase. As stated by the ONS, “because of the restrictions on pay, inflation has generally outpaced public sector pay growth since 2011, meaning that public sector workers have grown poorer in real terms over the last six years.”
Private sector workers are slightly better off but not by much. While pay in the public sector has risen by an average of 1.1% per year since April 2011, private sector pay rose by 2.1%, which is only slightly higher than inflation, which stood at 1.9% over the period. Therefore, private sector workers have seen their pay slightly increase in real terms but the increase has fallen well behind the tremendous growth of property prices.
The composition of public sector jobs has also changed over time with differences over wage growth amongst public sector workers. For instance, the earnings gap between education and other public sector areas has grown over time. While some public sector workers might be slightly better off than others due to their field, the outcome does not change: property prices skyrocketed while wages stagnated in a best-case scenario.
For existing landlords and potential buyers, affordability is the number one issue. Unless wages dramatically increase, we won’t see sustained demand for the extremely expensive luxury properties that have been the focus of homebuilders in the past few years.
The buy-to-let issue: the Government murdered the buy-to-let market
The Government clearly stated that it intends to get people on the property ladder. This means putting in place incentives for first-time buyers while penalizing landlords who own multiple properties and intend to remain active in the market.
I wrote an article on this exact topic not so long ago. You can find the full blog post here.
A toxic combination of higher stamp duty for additional properties, curtailed tax relief on buy-to-let mortgage costs, tougher lending criteria and increased regulation have dampened demand for buy-to-let properties across the country but especially in London.
While rent increased quite a bit these past few years, the increases did not match the surge in property prices. Rent is the main source of income for a landlord. Therefore, the annual rent divided by the purchase price will give a rough idea of the expected returns – or rental yield – of the property.
According to the ONS, London private rental prices fell by 0.2% in the 12 months to October 2018; unchanged from the 12 months to September 2018.
All things being equal, reduced annual income will amount to a lower yield if the property price remains the same. The worst combination for a landlord is to see property prices falling (after purchasing the property) and rents falling at a faster pace than the fall in property prices.
The arbitrage issue: properties located in the north of the country have more potential
Properties in the north of England are currently more reasonably priced but also are more likely to appreciate faster than London properties in the future.
The first proposition is a bit of a no-brainer: you can barely buy a studio for £500,000 in Westminster while you evenly purchase a five-bedroom townhouse for the same price in Manchester.
Of course, London is more attractive because the jobs pay better and foreign investors, including ultra-rich individuals from Russia and the Middle-East, prop up prices. While still dynamic and economically consequential, more regional hubs such as Birmingham and Manchester sill lack those drivers.
I also personally believe that there has been a concentration of talent towards capitals and big cities. Young graduates flocked in masses to London but also New York, San Francisco, Paris or Berlin. They also drove up prices in their search for better professional opportunities while leaving suburbs behind them.
Prices in the North have barely recovered from the financial crisis. Investors focused on investing in cities and completely ignored properties in more remote areas.
According to the ONS, the North East is the only region in which house prices are yet to surpass their 2008 peak. Flats in this region lost 20% of their value between 2007 and 2013. As a result, house prices in the North East are amongst the most affordable in the country. The price to earnings ratio in the North East is 5.2 compared with 7.9 for the rest of England.
I’m not saying that Manchester necessarily falls in that category. I used Manchester to have a regional city with strong business dynamics so that the comparison to London would be realistic.
Therefore, in both nominal and real terms, those properties are very reasonably priced compared to London properties.
But this is changing. Investors have noticed that London is overpriced and are going north to seek reasonably priced properties ready to go at a bargain. This is partly why property prices are increasing in the North while London prices continue to trend downwards.
The Brexit issue: EU citizens are no longer flooding London
Before the referendum on whether the UK should leave the EU, the number of EU citizens arriving in the UK was massive.
Today, the state of play is very different. The Financial Times reported that net migration from the EU to the UK in the year to March fell to its lowest level since 2012 thanks to a significant decline in western European arrivals and a small outflow of people from eastern European countries such as Poland.
Net EU arrivals have more than halved compared with the peak of 189,000 net arrivals for the year to the end of June 2016.
The decline in EU arrivals is partially offset by non-EU arrivals. Presumably, employers now have to look for talent further as EU citizens deem the UK to be a less attractive destination.
To be clear, the fall in EU nationals does translate to a fall in the number of EU nationals in employment in the UK. The EU nationals leaving are not students but people working in the UK, paying taxes and national insurance contributions. According to the ONS, from there were 2.28 million EU nationals working in the UK, 86,000 fewer than a year earlier. This is the largest annual fall since comparable records began in 1997.
Both skilled and low-skilled EU workers contributed to some extent to the surge in prices in London, which tends to be their primary destination. Skilled workers took jobs in finance, consulting and law in the City of London. Those workers can command high salaries and therefore are able to either purchase properties or rent larger properties than other workers.
On the other hand, low-skilled workers still had to find accommodation in London and its outskirts, which presumably also contributed to increased demand for housing, although probably at the lower end of the scale.
In the end, the math is clear. Given that the supply of homes does not decrease (we don’t really knock down buildings, and when we do, it’s to rebuild them), fewer people arriving in London means less demand for the same supply. If jobs are actually relocated in the EU due to EU regulatory requirements, the outflow of highly-paid EU workers would have a detrimental impact on London property prices.
The effect is not just on property prices. This also means fewer people buying their morning coffee at £3.50 in the City, which therefore has an impact for local businesses and retailers.
The quality issue: the quality of newly built properties in the UK is crap
There are multiple reports – or horror stories – about the quality of newly-built properties in Britain. According to the housing charity Shelter, over half (51%) of new homeowners have experienced major problems with their properties, including issues with construction, faults with utilities and even unfinished fittings.
Some homebuilders like Bovis Homes have seen their reputation torn to shreds and had to issue profit warnings given the mounting costs of repair.
Property prices dramatically increased and homebuilders had no issue reflecting such increases in their final prices. Worse, final prices sometimes even reflected price increases of the next two years based on optimistic forecasts.
Inflation cost is probably an issue, especially since the referendum as the pound plummeted and therefore the value of imports and materials increased. Still, given the magnitude of the defects, this can hardly be the only explanation.
Unless the quality of newly-built properties suddenly improves, I suspect that many buyers will ask for a further discount on the sale price to account for potential extra repair costs. Nobody wants to pay a property at a “fair price” if you have to invest a further 10% of the price of the property in repairs and refurbishments.
As a result, poor build quality could push prices lower.
The loan issue: interest rates are expected to increase over the next year
The latest decision of the Bank of England’s rate-setting committee unanimously voted to keep the base rate at 0.75%. On the assumption that there will be a smooth Brexit, market participants and the monetary policy committee indicated that they expected rates to rise gradually from their current level to keep inflation in check, close to its 2% target.
Even in the event of a disorderly Brexit, the governor of the Bank of England, Mark Carney, noted that he would not necessarily cut rates to support the economy. For one, the pound is expected to drop if there is no negotiated deal with the EU. A drop in the value of the pound would push up the cost of imported goods. It turns out that this impacts the vast majority of goods. Consumers would be the ones to foot the bill as it is often the case.
Other factors such as the demand for goods and services and the supply-side potential of the economy would also have to be taken into account.
Therefore, the base rate is only likely to move in one direction, and that’s up. Higher borrowing costs mean that financing a property is more expensive, even if the property costs the same price. Historically speaking, higher borrowing costs tend to push property prices downwards because whatever extra money that was supposed to go towards the purchase price is now re-allocated to borrowing costs.
Conclusion
There are definitely strong factors that will push down the prices of London properties in the short term, especially after taking into account inflation and looking at prices in real terms.
Some of the issues such as affordability and Brexit are here to stay. It will take a few years for wages to pick up meaningfully while the relationship with the EU is far from settled as we go from one transition period to another.
Loosening lending criteria would provide a temporary boost. At what cost though? We walked down that road in the past and we saw how it ended in 2008.
So does that mean everyone should stay away from buying property in London? Not necessarily.
First-time buyers working in London and who do not intend to relocate elsewhere within the next 7 to 10 years may go ahead, but only after a Brexit deal has been secured with the EU. If there is no deal, there might be a bit of panic-selling and then it would be a good time to buy the dip.
This is the only category of people who should buy. Although rents are relatively cheap compared to property prices, they will save significant amounts of rents over a seven-year period, in addition to building capital through mortgage repayments.
I’ve heard that foreign buyers would buy more properties because the pound is low. Therefore, property prices are cheaper for them. This is especially true for people with earnings in U.S. dollars.
The issue is that most foreigners interested in London have already bought property. They are also sophisticated buyers and are fully aware of the state of the buy-to-let market and worsening rental returns. If this wasn’t the case, why have foreign buyers failed so far to step in and scoop up properties at a bargain? Because given current valuations and the dim outlook of the market, it’s not a really a bargain at all.
Leave a Reply Cancel reply