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Investing Insights May 2017

UK Property: London’s Falling

Ailbhe Tobin 49 x 49 B&W.jpg Ailbhe Tobin
Investment Associate

More evidence is emerging that suggests London’s property market is coming under pressure. A recent article by the Guardian even reported that estate agents are offering cars, iPads and sound systems to entice buyers, which is a worrying signal that London’s property bubble is deflating.

Latest data confirms the market is turning

Anecdotes aside, the latest transactional data also confirms a weakening of the UK property market. House prices in the UK have fallen for two consecutive months in March and April of this year, the first time this has happened in nearly five years. The Royal Institution of Chartered Surveyor’s (RICS) survey is a sentiment survey of chartered surveyors and is regarded as a key indicator of current and future price expectations. In its April report it showed that new buyer enquiries have experienced no growth since November 2016. On a net balance, respondents expect that prices are going to decrease over the near term in London, while they still are slightly positive on price movements in the UK as a whole, as seen in Figure 1.
 

Figure 1: Surveyors expect property prices to fall in London

House price expectations, net balance (Next three months)


Source: Datastream, RICS survey​
 

London market bearing the brunt

Clearly there are a number of challenges facing London property owners. Prices are already sky high in the capital and the uncertainty surrounding Brexit negotiations is putting foreign buyers off buying a residence in the capital. Increased job insecurity, particularly among those working in financial services in the City of London as several banks look to move people overseas, has reduced activity in the property market.
London house prices fell 1.5% during the month of April. To put this into perspective, this is the largest year-on-year decline in almost eight years. In the prime segment of the market things are much worse. According to Savills, prime real estate in London has already fallen by about 13% from the peak in 2014.
That said, the rest of the UK is holding up much better at the moment. However, as formal Brexit negotiations have now begun, it is not known how many other companies may contemplate a move to the continent, taking jobs with them, and we could see pockets of weakness across the country.
 

Skyrocketing house prices in the capital

The property bubble in London has been well documented. A bubble can be characterised by a rapid escalation of prices, not supported by the underlying assets valuation. As Figure 2 shows, there has been an exponential increase in prices in London versus the rest of the country. Some of this can be attributed to the low interest rate environment pushing down mortgage costs, but it does not explain the whole story.  Since the financial crisis (when house prices fell 17%), house prices have risen by close to 40% across the UK but have almost doubled in London. This has pushed the average London house price to £480,000, compared to just over £200,000 for the country as a whole.
 

Figure 2: London has seen rapid price increases since the financial crisis

Average house price for the UK and London


Source: Nationwide​


The net result is that property gains have far outstripped individual’s income and priced many out of the market. As Figure 3 shows, the average price-to-earnings ratio (a measure of affordability) for first-time buyers in London has sky rocketed to historical highs. By the end of 2016, this indicator stood at 10.1 times the average income, which is in stark contrast to the average price-to-earnings ratio of 5.3 times the UK.
 

Figure 3: Affordability for first-time buyers in London has reached extreme levels

First-time buyer price-to-earnings ratio, quarterly change


Source: Nationwide​
 

 

Turning south

Corrections in the UK property market are not a new phenomenon. In the last 30 years the economy has gone through two housing recessions, in 1991 and 2008. How large the correction will be this time we don’t yet know, but the market is beginning to turn south. The Bank of England (BoE) is likely to keep interest rates low to insulate the negative impact of Brexit on the economy, which should limit the damage in the property market. But Brexit has claimed its first casualty. The reality is that some heat needs to be taken out of London property but even if prices fall by 20% this would still leave them looking expensive at eight times average income.

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