This could be the pin that bursts the London property bubble

The eventual crash will be brutal

London property is in a bubble.

Prices are now well above their pre-crisis peaks. They are also at their highest level, compared to the earnings of first-time buyers, since records began.

Yet people are not just willing, but queuing up, to pay these inflated values.

There are some good reasons for that. Low interest rates have driven down the price of mortgages. Taxpayer guarantees through the Help to Buy scheme encourage more lending. Overseas investors see London as a safe haven. And there is a genuine shortage of property – though developments are now springing up thick and fast.

But there’s also an element of blind panic. First-time buyers are seeing their chances of ever mounting the property ladder fade. So they are snapping up any house or flat, irrespective of whether they can really afford it. I’d also guess that many people who didn’t buy last year are kicking themselves.

However, there is a big change coming that could upset everything – and it kicks in from tomorrow…

It’s going to be a lot trickier to get a mortgage

In 2009 Britain’s financial watchdog (now the Financial Conduct Authority) concluded in a discussion paper that the mortgage market needed reform. It eventually published new rules – the Mortgage Market Review (MMR) – in 2012. These rules come into effect from tomorrow.

The big change is that lenders will have to make absolutely sure that a borrower can afford the loan. Details of what exactly counts as ‘affordability’ are deliberately vague. But the regulator has given guidance, which involves looking at spending patterns and sources of income.

There is also an obligation to ‘stress test’ the loan. In other words, the borrower will need to be able to afford payments even if interest rates rise. The upshot is that most people will find getting a mortgage trickier.


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Unsurprisingly, lenders have been up in arms. Given their role in the financial crisis, you probably think they’ve got a cheek to complain, and you’d probably be right.

That said, the vague scope of the rules could lead to a legal nightmare. It’s easy to imagine a scenario where banks are sued by homebuyers for allowing them to take out more than they can afford.

The government could also use it as an excuse to renege on Help-to-Buy promises in the event of a crash. After all, US banks (rightly so) ended up having to repay insurance payouts from Fannie and Freddie on loans with shoddy lending standards.

In any case, it seems that lenders are taking the MMR very seriously indeed. There have been reports of banks telling their staff to refuse loans if the borrower has the occasional flutter on the horses, or is a member of a wine club.

Some are asking for detailed banking statements over a much longer period than the usual three months. People will also be required to make predictions about the future. For instance, Barclays has said that it will require disclosure of details of future renovations. Those who lie about future spending could face having their loans revoked, or the interest rates changed.

When the crash comes, it will be brutal

Anecdotal evidence suggests that a handful of banks have already started applying the rules. The latest figures from the Bank of England suggest that the MMR could already be starting to have an effect.

After rising for 11 straight months, the amount of mortgage lending (for house purchases) fell by over 8% to £70.3bn in February. This is the lowest figure since October. Meanwhile, remortgaging activity fell by 14% in March, according to the Council of Mortgage Lenders.

At some point this bubble has to end. More houses are being built, reducing any physical shortage that actually exists. The Bank of England may or may not raise interest rates soon, but already fixed-term mortgage rates are rising.

There have been hints that the most toxic part of the Help-to-Buy scheme could be wound up after the election, whoever wins. Above all, old-fashioned reversion to the mean (prices returning to more normal levels) will also play a part.

My guess is that the government would be happy to keep the bubble going until election day. It could then let the market deflate. However, if the MMR means that banks really dial back mortgage lending, it could end up happen even sooner than George Osborne hopes.

When it does take place, the crash could be brutal. To go back to the average price/earnings ratio over the last decade, Greater London prices would have to fall by around 18%. If it went back to the average since records began, they would fall by nearly 40%.

Of course, with more and more people expressing irritation with the property-centric nature of our economy, perhaps a slump wouldn’t be quite the vote loser it once was. But I suspect Osborne isn’t keen to test that hypothesis out.

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22 Responses

  1. 25/04/2014, JohnnyC wrote

    The first question: does the author own a property? Probably not as it seems that you are trying to find any possible reason to convince yourself that house prices will fall.
    What’s the big deal if mortgage lending fell by 8% in one month. You should be qualified enough to know that a one month drop is not a trend. Compared to last February the lending level is up by 34%!!!
    I’ve been listening to Moneyweek banging on for over a decade that the property market will crash but all we’ve had is a soft landing and very few repos.
    Given the level of money printing over the past six years and the fall in purchasing power of the pound there is nothing to worry about until interest rates rise above inflation. When was the last time that happened? And it would need to be a significant rise over an extended period to concern me.
    The only group in the property market that is struggling is the first time buyers group and the best way to tackle that problem is to find a nice way to encourage older people to sell their big homes. Also, abolish Stamp Duty or significantly raise the exempt threshold level above the average property price in London.

    • 29/04/2014, tuesday wrote

      Exactly.

      “I’d also guess that many people who didn’t buy last year are kicking themselves.”
      You mean the Money Week readers who took your advice last year or for the previous six?!

      I’m sure you are desperate to buy somewhere and I sympathise but it is tragic to continually try to talk a crash int happening. It may do – but you have absolutely no idea when – although no doubt MW will claim it predicted it when it does – like it predicted the end of the Euro, the end of the Pound, the end of Greece, Spain, Portugal, the end of Britain and everything else – apart from the fall in gold!

    • 10/05/2014, NeutronWarp9 wrote

      ”Vesuvius has never blown in my lifetime and it never will”. Titus, 23rd August, AD 79.
      We can see the smoke, we can feel the earth tremors, we can smell the foul sulphurous air, but house prices won’t crash for one obvious reason. We don’t want them to! Will we ever learn?

    • 17/06/2014, Tin wrote

      This “you’re just jealous” retort is attempting to counter a sensible argument with a simple ad-hominem attack.

      Can we move on and start thinking about when prices will fall, how fast they are likely to fall and what the government can do keep them propped up so that the whole economy doesn’t fold in half.

  2. 25/04/2014, Arkiruthis wrote

    “The big change is that lenders will have to make absolutely sure that a borrower can afford the loan.”

    But we know how this will play out in practice. Market forces in play, people want mortgages, brokers want to sell mortgages… so the ‘rules’ will be bent out of shape in order to please both parties. The more the world changes, the more it stays the same.

  3. 25/04/2014, AdamM wrote

    I see the imposition of capital gains tax for non-UK Residents in April 2015 being a bigger threat to bursting the London property bubble than the MMR.

    • 29/04/2014, Lupulco wrote

      I can see the imposition of capitol gains tax on property for all property owners UK resident or not.
      Plus sooner or later we shall have to find a replacement for Council Tax, and/or revaluation of housing values to sort out imbalances
      Bog standard house built 20 years ago in the same area as another bog standard identical built today can be 2 or 3 Council Bands higher.
      If nothing is done in years to come we shall have new town houses at the top of Council Tax bands whilst 4/5 bedroom detached homes built 20-25 years earlier in a lower band?

  4. 25/04/2014, mr clyde wrote

    A simple way to incentivise Lenders to lend sensibly would be to, as is done in the US, limit the borrower liability to the value of the property i.e. abolish negative equity. The American system only blew up when the mortgages were sold on and used as collateral elsewhere.

    • 29/04/2014, Lupulco wrote

      Mr Clyde, spot on. Unlike the US the UK Lender can pursue the Mortgagee even when the property is sold al less then the value of the mortgage. They sue for the difference.
      If the lender had to pay Council Tax on property, or property tax, until the property was sold. Plus once the lender as gained possession of the mortgaged property it would make them extremely wary of both overvaluation of property values, as well as self-certified loans of 6-7 time the supposed salary.

  5. 25/04/2014, Quant wrote

    Has anyone done the analysis of the returns that would have been achieved by investing in London property (with modest 50% leverage say) from the time since Moneyweek first started predicting that the bursting bubble was imminent vs. investing in a basket of Moneyweek investment tips?

    ….I have a strong feeling the london property investment would have hugely outperformed. I think Moneyweek needs to stop doom-mongering and just focus on where they think people should put their money as opposed to a massive amount of articles warning of the london property doomsday apocalypse which have done no credit to the magazine so far as they are all so one sided.

  6. 25/04/2014, Sage of Aldershot wrote

    I found the article interesting because I heard about the MMR for the first time this morning and was wondering what it was all about. Thank you Matt. Let the moaners find the perfect tipster to make their decisions for them.
    However, that said, I do agree about the repeated and unoriginal doom mongering by Moneyweek, notably “The end of Britain”. It would be good to see MW’s response to http://anotherangryvoice.blogspot.co.uk/2013/01/moneyweek-and-their-end-of-britain.html which seems to take the MW argument apart pretty effectively.

  7. 25/04/2014, Alec wrote

    MMR is a bit late in the day, had it been implemented 10 years ago we wouldn’t be in the financial mess we’re in today with a rigged property market and artificial interest rates and , of course, negative equity.

  8. 25/04/2014, MikeOS wrote

    For those referring to the ‘End of Britain’ MW article, although there is an element of truth in it, it was for the most part a marketing campaign to sell the magazine.

  9. 25/04/2014, Ellen12 wrote

    London property has become a betting table and people are piling in, on the back of rising prices and government sweeteners, assuming prices can only go in one direction. It looks like a combination of panic and greed and we could easily be at the ‘delusion’ point in the bubble cycle. I wouldn’t want to call it as politicians appear to be hell bent on forcing people into defining their life’s work as a three bedroom suburban semi! I expect when the government have finished enabling the banks socialise their losses onto the general population we will see the downturn. But it’s not what could be described as the dynamics of a free market economy.

  10. 26/04/2014, Robharris wrote

    Surely the issue is a lack of supply of houses both inside London and across the country generally, not the supply of mortgages (driven by help to buy). Much of this is down our bureaucratic planning laws. Instead of priming prices and builders margins by subsidising lending on inflated prices (lots of lovely stamp duty to cover the costs), politicians should be freeing up land for housing and encouraging developers to build – how about a tax on un-used land as well as simplified planning laws?

    When banks generally look for a 25% deposit they have a fairly substantial cushion against losses on a default as well as a future claim on any defaulter. They do not need these new regulations to ensure their loan security but they have been led to believe a borrower could sue them for giving a loan that was not stress-tested when the borrower defaults. Utter madness!

    Clearly this is yet another classic example of the State run by people who have never had a job in the real world and cannot help making matters worse just for the headlines they can harvest today.

  11. 28/04/2014, CaptainPeacock wrote

    RE: the crash could be brutal.

    Yes…yes Matthew young man, history will REPEAT …simply to show these moronic sheeple that property prices DO NOT just go north forever!

    RE: fall by nearly 40%.

    Think about this folks, when property prices start falling …what are the Muppet’s in power going to do this time…?

    …well they CAN’T lower interest rates as they did in 2008 ROBBING the careful savers…

    Folks get ready for the ULTIMATE meltdown! The 1990′s price falls will look like a picnic…to whats coming.

  12. 28/04/2014, CityFarmer wrote

    Captain Peacock, if it helps you to understand why property over the long run always rises, whilst savers are always robbed, think of it in terms of the value of money as consistently falling.

    As for history repeating itself yes it probably will, London will slow down, the current boom will for several years spread out across the UK, rates will gradaully rise, then they’ll be another recession a mild price drop in property prices ( at which point you and MW will get very excited and declare the end of the world as we know it ) before prices stabilise then head back up again higher than ever. Meanwhile you, (although notably not the MW Editor it seems or I bet the author of this article) will have missed out on the chance to use any short term fall in prices to get into the market.

  13. 28/04/2014, Ellen12 wrote

    City Farmer – Before getting too complacent about UK property, I would like to remind you of a few things.
    - ZIRP has been fully priced into asset prices, especially housing, and ZIRP was put in place to bail out bankers, not mortgage holders.
    - Regardless of how our ‘recovery’ is dressed up, the UK national debt stands at £1.2 trillion, a 50% increase since the Conservatives come to power. This figure does not include unfunded liabilities such as pensions.
    - UK household debt has doubled in less than 10 years and many households are living paycheque to paycheque, despite the dramatic increase in duel income households.
    - It is estimated that in excess of a million people in the UK have visited a foodbank because they were hungry in the last year.

    I am not saying that house prices could not climb further but you would be wise to recognise that house prices are being rigged to fulfil a purpose to suit the banks and George Osborne and, if or when their strategy is exposed as manipulation against the citizen, we, and they, already know that the instigators are ‘Too big to prosecute’. So, if anyone else finds themselves over leveraged when this happen, there will be no bailout for them.

  14. 06/05/2014, CaptainPeacock wrote

    @CityFarmer

    Firstly you do NOT know me so DON’T assume..!

    RE: “the current boom will for several years spread out across the UK”

    Really? What planet are you on?

    A decent semi in the S-E is now close to 300K an absolutely CRAZY Valuation.

    Wages have NOT increased for 10 years…

    Right now this BOOM is being driven by FEAR of missing out!

    Why? It has the same theme from years ago, sound familiar…

    In late 1987 I was a 23 year old persuaded to buy a house cos if you DON’T do it NOW… you will NEVER be able to afford one…

    This advice was given by so called experts (some in their mid 50′s) at work who said property NEVER EVER goes DOWN.

    18 months later house prices collapsed, with news on TV how much they were going down every week.

    [for the next several years you have NO idea of the struggles we went through to keep up payments & put up with negative-equity ect. If ONLY I did my own research instead of listening to pri*ks]

    ’Prices are set by supply and demand and right now demand outstrips supply.’

    WRONG!

    These MUPPET’S in government will do everything in their power to keep property prices inflated.

    Do you think we would have these HIGH prices if there was NO government interference, i.e QE, low interest rates?

    It all seems SO so, rosy & dandy at the moment until the PARTY ends…Remember UK in 1990, Dubai in 2007,Spain, Ireland, Japan went down for years and years… even with ZERO interest rates! etc.,etc.,etc.

    WAKE UP AND SMELL THE COFFEE!

    @Ellen12

    “house prices are being rigged to fulfill a purpose to suit the banks and George Osborne”

    CORRECT.

    Ellen12 — EXCELLENT post from YOU as ever!

    • 10/05/2014, Keith Thomas wrote

      From my memory.
      In 1987 property had been booming under Thatcher/Lawson. At that time it was possible for multiple buyers to club together to buy a single property and each be able to claim 30k mortgage tax relief (The average house price was probably 20/30k). Earlier that year the government announced that tax relief was to be limited to one buyer per property. This caused a panic buying in order to beat the announced deadline. Those who were planning to buy in the next couple of years brought their purchases forward. The crash that started more or less immediately after the deadline, was preceded by an Economist magazine front cover “Don’t Buy A House”, and a catalyst could have been the stock market crash of October 27 1987.

      Is this similar to what’s happening now? Panic buying while H2B is still up for grabs, or Is it different this time? Except for the foreign buying phenomenon in London, when H2B is withdrawn, and interest rates rise, where will the new money come from to keep the property market afloat?

      I don’t think the government can afford to allow a crash before the election, and if looks like happening they will ride to the rescue with more taxpayer money. Perhaps we could get something like an STFGF. Stress Test Failure Guarantee Fund.

      Keith Thomas.
      Singapore

  15. 12/05/2014, CityFarmer wrote

    @CaptainPeacock, one simple question, I’m sure you can manage to give a simple answer to, so this house you were duped into buying in 1987, that apparently collapsed in value…….how much is it worth today? I’m sure you can find out via Land Registry.

  16. 21/05/2014, CaptainPeacock wrote

    @CityFarmer

    of course the house is worth more than in 1987.

    my argument is about the sheeple who think houses go up forever or that prices are set by supply, which is total BS.

    we have these HIGH prices because of government interference, i.e QE, AND MEGA low interest rates – END OFF.

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