London house prices are heading for a 20% fall

London houses © Getty Images
London house prices could be about to get hammered.

Deutsche Bank has issued a really interesting (and very chunky) report on the state of the UK’s property market – and London in particular.

Deutsche warns that the London prices could be about to get hammered. And it’s got nothing to do with voting “in” or “out” at the EU referendum. Instead, it’s all about the recent changes to the tax rules surrounding buy-to-let.

So what’s the story?

Chancellor George Osborne has introduced two major tax changes that make buy-to-let far less attractive. There’s the stamp duty surcharge on second homes – that makes it much more expensive to buy a second (or third, or fourth) property to rent out.

And from 2017-2021, tax relief on mortgage interest is being slashed for landlords. So where you could once write off interest charges on a mortgage as a business cost, the relief is far, far less generous.

You can see already that these two factors must logically make buy-to-let less attractive. All else being equal, a landlord’s costs have been driven higher, and there’s no guarantee that rents can be pushed up to compensate (at any given time, rents should be roughly what the market can bear, rather than what the landlord would like the price to be).

Then you have to throw in the fact that rental yields have been driven down to meagre levels. This is not unique to the property market – it’s just another symptom of the frantic hunt for yield that central banks have sparked by keeping interest rates as low as they are.

But, says Deutsche, it does mean that it’s almost impossible for a new buyer to make a profit when you take the new rules into account.

Let’s say the gross rental yield is 3.5%. “A purchaser on an interest-only mortgage faces a net cash yield of 0%-0.5%… this reminds us of the 2006-2007 lending boom where net yields turned negative.”

In other words, unless you believe that property prices will keep soaring (which, let’s not forget, drives rental yields even lower), then you can’t make money off buy-to-let. Essentially, you’re betting on a bubble continuing, rather than making a sensible investment.

As Deutsche puts it: “If the running cash yield on a buy-to-let investment is negative, reliance on expected capital growth can only make the asset class more vulnerable to shocks”.

Landlords are a big source of demand in the London market

So what sort of impact might this have? Firstly, the number of buy-to-let purchases will fall. Even if a landlord is sufficiently green around the gills to think that buying a zero-cashflow property is a good idea, the bank that has to decide whether or not to lend them the money might not agree. So between tighter mortgage rules and less attractive returns, expect deals to fall.

Secondly, the new tax laws will force some landlords to sell up, as massively increased tax bills destroy the economic rationale for owning – “the earnings power of the underlying buy-to-let asset in London no longer supports the repayment of a mortgage in many cases”.

Does this matter? Well actually it does. Deutsche points out that the property market has been particularly illiquid since the days of the crash – “only 3.5% of stock turns over” per year.

Of that, homes bought with buy-to-let mortgages “represent as much as one third of London transactions”. So let’s say that source of demand dries up. You then have a group of squeezed landlords suddenly keen to get rid of their property millstones too. So supply goes up at that end.

So you have a situation where, in a section of the market that accounts for a significant chunk of all annual transactions, the number of buyers is falling and the number of sellers is going up. As a result, “buy-to-let potentially swings from a low turn segment to a material source of supply”.

This could “create a major shock to the market due to a significant decline in London buy-to-let demand, some selling… and incrementally more housing supply”.

To cut a long story short, while Deutsche Bank believes that the fundamentals of London property are good in the long run – global city, wealthy inhabitants, rising population, yada yada, you know the drill – right now, it’s ridiculously unaffordable, and due a big correction.

“If prices return to around 2012/13 affordability levels this would imply about 20% pricing downside.”

Now, we’ve heard predictions for lower property prices many times in the past, but this argument doesn’t depend on any change in interest rates. Indeed, Deutsche Bank notes that rising rates would make any fall in prices a lot bigger – a one percentage point rise in rates would correspond to another 10% drop in property prices, roughly.

Nor does it take account of the potential for rent control in London, as suggested by Sadiq Khan, the new mayor.

Instead, it’s all predicated on tax laws that are already in place. And it’s just a matter of time until landlords wake up to the implications and start to sell out.

This is good news for first-time buyers of course. Indeed, that was the point of Osborne’s changes. Will it have a knock-on effect elsewhere in the country?

As I wrote in a recent issue of MoneyWeek, house prices elsewhere in the UK are expensive by historic standards. But London is staggeringly so. So maybe the impact won’t be quite as great.

There again, once landlords generally get the sense that their asset class of choice is not such a great business plan – well, who knows how the sentiment will affect things?

Markets tend to overshoot both on the way up and on the way down. A muted or crashing London market certainly will make most people think twice before embarking on a career as an amateur landlord – even in Hull (the latest hotspot according to various bits of PR fluff I keep getting sent).

  • Stephen

    I like the way you say: “Now, we’ve heard predictions for lower property prices many times in the past..”! You mean from Money Week right?! Countless ones in fact – since 2008. For readers taking your advice back then, even a reversion to 2012 prices would have lost them 4 yeas of capital growth.

    You may be right – this time, next time, next year, one day for sure, but timing is everything as we know, and based on your track record, you can’t time this one. You are not alone in that but at least own up. Why should readers heed you this time? Sigh.

  • quark

    I am fed up with Money Weeks’ property articles. Stating the obvious – although note Stephens comments – isn’t very analytical is it? I get Money Week for company and share analysis/market strategy, not for property articles which keep banging away at the ‘bleeding obvious’. Property is a long term investment and those who bought for buy to let in the Spring on borrowed money are just greater fools. I trust you do not believe that your readers are too. So please stop this obsession with the property market. It’s getting really, really boring and pointless. I suppose it’s just Money Week journalists wallowing in their obvious depressive tendencies. Get some anti-depressants from your Doctor (and that includes Tim Price while we’re at it) and concentrate on the real issues. Like the effect on the banking industry and consumers, of plunging property prices. Now that is an analysis that would be of value.

    • Muhammad Rafiq

      my friend this is the policy of MONEY WEEK to attract the innocent customer by this way.

  • Julian

    Prime Central London is already in a slump and large correction, most properties on the market now the sellers will snap your hand off for a discounted deal.

    The trouble is stamp duty has risen 100% since end of 2014 along with capital gains tax for foreigner buyers, it’s no longer that attractive for foreign buyers to park money in London and sit back and wait for big returns.

    The party is over and there is a massive over-supply shock coming up, there are thousands of luxury apartments for sale and thousands more under construction and developers are starting to wonder how they will shift them!

    In simple terms Central London is vastly over-valued and a 40%+ correction is required in order to tempt new overseas money in again. This could take 2/3 years of falling prices to mop up the over supply.

    • A_Londoner

      Yes, demand from buy-to-letters will decrease but population growth has and is going to exceed the growth in new homes. Only buy-to-letters with high gearing will be forced to sell, but these numbers won’t be higher than population growth. So I can’t see any shock coming from the extra tax measures (existing buy-to-letters who are not over-geared will hold onto their stock and ease in extra increases). The shock will only happen if rates start climbing quickly, affecting all mortgaged properties (even fixed as their initial fixed terms end).

      • LR

        They will also come from affordability at the rent level. The government will have no choice but to further kerb and freeze housing benefit, which will put pressure on rent levels which are intrinsically linked to asset prices.
        It’s hard to believe that the London property market is anything other than a massive tulip bubble. It won’t burst simply overnight and Moneyweek will continue to struggle to predict timing, but like night following day — it will happen.

    • Stephen

      I can possibly answer some of that having recently been in a meeting with the developer for the Vauxhall Exchange site (as a local resident).

      The 25 storey block of 1 and 2 bed flats they are proposing will be sold in its entirety to one owner – probably an institutional investor. The entire block will be managed and rented with no individual owners.

      Apparently some of the Nine Elms developments have already been sold this way. It isn’t politically popular but the developer minimises their exposure and legal work (in return for a substantial discount). The new Buy to Let rules don’t apply to these quantities and the theory is that stability is introduced as this kind of owner can weather short term storms and down turns in a way that small- time investors can’t.

      But whether that works out or not, I am still not sure why Money Week is continually pushing a property crash!

  • silondon

    Ms Somerset Webb et al have been telling us HPs are crashworthy for simply ever. I suppose if you have a mantra you have to stick with it but I’m not sure it assists in their credibility when they consistently call it wrong. What amazed me was MSW’s purchase of a flat in London earlier this year (when renting was the option – in a market supposedly about to correct). This underlined for me London’s draw and position as global city primo. For prime London and those fringe areas where rises have been extraordinary, 20% would be acceptable on the basis this possibly represents just a couple of years growth. Given the investment for BTls and home owners, the returns long-term are probably very healthy.

  • Robin De Villiers

    I’d like to take this opportunity to thank MoneyWeek for again being the voice of reason in the Property Debate in the UK.

    The only reason you guys have been wrong on this issue for so long is because, and I’m being blunt here, the guys changed the rule book.

    And I wish the rest of these commentators would keep that in mind when they mutter their disparaging remarks. You guys need some perspective. They changed the rules. That statement should be in bold face. They printed money. They did things no-one would have predicted.

    I’ve been waiting ten years to buy a house. 2005 houses were overpriced compared to their long run average. The single biggest investment I will probably ever make, a decision that will enslave me with a mortgage for the majority of my working life, a house, and I’m forced to buy one in this insane market? I’m supposed to suspend all reason, reason I would equally apply to equities or bonds or any other investment.

    Hey, I’m one of the lucky ones, I can take out a mortgage for an overpriced rabbit hutch. Many families cannot. This is a socio-economic disaster for London and the UK. Just wait, there will be many tears. We will be lucky if there is no blood in the streets.

    The reason all the foreigners are dumping their cash here, is because British society is stable. That’s largely down to the British Temperament. We believe in law and a society that is fair. When the younger generation finally get around to concluding that our society is not fair, the British Temperament will be no more.

    • Dan C

      You are spot on Robin with your comment about others’ disparaging remarks. A housing crash was only prevented because the magician, having run out of rabbits, pulled a couple of giant deformed elephants out of his hat to keep the show running.

      Loose monetary policy and bizarre government incentives have conspired to inflate house prices to ridiculous levels.

      Problem is, ultimately this trend has been going on in one form or another for decades. Rates have been falling for the last 40 years, Japan has had zero rates for a quarter of a century. QE has been around for a century, and currency debasement has been around since there has been currency.

      Asset prices across the world are now past the point of no return. They cannot be allowed to fall to levels based on historic fundamentals, as this would destroy the whole system. So the show will be kept going as long as possible.

      Kids these days don’t realise that a single median salary could buy a decent house (not a flat) in most of the country (including London) 50 years ago. But it’s easier to pull the wool over their eyes and rip them off than it is to enforce financial reality – imagine what would happen if a third of homeowners were in default on their mortgage! Better to rip off the young.

      They will ALWAYS devalue the currency through low/negative rates or printing more, because that is the easier thing to do.

      Given this, I think of currency rather like a valuable but rapidly degrading radioactive isotope – use it or lose it. The Pound’s half-life is currently about 20 years I believe. That’s according to the official figures, so in reality it is probably half that or less.

      £1 has the same buying power as 8 pence in 1971….

      • GSL

        Like Robin I have been watching this mess for over a decade now. Ten years back it was mass speculation by retail banks – the same banks that went on to fail and loose 97% of their value (requiring mass bailouts and/or ownership).

        Then we had the intervention by central banks and politicians to prop the whole thing up with QE and ZIPR and the taxpayer interventions (HtB). Prices could only go on way.

        Regarding your statement that ‘Asset prices across the world are now past the point of no return’ isn’t that simply another version of ‘it’s different this time’

      • Muhammad Rafiq

        Dear Dan do you know why Government has loose monetary policy?
        It is a deliberate act of the Government and I think property prices will not go down unless an honest person come to govern this Country who has pain in his heart for the poor people.

        1) London is a safe heaven for foreign corrupt politicians, bureaucrats and drug mafias because they can convert their black money to white money by buying a house in UK. They do not mind to pay some extra taxes rather than loosing all money in their Country.
        2) Why the Government has this loose monitory policy?
        Because they are getting too much money in the form STAMP DUTY. This is the biggest source of income of our Government. I have seen so many houses sold more than 5 times. Just calculate the amount of money Government has. Its mean a quarter of house price has been paid to Government in the form of stamp duty.
        If Government brings a strong monetary policy then who will be the looser? The looser will never let it be happened.
        3) If you buy a house (same like London’s house) in third world, the price will be 15 to 20 times less than UK house price. Just imagine how much money is coming into our Country, when a foreign investor buy a house in London. Our economy is running due to these foreign buyers because we are selling our lands to them 15 to 20 times more than the original price.
        That is why Government is not increasing interest rate because they do not want to loose all this money if the housing industry burst. So they have to protect it for their own interest.

  • Mark Bishop

    It’s true that buy-to-let property in most parts of the UK, but especially London, no longer stacks up on a free cash flow yield basis. However, there are precedents for markets in which buy-to-let remains popular despite negative cash flows (New Zealand, for instance) – they key is the expectation of capital gains, and how those windfalls are taxed (if at all),

    Here, non-resident and non-domiciled investors may still see merit in BTL, provided they believe the market will continue to rise. And some might overlook declines in values, at least in Sterling terms, if they believe that currency movements will help them turn a profit or if they’re laundering money extracted from dysfunctional home nations (China, Russia, the Stans etc).

    In this respect I’d argue that prime central London property may defy gravity for longer than native Brits might expect, not least because of yesterday’s referendum decision and the impact on Sterling. That lateral apartment in Mayfair is 8.5 percent cheaper today than on Thursday, if you hold Dollars…

  • Niceman12

    A price drop is highly unlikely in the next two year . HSBC released mortgage 0.9% interest fixed rate for two years . BoE base rate might go to negative . The bubble is artificially created by laws and rules , including but not only tax , and is ongoing !

  • Niceman12

    First listed £200,000 on 13th Oct 2015
    Asking price changes £215,000 7.5% Increased on: 2nd Mar 2016
    Last sale £184,950 on 14th Dec 2007


  • Van Dieu

    20% will just be the froth on top of the layer of scum that sits atop of the London property market. We need 50-60% real price correction for the market to return to sensible levels that ordinary Londoners or ordinary London wages can buy. Meantime think I’ll continue to stack precious metals.

  • James Black

    This is like reading a horoscope. A bit for everybody and depending on your views something will fit..and of course there is never a conclusion.

    Money Week articles like this are a bit of a joke. If you can’t state a firm view and support it with researched findings then get another job and give somebody else a chance who can.

  • ab

    Wishful thinking. ..Yeh London property market will go down when everything else gos dawn before it happens. This includes the Golbal market going into a other cries. ..which will badly effect your poker first. Than you may possibly see London over all property market go down. As it is right no major changes moderate pace and prices are higher than before jun 2016 accept in millions £ property market some well over priced properties dropped to more or less the right value. .which is still high. One of the main factor is the population and the forecast for more people coming to work and live in London. ..some with big cash with them.This happening in all big cities round the world Not just London. The problem is global not London problem. As we speak more people are moving in to big cities. Not to forget the cost of building materials is over the roof at the moment and the cost and even improve your home it’s sky high and it looks like there is no coming back any time soon
    .accept a serious global economical problem than..possibly will bring the UK property prices to lower level. Brexit is a major problem for the UK property market and it could go higher or lower but not in any way close to 20%.