Here’s why Mark Carney might prick London’s property bubble this year

The London property market is getting out of control.

Just over a week ago, I went to two ‘open houses’ in southeast London. The first flat, in Charlton, had originally been put on the market in November at £325,000. Just two months later the asking price was up at £370,000 – a 13% jump.

The second flat was a privately-owned two-bedroom flat in a local authority building. Granted it was in Blackheath village, which is never cheap, but it was pretty basic. That was also on at £370,000 – up £100,000 (37%) on six months ago.

Both properties had plenty of potential buyers lining up to view, including some from outside London.

The consensus view is that the UK property market will keep strengthening, certainly this side of an election.

But I’m not so sure that London can wait that long for a pin to prick this bubble…

Mark Carney’s uncomfortable dilemma

I’m hardly alone in thinking that London property prices are getting out of hand. Legal & General chief executive Nigel Wilson tells The Daily Telegraph that prices are now “absurd”. The government’s ‘Help to Buy’ scheme is “stoking demand” and should be scrapped.

Given that the housing market is at least partly responsible for the UK’s sharp economic rebound in the past year, George Osborne won’t be keen to do anything to risk it. But Bank of England boss Mark Carney may yet surprise us all.

Carney must be feeling a bit uncomfortable. When he agreed to take over as bank governor, Britain was still facing headlines about a ‘triple-dip recession’. Now everyone’s talking about a boom. Unemployment is plunging. When Carney said that he’d think about raising interest rates if unemployment hit 7%, he thought he’d effectively parked the issue for two years. But we’re now at 7.1%, and quite possibly only months or even weeks from his target.

We’re not saying that Carney will raise rates imminently. He’ll make an excuse to adjust the horizon. But he’s running out of excuses to argue that the economy needs the added stimulus of a government-backed mortgage scheme.

Carney has hardly embraced surging house prices with open arms in any case. In December, he warned that there was the “potential” for another crash. While it’s easy to dismiss such words as rhetoric, he has made some changes – such as preventing the Funding for Lending scheme from being used to fund mortgages.

Of course, even if he’d like to, Carney can’t scrap Help to Buy. Having house prices crash months before an election would be political suicide for the government. But that doesn’t mean the scheme will survive in its current form.

The Bank of England is due to re-examine it in September to see whether it is working properly. This would provide the perfect opportunity to impose restrictions that would reduce its scope, but not cause the disruption that an outright end would produce. If there’s ever been a good opportunity to test whether a central bank really can stop a house price bubble without crashing the rest of the economy, then this is it.

Can Carney surgically pop the London bubble? It’s a good time to try

One option would be to ban London homes from the scheme. Obviously, he can’t do this explicitly. But reducing the maximum value of properties eligible would do the same thing.

Today you can get access to Help to Buy for any property valued at up to £600,000. At the moment, that covers the average house price in 27 of 33 London boroughs (according to Nationwide data).

But say you pull the maximum down to £400,000. You could still buy the average house in Brighton (the next-most expensive town), but you rule out about half of London.

And a cut to £300,000 would leave just six London boroughs eligible, but still be higher than the average price in just about every other part of the UK. Better yet (from Carney and Osborne’s point of view) this might not be bad politics.

As our editor-in-chief Merryn Somerset-Webb has pointed out, many people think house prices generally are too high. In fact, a November Ipsos-Mori poll MoneyWeek sponsored suggests that more people want them to fall than rise (39% versus 29%).

But in London this feeling is particularly strong. Only 27% want further rises, against 46% who want falls.

House prices in London are extremely overvalued

If Carney does decide to tighten up Help to Buy, then the London market could be extremely exposed. Nationwide data suggest that prices in London are now 7.5 times the income of the average first time buyer. That’s the highest ratio since records began at the start of 1983.

It’s also 56% higher than the average during that period, which was only 4.8 times. While prices have also outstripped average incomes for the rest of the UK, the difference is only 34% (4.6 times, against a historical average of 3.4 times). In short, London is particularly over-priced right now.

Of course, the city is still seen as a global safe haven, which may prove important if the euro crisis (or revolution in the Middle East) flares up again. However, research by Christian Badarinza of Oxford University last year suggests that people investing in this way tend to cluster – they buy mainly in areas where fellow nationals have invested. So unless you live in an area with a large number of wealthy Greek or Italian exiles, this is unlikely to be a major factor.

In any case, whether the final outcome is a breakup or a painful recovery, the euro crisis will eventually be resolved. And when this happens, the ‘panic money’ is likely to go back where it came from, hitting prices.

Prices in the rest of the UK, which still haven’t fully recovered from the crash, may have a way to run. However, London prices are clearly in bubble territory. And if they continue to rise at this pace, it just means the crash will be harder when it does take place.

If you really want to invest in London property, you might be better looking at the commercial property side instead – here’s one company I wrote about in November.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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  • tot777

    The last rate-hike cycle was in 2006 in the UK. Those 8 years of falling/flat interest rates have propped up the housing market and all the of its hangers-on quite nicely. A rate-hike cycle is long overdue, but I don’t see rates going anywhere until after the 2015 election. Carney the snake-oil salesman will come up with a new-fangled justification (excuse) for not raising rates until then, causing more adulation/fawning from the media/economists.
    Looking beyond that, I think raising rates will expose the UK “recovery” as the fragile debt/house price-based recovery that it is. A small rate-hike cycle could easily be followed by rate cuts, a la the ECB in 2008 and again in 2011.

    Anyone can see London is in a bubble, but calling the top of asset bubbles is impossible. Who’s to say those local authority flats won’t be worth even more in 2 years time?

    Douglas Carswell has written an interesting paper on monetary policy recommending rate rises :

    • Ellen12

      Thank you for posting that link. I think breaking up the banking cartel would help focus the economy off them and onto everyone else. Letting a few of these ‘too big to fail’ banks would be good for everyone. And ‘Osbrown’ is the appropriate term for the reckless behavior of both Brown and Osborne …. I find myself being very angry with this Osborne/ Carney alliance because they know the misery they are causing in housing with asset price inflation – pitting investors against working people trying to buy homes. But worse, I think they are aware of the total misery that will follow when interest rates do begin to rise. They obviously think their careers are worth it. The current labour opposition are being tight lipped on where they stand with the reckless post 2008 monetary policy.

      • tot777

        Ellen12, you are welcome. As Carswell highlights in his paper, both Labour and the tories endorse monetary activism. So it’s Hobson’s choice for monetary policy, as far as the election goes. Vote Tory/Labour, get QE and ZIRP. Democracy in action!

        Osborne is no dummy and will be only too aware of the longer-term pain being stored up by Help-to-buy. I too lost what little faith I had in politicians when the tories announced it. Our flawed electoral system actually encourages reckless short-term policies like Help-to-buy. Despite being a tory MP, Carswell actually has a good grasp of the flaws in our current political/economic setup and how to fix them. I would recommend his book, the birth of iDemocracy for further reading.

        Until people and in particular the media get out of the “house price rise good” mentality, then nothing will change. Few papers highlight that for many, a first-time home gets further away with each price rise, or that more and more people will pay stamp duty with each price rise. House price rises don’t create any long term real wealth. It only transfers it from one section of the population to another. Try telling that to a dailymail reader though!

        • dlf75

          “Until people and in particular the media get out of the “house price rise good” mentality, then nothing will change.”

          Completely agree! Unless you are downsizing or have paid your mortgage off years ago, rises aren’t “real”. Would much rather our flat was worth less and the houses we are trying to buy were less too. A smaller mortgage a month means more money to spend on stuff (the economy!).

          Too many people like the “status” of an expensive house or are remortgaging to take equity out because they need money to buy stuff with. Unfortunately there are enough people with too much money that will play the game and on we go.

          In some areas of London there is a “status” thing where people put their houses on the market at inflated asking prices with no real intention of selling, to say look what I’m worth!

        • seetee

          I agree that house prices rises are not good and I am a Daily Mail reader. It is exactly this type of institutionalised type-casting that helps Politicians manipulate all of us. The DM merely adopts a stance that is diferent to it’s competitors so as to keep it’s circulation. The real enemy is Career Politicians who know bugger-all about anything except politiking. Let’s stop bickering amongst ourselves and turn our efforts to changing a system that keeps attracting completely inept people into a career in politics!

  • Harrygate

    There is a disconnect between the London economy and the economy of the rest of the UK. They are two separate economies if you will. London is the only part of the UK that is showing signs of an exit from recession and if properly managed should assist in dragging the rest of the UK along with it via trickle down. Yes London property is soaring in value but there is a huge shortage of supply and an ever increasing young in-work population creating demand. Many transactions are fulfilled without recourse to lending and foreign buyers are treating London property as an investment class. I don’t agree that London property is in a bubble its just market economics working itself out. I believe the idea of BoE intervention to “correct”a perceived bubble is flawed. Leave the property market in London to sort itself out. London is an economic beacon of hope for the UK. Don’t mess with it.

  • dlf75

    London prices are ridiculous, but there seem to be enough buyers able to afford modest Victorian terraced houses in unsalubrious areas for £500k+. They are queuing up at viewings on Saturdays. Houses going for £50k + over asking price by Monday lunch.
    30 something couples in competition with cash buyer developers/landlords. There just arent enough decent houses to go round. Classic supply and demand problem.

    Not sure the help to buy is affecting houses much, first time buyer apartments maybe. The interest rates with a 5% deposit are awful. That said, London is a different economy. There are plenty of double income couples for whom these properties are only 3 times income or less.

    The £500k stamp duty threshold also creates an artificial boost. Houses that were on for £470k in November are now £525k or higher.

  • mr clyde

    There is a very easy answer that would target London house price pressure (or any other asset bubble) without directly effecting other areas of the economy still requiring low interest rates. Unfortunately it is not in the gift of the BoE and it is too radical for any politician. The answer: Remove CGT relief from primary residential properties and replace it by allowing unused current annual CGT allowance to be accumulated to offset future gains. As a transition this allowance could be suitably backdated. Simples.

    • Boris MacDonut

      mr clyde. This is a brialliant idea. I love it and I am not being facetious. MW should get behind this pronto.

      • mr clyde

        Boris – I’m glad you like it. Of course the other great advantage is that as soon as homeowners are required to consider their capital gain then they are going to demand receipts for any repairs/improvements. Think of the new tax-revenue stream from the current cash in hand ecconomy!
        The shame is that this isn’t new, merely a return towards to Adam Smith’s principles of good taxes.

        • Boris MacDonut

          mr clyde. It gets even better. Of courser your idea is so practical and of such benefit to the vast majority no political party or financial pundit is likely to get behind it. I will suggest it as a policy at my next Mebyon Kernow meeting.

  • Realist

    I don’t know where they get the idea that house prices haven’t recovered in the rest of the Country. While that maybe true in the north of the UK, certainly in the south east, the prices are back to 2007 levels. That is why this Help-to-Buy is still a ridiculous idea, what ever the level, as prices for even a modest house around my area of Cambridge have shot up in the last six months and FTBers just cannot get a foot in the door.

  • gamesinvestor

    I don’t think you understand. Mark Carney won’t be raising rates under ANY circumstances until he is told to do so by the prevailing government’s Chancellor (currently Osborne). He is a puppet and a rather unintelligent one, witness Forward Guidance or Forward Nonsense.

    The only thing that will allow rates to rise is a global event that triggers it and takes the decision out of the UK government hands. This is unlikely to happen any time soon if the world is heading towards deflation.

  • Kalvin

    East End of London seems to be a different place altogether by the looks of it. London property in SOME parts of London is very expensive. Property in East LONDON seems not to have caught up with the rest of London. There are still Beautiful 3 -4 bedroom Victorian properties in the E postcodes of London which still around £250 – £300000, compare that to the rest of London there is IMO no property bubble here. The same property in any other postcode will cost you twice the price.

  • tuesday

    Money week has been histrionically warning against London property since 2008. If you took their advice and sold – or chose not buy – you would be massively out of pocket. The have never acknowledged this.

    But maybe it is different this time!

    MW is oddly attached to there being a property price crash – well crashes in general.
    The hand wringing over affordability seems a rather tacked-on moral stance to bolster / justify their position – and not one they apply to other morally dubious investments like BAT or BAE Systems.

    I assume it is because their writers want to buy here – or get a buy to let and can’t afford it.

    • Dulaman

      Tuesday I can confirm that I did take their advice, sold out Jan 2009 and waited, and waited, and now sadly cannot afford to buy back in.

      I am probably circa £100k to £150k down as a result. But I do still hope to buy when the next crash happens but will probably be long gone by then.

      I do accept no-one forced me to follow the advice and I did make my own decisions on this but did believe what Moneyweek was saying as the experts. Lesson learnt and subscription cancelled.

      • seetee

        I didn’t take their advice either and continued to buy a few 2 bed BTL houses in the Midlands, all of which are now worth at least 20% more than I paid for them some 2 yrs ago. The simple truth is; “there are no experts just good guessers.” The better their education, the better their guesses.One must learn one’s own facts about a given sector of the economy and then rely on one’s education and instincts. The people at MW are no cleverer than you and I; they just get mugs like us to pay them for their opinions (have you seen the prices for their cruises?).

  • DLF75

    Good luck with that!

    In E3, admittedly zone 2, terrace houses now come on market for £775k, which would have sold on same street for £620k in December 13.

    Flats going for £50k more than they were late 2013.

    Anywhere on the Crossrail line, eg: Forest Gate, asking prices for OK houses are up £150k+ on late last year. It’s absolute mayhem out there right now.

    Too many buyers, not enough property.

    You might get a small rundown Victorian on a scruffy street nowhere near transport in zone 3-4 for £375k if you’re (un)lucky.