London property is heading for a long-overdue correction

London property © Getty Images
London: overdue a correction

The London house price madness continues.

Last week I was in holiday in France. I returned on Saturday evening to a pile of post. Among the mail, there were no less than three letters inviting my landlords to sell their house.

While they have no intention of doing so, this isn’t uncommon. I’ve even seen local estate agents advertise discounts to prospective sellers, something they’ve never done in the past.

The fevered market is partly driven by a genuine shortage of homes (though some experts dispute this).

But more important is the demand stoked by schemes like Help-to-Buy, low interest rates and above all, a readily available supply of credit.

The bad news for sellers – and good news for buyers – is that things could be about to change.

The fuel for the London bubble is being cut off

Most of the UK isn’t suffering a housing bubble – yet. But London prices are a different case. However, the London bubble could be about to meet its pin.

It looks as though lenders are turning off the easy-credit taps that have been inflating prices. Two months ago, the regulator, the Financial Conduct Authority, introduced new rules (under the mortgage market review), designed to stop what it sees as reckless lending banks.

The rules were left deliberately vague so that banks couldn’t get away with just ticking a few boxes. Instead, they have to consider a wide range of criteria, including the potential impact of future rate rises and the stability of an applicant’s income.

It’s easy to be cynical about this. Rather than tighten mortgage lending criteria, it might have been easier to just drop the large subsidies, available through the second part of Help to Buy, which have pushed down the cost of loans.

However, the new rules already seem to be having a real impact on the availability of loans. According to the Bank of England (BoE), the value of mortgage lending for new purchases is at its lowest level since last August – and is 20% below the peak in January.

Conditions are set to get even tighter. Nationwide and Lloyds (who account for about a third of total lending) have recently been phasing out tracker mortgages, which follow the Bank of England base rate. Instead they are pushing people into fixed-rate loans.

It’s clear they’re worried that people could end up taking on cheap mortgages only to have trouble repaying when rates rise (as the BoE heavily implied it would do next spring).

A crackdown on mortgage lending

These measures are important. But the most radical move is the decision by both Lloyds and RBS to heavily restrict high-value mortgages. Both have put in place a new rule that means that those seeking mortgages of more than £500,000 are limited to no more than four times their earnings.

Of course, this will have a minimal effect on the wider UK market. After all, the average housing price in the UK is somewhere between £172,000 (Land Registry), £184,000 (Halifax) and £186,000 (Nationwide).

Even in Brighton and Hove, one of the most expensive markets outside London, the average price is only £356,682.

Overall, UK prices are running at around 4.7 times the average income of first-time buyers.

However, in London the average price is £362,000 (according to Nationwide). And in no less than nine boroughs (counting both Kensington & Chelsea and the City of London), average prices are above £500,000.

Across London, the average price is a staggering eight times the average first-time buyer’s annual earnings.

To put this into perspective, to get a mortgage on an average house in Wandsworth under the new rules, a family would need a joint income that was roughly the same as David Cameron’s salary of £146,000. Even the best-paid couples might struggle to get a mortgage for a house in Hammersmith & Fulham (£705,695) or even Islington (£643,784).

London’s long-overdue correction is coming

The government and the BoE are under pressure to do even more to deflate the bubble. The International Monetary Fund (IMF) has chipped in with its two-pence worth as well now.

The IMF has warned that the housing bubble is one of the biggest risks to the UK economy. It has urged the government to adopt formal limits on lending and to consider scrapping the second part of the Help to Buy scheme (which guarantees mortgages).

The scheme is too politically important to be scrapped, of course. And both the BoE and government seem reluctant to act, each insisting that it is the responsibility of the other. It’s clear that neither wants to be blamed for a large drop in prices just before an election.

However, it looks like the BoE will take some action before the end of the year. The Financial Policy Committee starts a review of the mortgage market and Help to Buy in the next few weeks.

So what does this mean? Outside the capital, at least some property remains decent value, with prices close to (or slightly above) where they were at the peak of the crisis (which means they’re still much lower after inflation is taken into account).

However, it’s clear that London is overdue for a correction. This could come sooner, and be bigger, than many people think. Indeed, to get back to historical price/earnings ratios – prices would have to fall by a third.

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

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  • Kevin Ramsey

    I think the housing shortage outside of London is much worse than it appears to be. There is also the issue of quality. The average may indeed be around £180,000 but i suggest that this average is distorted by the huge quantity of small and old housing stock and houses in “bad” areas which no-one really wants if they can avoid them. I believe the typical price for anything you might actually aspire to own is considerably above this so-called average.

  • mr clyde

    KR makes an interesting point. Is there really a housing shortage, or just a shortage of houses that people want to buy? Londoners appear happy to have a go at anything (because they have to) and this should be encouraged everywhere. So why is VAT charged on renovating current stock and thereby improving ‘bad’ areas, whilst green-field developments are VAT free?

  • quark

    Hasn’t the Govt put out figures that “help to buy, is only a minimal factor in London? And aren’t one in three purchases made in cash?
    You may well be right that house prices in London could crash; but 2 young members of my family earn well into 6 figures working in London.
    First time buyers are always the casualties in the madness that is called the property market; but there are also some very well paid first time buyers in London, or wealthy parents/grandparents to help them.
    Even if prices crash, there will be a, long term recovery. There always is. And with Ed Milliband around the corner with the support of Unite, we may well see wage price inflation in an attempt to solve “the cost of living crisis”, making house prices more affordable. And didn’t Money Week forecast that QE would eventually cause inflation?

    I will never forget, when I put up my £75,000 house as security for a business loan in 1985 the bank manager telling me (bank managers. What are they dad?) that house prices always go up. Come 1991, look what happened. Negative equity. Memories are short and £75,000 for a house is a dream. Do I feel better off? No. But the madness will in the long run, continue, even if prices do come down with a bump. One other thing. Over 40% of Londoners were born abroad. Immigrants are attracted to London, a vibrant and cosmoplitan City. There will always be a shortage of decent houses or flats London. Immigration into London will not cease. Nor will the attraction of property?

  • Realist

    Why not come back to us when property prices have actually fallen by some degree, because I am sick of listening to Moneyweek saying it might, it could, conditions are right, etc etc etc. This crash has been more or less promised for way over 5 years and everyones patience is wearing thin.

  • Vanderlay Industries

    To be fair, I don’t think anyone factored in how far the government would go to prop up assets. Take away trillions of QE, help to buy and ZIRP and they’d be spot on. It’s not so much property going up, as money being decimated.

  • Longtermyieldman

    Ultimately, any income-generating asset will revert to a mean valuation based on its free-cashflow yield: there’s a limit to how long buyers will purchase an appreciating asset class solely in the expectation that a greater fool will buy it off them at a premium.

    Prime central London property currently achieves a gross yield of 2.8 percent and falling. So the fundamentals are against it. However, loose monetary and mortgage lending policies may continue to inflate the bubble for some time. And history shows that the longer a bubble is allowed to inflate, the greater the collateral damage when it finally bursts.

    My greater concern, though, is whether Government – based in London – may be too heavily influenced by journalists, economists and others based largely in the capital into over-reacting to the micro environment within that area prematurely to choke off recovery elsewhere in the country.

    I believe there’s a policy lever not currently being used that, if deployed, could selectively cool London, without affecting the rest of the country: require banks to hold prohibitively large capital buffers against mortgages for which the monthly repayments, when interest rates return to the long-run average, exceed those properties’ rental yields.

    Under such a policy, 100 percent LTV loans would remain available in the many areas of the country where prices are far behind their 2008 levels in real terms, because in those areas, rental yields are generally high; in contrast, lending in London would be reined in. This would help rebalance the market.

    There would be a significant fringe benefit, in that, if a homeowner’s circumstances changed, such that he or she could no longer pay the mortgage from earned income, the lender could instead rent out the property and know the payments would be covered. This would avoid the vicious circle of repossessions flooding the market and driving prices down, which is the underlying cause of the depressed property market that persists in some regions. Indeed, the lender could rent the property back to the former homeowner, who would now be a housing benefit-funded tenant: in societal terms, far better, and cheaper, than forcing people into temporary accommodation followed by the expensive privilege of a lifetime’s subsidised social housing tenancy.

  • Ellen12

    The is a crisis in housing in London and it is caused by placing investors interests between supply and demand. If the word be used to describe it is “crisis”, than our politicians need to give it their full attention to solve it. It is long past time our elected representatives stopped putting the basic physical needs of their citizens at the bottom of their priority list. While people are not able to access reasonably priced homes to buy, investors, both foreign and domestic, should face a punitive tax regime until housing becomes balanced enough to enable the majority to buy an average home with an average salary. All this other monetary fiddling around the edges just perpetuates the movement of wealth upwards and continues to marginalise those who want to buy a house to live in.

  • CityFarmer

    I think people in general, incl MW writers need to accept that London is one of a handful of emerging Global Capital Cities, it’s property prices have little to do with UK average earnings and more to do with the average earnings of the top 1% of the worlds population.

    We should welcome this as huge amounts of wealth are drawn into the UK as a result and ripple out across the SE and SW.

    Combining the FX move of the £/$ and local price rises an international property buyer will have seen a 30% profit in the last 12months. No one can say that the £ will definitely hit $2 but neither can it be ruled out, even if London prices stagnate in £ terms there is still money to be made.

    London property crash? I very much doubt it.

  • milly

    I agree with realist , me to getting sick of the same borring money week topic regarding house prices, come back when they have fallen or you have some real news re falling house prices

  • dan w

    yes, look at any MW issue circa 2009 and be screamed at to get out of london property before the coming crash. that’s a piece of mis-advice that could have lost a great deal of wealth for many readers. it’s one market that the magazine has no understanding of, nor willingness to learn from their wrong-headedness.

  • Jack

    a year on – and nothing has materially changed. prices are still going up and lenders continue to misdirect their energy in hauling blue chip remortgage customers over the coals for no real reason (400k house, 125k mortgage, 70k income – if we were asked what we spent on food one more time I told them I would scream)