London house price bubble hits the record books

Consumer demand


UK house May14The UK no longer leads the world in soccer, as next month’s World Cup will confirm.  But it can still hold its own when it comes to creating house price bubbles.

China would be the obvious winner of the World Bubble Championship, with Shanghai prices at an eye-watering 29 times average earnings.  But London would have a good chance to reach at least the semi-finals, as the above chart shows (based on data from the UK’s largest lender, and National Statistics):

  • It shows prices adjusted for inflation, to enable comparison over the period since 1971 when records began
  • Today’s nominal price of £362k ($615k) becomes £29k in £1971
  • London house prices have risen four-fold over this period, from £7k ($11.2k) to £29k today (blue line)
  • Even more importantly, London prices are now at 10 times median London earnings, an all-time record
  • This is also double the long-term average between 1971 – 2000, highlighting current unaffordability

Of course, policymakers deny there is any sign of a bubble.  Their predecessors have built up a global reputation for only shutting stable doors after the horse has bolted.  Clearly, they wouldn’t want to spoil this record by recognising the obvious signs of a bubble today, before it bursts:

  • The first bubble took place between 1971-3, when prices rose 51% in real terms, before falling 31% by 1977
  • The next bubble took prices up 37% by 1979, before they then fell 15% by 1982
  • The third bubble was a real winner, doubling prices by 1989, before they then almost halved by 1995
  • At this point, one in seven home-owners owed more on their mortgage than the house was worth

The next bubble was the one that future historians will research with wonder.  By 2007 it had trebled prices in just 12 years.  This was exceptional even by comparison with the US subprime bubble.  And unlike 1989, prices then only fell a modest 10%, before rebounding to reach today’s new record level.

Yet unlike the early 1970s, when large numbers of BabyBoomers searched desperately for somewhere to live, there are few signs of a real shortage of accommodation.  Instead affordability is the key concern for many UK homebuyers, with 1 in 8 borrowers (and 1 in 4 first time buyers). forced to take on mortgages with up to 40 year terms:

As the Financial Times has reported, “whole sections of London have become completely unaffordable” for even solidly professional middle class families, whilst “34% of resale transactions in prime locations now involve international buyers, who also account for almost three out of four sales of new-build homes in prime central London.”

These international buyers don’t normally even live in their homes, as their aim is simply to move money out of unstable areas such as Russia, the Middle East and Asia.  Instead of discouraging such capital flight, the UK’s finance minister has chosen to further inflate the bubble.  His Help to Buy scheme allows people to buy with just a 5% deposit.

A sign we are probably near the peak of the bubble has come from 3 former finance ministers, and the OECD.  They have broken with tradition and warned that a house price bubble may be underway.  Similarly, the Governor of the Bank of England has warned that “the biggest risk to financial stability…centre(s) in the housing market“.

But for the moment, the current policies remain.  Their attraction is obvious to a government seeking votes in the short-term:

  • Higher house prices create a ‘wealth effect’, and so encourage consumption
  • Consumption is 60% of UK GDP, and so economic growth is artificially increased
  • Higher prices also disguise the fact that UK real incomes have fallen since 2010 in every income bracket

There seems little now to do, but wait for the inevitable crash.  Experienced players, such as the Duke of Westminster’s property company, have stopped building new homes for sale as they believe “the prospect of a correction is becoming more likely”.

Young people who recently bought their first homes will as always be the major losers.  Like their predecessors in 1973, they may have to wait decades for prices to fully recover (if they ever do).

The blog’s fear is simple.  This bubble has effectively run for 20 years, with just a minor correction after 2010.  It has been so vast, and so extended, that the crash may also be on an epic scale.





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