Ominous signs in the London housing market

Deep structural issues in the London housing market are distorting economic behaviour, with prices wildly out of step with earnings. Has the property boom peaked for good?

London - Do I or do I not inhabit a bubble in the London housing market?

It feels like a bubble. I have received an offer for our house significantly higher than I had expected, and I know where I would like to move to. The Barbican in the City of London is a sprawling development of high and low rise flats surrounded by every conceivable variety of cultural venue. There are flats for sale, but they would stretch our budget, and, as the weeks have gone by, prices have risen swiftly. A local agent reported that each sale was going for £100,000 more than the previous one; that is consistent with a rise of around 7.5 per cent.

Evidently, I have been priced out of my sector of the London house market. Statistics help to explain why. The Land Registry reports that in April, house prices in London have been rising at the fastest-ever rate: 4.2 per cent, or £588 a day. Over the previous 12 months, the rise in London was 17 per cent, almost twice as much as in the whole of the country. (Not that the rest of the country has escaped heady rises: early May data from the private Halifax survey showed an average price rise of 3.9 per cent for the month, and 8.7 per cent over the year, for housing across the nation -- the steepest upturn in 12 years.)

That sounds to me like a bubble.

Mark Carney, the governor of the Bank of England, has said that the housing market poses the biggest risk to Britain’s remarkable economic recovery. He fears that inflated prices will provoke a re-run of the 2008 debt crisis, and is doing what he can to reduce the risk. New rules require lenders to test the ability of applicants to keep up mortgage repayments once interest rates begin to lift off the floor, which is expected to begin to happen early in 2015. Governor Carney is also keeping an eye on the banks to make sure they can cover any consequential risk.

What the Bank of England cannot do, though, is build houses. Over the past decade, supply and demand have become detached. Planners have not encouraged the industry to build enough new houses to meet demand. This is the deep, deep structural problem in the housing market that Carney refers to. It is one of those crises that are familiar in democracies. Everyone knows that a problem is growing, but until it starts to distort economic behaviour, no one does anything until it is too late. Plenty of houses are being built now; there is already a shortage of materials, but the total of new housing is still well below the level of 2008.   

The government’s response has been a Help to Buy scheme, which helps buyers qualify for mortgages by guaranteeing a part of the deposit required by the providers. Critics howled that this would be inflationary, but first indications are that half the recipients are first-time buyers, and that the average price of a mortgage taken out under the scheme was a comparatively modest £150,000. So far, the contribution of Help to Buy to curb the wilder excesses of house prices has been nil. RBS and Lloyds have declared that they will cap loans of more than £500,000. Helpful, perhaps, but still modest. 

The European Commission in Brussels put its 10 euros' worth into the argument last week with a perfectly sensible suggestion that property taxes should be raised. Presently, they are a monument to inequality: the owner of a multi-million pound penthouse in Kensington pays no more council tax than the owner of a suburban house in Manchester. Both the Liberal Democrats and Labour have proposed 'mansion taxes', but the Tories are reluctant to offend their constituents. Not much room for manoeuvre there.

Tim Harford, the clever 'Undercover Economist' in the Financial Times, notes that the price of any asset should be related to its future income, and that house prices in Britain, relative to rents, are one-third above their long-term value. In London, prices have lost touch with earnings and they are growing even more so. Harford says all this seems unsustainable, especially after interest rates finally rise. If prices do then burst, that means it must have been a bubble.

Harford admits that London’s house prices are buoyed by the influx of money from trouble spots such as Greece and tiger economies in south-east Asia, but he insists that laws of supply and demand have a habit of reasserting themselves. He points out that house prices in Japan have almost halved since 1992, and that prices in New York City have fallen by about one-third since 2006. He leaves us thinking that the same could happen in London.

There have been indications in the past week that the property boom might be peaking. Mortgage approvals in April were down 17 per cent from January. Mortgage lenders such as Nationwide have detected a cooling in the London market; prices are still rising but more slowly. Estate agents confirm this as people like me decide that they cannot afford to play catch-up in a market divorced from economic fundamentals.

The price of the most recent flat for sale in the Barbican was only £50,000 higher than the previous one. Maybe this can be called cooling. Maybe when the bubble bursts, distressed sales will start. But if the answer to my question is that I am indeed living in a bubble, the price of my own house will fall too.

Chances of that move to the Barbican do not look good.

Stephen Fay is a former editor of Wisden and author of books about the Bank of England and the collapse of Barings.