In October, London real estate asking prices jumped 10%. In my view is kind of parabolic-looking jump has developed out of quite a silly situation, and one I think is a good exhibit of just how irrational and weird markets can sometimes be. London real estate prices have been rising strongly for a long while, and a large quantity — over half for houses above £1 million — of the demand for London real estate is coming from overseas buyers most of whom are buying for investment purposes. It is comprehensible that London is a desirable place to live, and that demand for housing in London might be higher than elsewhere in the UK. It is a diverse and rich place culturally and socially, boasting a huge variety of shopping, parks, art galleries, creative communities, restaurants, monuments and landmarks, theatres and venues, financial service providers, lawyers, think tanks, technology startups, universities, scientific institutions, sports clubs and infrastructure. Britain’s legal framework and its straightforward tax structure for wealthy foreign residents has proven highly attractive to the global super rich. With London real estate proving perennially popular, and with the global low-interest rate environment that has made borrowing for speculation cheap and easy, it is highly unsurprising that prices and rents have pushed upward and upward as the global super rich — alongside pension funds and hedge funds — sitting on large piles of cash have sought to achieve higher yields than cash or bonds by speculating in real estate. In some senses, London real estate (and real estate in other globally-desirable cities) has become a new reserve currency. And while this has occurred, price rises have proven increasingly cyclical as both London residents and speculators have sought to buy. The higher prices go, the more London residents become desperate to get their feet on the property ladder in fear they won’t ever be able to do so, and the more speculators are drawn in, seeing London real estate as an asset that just keeps going up and up.
Yet the bigger the bubble, the bigger the bust. And I think what we are seeing in London is a large psychological bubble, a mass delusion built on other delusions. Chief among these delusions is that real estate should be seen as a productive investment, as an implicit pension fund, or as a guaranteed source of real yield. While investors can look at real estate however they like, there is no getting away from the fact that real estate is a deteriorating asset. Sitting on a deteriorating asset and hoping for a real price gain — or even to preserve your purchasing power — is a speculation, not a productive investment. For commercial enterprises buying as a premises for business, or for residents buying as a place to live this is not in itself problematic. But as an investment this can be hugely problematic. It is just gambling on a deteriorating asset under the guise of buying a “safe” asset.
Of course, in the UK where housing has been treated by many successive governments as an investment, and as a haven for savings and pensions, real estate owners have done particularly well. Governments have been willing to prop up the market with liquidity via schemes like Help To Buy and via restrictive planning laws to rig the market to restrict supply. This may make investors feel particularly secure, but governments can be forced — not least by demographics — to swing in another direction. An important side-effect of continually rising prices and a restricted supply of housing is that many people will not be able to afford to buy a home. With the house prices-to-wages ratio sitting far above the long-term average, the next UK government will come under severe pressure within the next few years to allow — and probably subsidise — much more housebuilding to bring down housing costs for the population. The past-trend of government-protected gains may have inspired a false sense of security in investors.
But such a reversal of policy would not in itself crash the London real estate market. After all, London is a unique place in Britain, and the majority of the new housebuilding may take place away from London. More likely, the bubble will simply collapse under the weight of its own growth. Sooner or later, even with liquidity cheap and plentiful, the number of speculators seeking to cash out will exceed the number of speculators seeking to cash in, and confidence will dip. Sometimes, this simply equates to a small correction in the context of a large upward trend, but sometimes — especially when it can be negatively rationalised — it manifests into a deeper malaise.
When this occurs, one probable rationalisation is as follows. Domestically, many of the relatively low-income artists, designers, technologists, musicians, students, artisans, academics, service workers and professionals (etc) who make London London are priced out, then they will go and contribute to communities elsewhere where rents and housing costs are lower — Birmingham, Manchester, Glasgow, Paris, Berlin, out into the sprawl of the home counties, and deeper into the English countryside, to places where a four bedroom house costs the same as a studio apartment in central London. Where once this would have been culturally, professionally and socially prohibitive, fast, ubiquitous internet allows for people to live a culturally and socially connected life without necessarily living in a big city like London. Internationally, other cheaper cities and jurisdictions will simply catch up with London in terms of amenities and desirability to the global super class. Competition for global capital is huge, and while London as an Old World metropolis has done well since 2008, it may suffer in the wake of renewed competition from newer, cheaper, faster-growing Eastern metropolises.
When the bubble begins to burst — something that I think could occur endogenously within the next five years, especially if the fast increases continue — speculators, and especially speculators who are heavily leveraged may face severe problems, resulting in a worsened liquidation and contraction, and possibly threatening the liquidity of heavily-invested lenders. As many people at the table are sitting on big gains, they may prove desperate to cash out. Just as many presently feel pressured to get in to avoid being priced out of London forever, a downward turn could be severely worsened as many who are heavily invested in the bubble and scared of losing gains on which they hoped to fund retirements (etc) feel pressured to get out. Such an accelerated liquidation could easily lead to another recession. While I doubt that London prices will fall below the UK average, prices may see a very sharp correction. The psychological bubble is composed of multiple fallacies — that housing is a safe place to put savings and not a speculation, that deteriorating real estate should yield higher returns than productive business investments, that the UK government will continue to protect real estate speculators, that large flows of capital from overseas speculators will continue into London. A bursting of any of these fallacies could begin to bring the whole thing into question, even in the context of continued provision of liquidity from the Bank of England.