Deutsche Bank has called the top of London's runaway housing market in a blisteringly pessimistic note sent to clients on Thursday.
In the bank's sixth "Konzepts" paper, Sahil Mahtani argues that a combination of rising interest rates, the Bank of England's tinkering with the market, and the increasing "politicisation of the housing issue" means London's insane price rises can't continue — and price falls could be likely.
What's more, Mahtani argues there are "multiple catalysts to suggest that 2015 is the turning point" and concludes ominously: "London’s property is unlikely to enjoy the next thirty years as it did the last."
The rise
Mahtani begins by illustrating just how spectacular the rally in London property prices has been over the last few years, with some stunning facts:
- Every £1 invested in London property in 1990 is now worth £5, double the performance of the FTSE 100.
- In the last sixty years, London house prices have only fallen 3 times: during the Volcker recession of the early-1980s; the sterling crisis of 1992; and the 2009 financial crash.
- Conservative estimates put average London house prices at 13 times average gross incomes.
- London residential mortgage debt amounts to a quarter of the country’s total.
London's housing market is huge, expensive, and hot. It's not hard to find stories of property insanity in the capital and popular opinion holds that its a flood of foreign investors buying up homes and leaving them empty to accumulate value that has sparked the boom.
Mahtani says it's simple supply and demand — the supply of homes has failed to keep pace with demand from buyers, be they foreign or otherwise.
But crucially Mahtani sees a second, overlooked factor for spiraling prices — buyers believe house prices will keep going up. People are willing to pay silly prices on the expectation prices will keep rising and they can cash in themselves later. That in turn bids up prices.
The fall
But the second cause is a worryingly self-fulfilling practice that isn't sustainable. What's more, Mahtani thinks economists are underestimating just how much perception effects prices.
He points to the Hong Kong property crash of 1997, when prices dropped 40% in just over a year, as evidence for what happens when the wind changes direction on public opinion.
Here's Mahtani:
A shift in expectations about future supply was much more instrumental in bringing about the downturn. The post-handover government had made it known that it would welcome a decline in property prices and would increase supply by 85,000 units a year. In retrospect, at no point during the next five years did housing completions reach 35,000 annually. Yet because the decision had credibility, it changed expectations and the 85,000 figure is still cited today as a reason for the market decline. The government announcement precipitated a change in psychology that diminished the speculative increment in the market.
It didn't matter that supply increased nowhere near as much as promised — the "psychology" had changed and that was enough to send buyers running.
Interest rates are bound to rise soon in the UK which will take out a lot of the momentum in the property sector. But Mahtani believes something similar to Hong Kong could also happen in the UK, caused by state and Bank of England intervention.
Mahtani says the Bank of England is beginning to see housing "more like a utility and less like a financial asset," because Governor Mark Carney sees mortgage lending as a key component of bank stability and the wider financial system.
That makes it more likely the Bank will put in place more measures to rein in certain lending and buying practices. This will likely have an outsized impact on London because of its huge weighting in UK property debt. Here's Mahtani:
The most advanced practitioners of macroprudential policy are Hong Kong and Singapore where loan-to-values for buy-to-let properties are capped at 50 per cent, foreign purchases of property are hit with 15 per cent stamp duty and second and third home buyers face differentiated, punitive treatment. In this approach, housing becomes more like a utility and less like a financial asset. The Bank of England appears to be moving in this direction.
Secondly, and perhaps most importantly, housing is growing issue for both the left and the right. Only 40% of today’s 25- to 34-year-olds own homes, compared with two-thirds in 1991, and Mahtani says both parties are trying to address this in a bid to win over the next generation of voters.
flickr: muddyclay The redevelopment of Battersea Power Station is one of the most high-profile residential developments in London.
The Conservatives have already moved to increase stamp duty at the top of the market and cut tax benefits for buy-to-let landlords, which has taken some of the air out of the top of the market. This could be just the start.
Mahtani argues that the more house prices rise out of step with earnings, the more it will "sow the seeds of its own correction" by increasing resentment and discontent amongst would-be home owners.
He says: "The fate of house prices may well be decided in the political face-off between younger voters and the elderly harnessing their political power to prevent price declines to their house-cum-pensions."
Ultimately, Mahtani says, we may have reached a point where "policy intervention will favour stabilising or reducing prices."
The aftermath
If you're a would-be buyer, all this is great news. But for people who have recently bought it's another story.
As in Hong Kong, Mahtani thinks that even if policy intervention is only meant to put a lid on things, it could end up sending prices into reverse.
He says: "Again, all that needs to happen is for investors to think price outcomes are asymmetric, with low upside and large downside." In this way a self-fulfilling cycle in the opposite price direction could emerge.
Homeowners would then find themselves in negative equity, freezing much of the market as people sit on their property until the price gets above water again.
Another issue is interest-only mortgages. Mahtani writes: "Over a third of those with mortgages have interest-only loans, with the first sizeable wave of principal repayments due in 2017-2018." That could lead to a wave of repossessed homes, again driving prices down.
Mahtani says that ultimately it's "a losing battle to call an end to the froth in this market. But perhaps we are close to the turning point."
In short, either prepare for more afforadability or brace for impact because London's property market is heading for a big shake-up, according to Deutsche Bank.