The unsustainable market for housing in Central London
Yesterday, I saw a couple of stories about a sell off in luxury flats in London. The gist was that luxury homes in central London had corrected as much as 20% in the last year. The decline is severe and Foxtons, the estate agent, has been hurt by this according to their earnings report today. The Telegraph pointed to a Mansion Tax to explain the softness. But my cursory investigation says the weakness is warranted.
As background here, think of the world today post-globalization as one in which well-educated or wealthy residents are much more footloose and prone to congregate in a number of posh urban areas around the globe. In North America, think New York, Los Angeles, DC, Vancouver and Toronto. In Europe, think London, Paris, or Munich. Globalization and income inequality have come together to produce huge demand for luxury accommodation in a select few urban areas, driving prices there to astronomical levels.
London is uniquely positioned for the luxury boom as a member of the EU, a financial markets hub, an English-speaking nation and a former colonist with historical connections to elites throughout the world. Wealthy people from Greece, Russia, and the Mideast see a home in London as a good real asset hedge and a good investment. Bankers from American and European firms want to live in Central London. There is an endless number of reasons that London is at the top of the list for housing in today’s global economy. Nevertheless, I find the rise in London prices unsustainable and I wanted to give a couple of anecdotes why.
About 15 years ago, I lived in a basement flat in Kensington, an upscale area in central London. While the overall area was posh, my flat was decidedly not. Central London was still undergoing an ‘upscaling’ transformation. And my flat hadn’t been included yet. It was a dark two-bedroom, one bathroom place with a semi usable courtyard, as long as we dodged the pigeons having their way on the patio floor. We left after about a year for a larger, brighter and more upscale flat about a mile down the road.
After I saw the price decline data, I decided to check listing history in the area, which you can do via a website called Zoopla, that lists all transactions in a specific post code back to 1995. So you have almost twenty years of data. This basement flat was sold 6 years after we left in December 2005 for 365,000 pounds, or about $575,000. That’s expensive for a decent two-bedroom but not bleeding edge. The same flat was sold again in June 2013 for 755,000 pounds though and that puts it at about $1.2 million – for a basement flat.
Now mind you, the flat had been renovated to the upscale standard of today’s Central London. Here are pictures of the sitting room, washroom, bedrooms and kitchen:
Notice the bars on the windows though. They were there when I lived there too. Remember, this is a basement flat.
Now, the 755,000 figure is an actual sale. Zoopla estimates the flat could go for about 870,000 today.
The flat we left this one for had doubled in 1999 after the house crash in 1992. And it doubled again in a 2006 sale. Zoopla estimates it is now worth double that 2006 price – or roughly 8 times the price of the 1992 sale. When I ran the numbers on this flat, the rental yield came out at a paltry 3.13%, with negative cash flow, as the rental income is well below the monthly payment for an 80% LTV mortgage.
These are just two examples from areas in Central London that I know well. I have seen scores of others that are similar. These are the kind of calculations I used to do over and over again in the US in the lead up to the housing crash in 2006. As I ran the numbers, I kept asking myself who would buy an asset at such a huge premium to rent when they could rent an equivalent accommodation for 20 or 30% less and save the difference.
And if you think residential property is the only market where we are seeing these factors come together, think again. Commercial property is showing the same kinds of trends in terms of markets that attract global business and rental yields that are miniscule. Witness this excerpt from today’s Irish Independent:
Only four European cities are more expensive than Dublin for retail investment values: London’s West End with a 2.5pc yield; Zurich at 3.2pc; Paris at 3.25pc and Vienna at 3.9pc. Dublin with a 4pc yield shares fifth most expensive slot with Munich.
This is a dramatic turnaround in only three months as prime Dublin retail investments were as low as twenty third in the league at June this year and ranked 33 in the league two years ago. Still Dublin yields have yet to reach the lows of less than 2.3pc which some Grafton street shops achieved during the boom.
There are good reasons Dublin rental yields are low, one of them being low bond yields. But the climb in prices is steep and is matched by an even steeper climb in residential prices (see here).
I don’t have a story to explain what’s going on here besides what I wrote regarding globalization and a footloose global elite. But property is fungible. The basis for any property is the land value. The same residential accommodation can be sold, it can be rented. It can be used for hotel accommodation or it might even be able to work as a commercial property, given specific circumstances. But ultimately the question is how valuable is the location and building site and then, secondarily, how valuable is the actual accommodation given today’s tastes and standards.
What I am seeing across a wide swathe of Central and West London that I have investigated – post codes like SW1, SW3, SW5, SW7, W8, W2, W11 – are purchase prices that consistently yield negative carry from a buy-to-let perspective and are many multiples of previous prices and of incomes. All of the metrics point to prices out of line with fundamentals. Prices may have fallen 20%. Still, there is a lot of froth still left in the property market in Central London.