Economic Implications of Rising House Prices

On Thursday the 26th of June, Mark Carney, the governor of the Bank of England, announced a plan to curb the issuance of mortgages in the UK, by imposing two sets of rules.This comes as a reaction to the rapidly growing prices of UK and especially London property markets. Carney’s plan might work in terms of subsiding the threat of a UK housing bubble, but will hardly have any impact on the rapidly growing prices of properties, especially in London.

According to the news release on the Bank’s website, no more than 15 percent of all mortgages provided by lender can be lent at a mortgage to income ratio greater than 4.5. Moreover, banks must ensure that the mortgage recipient will be able to repay the loan even if the interest rate would rise by 3% above the originally agreed rate.

These rules ostensibly appear to be a correct set of measures as they limit the potential risk of another asset bubble bursting, this time in the UK, but they do not address the problem of rising house prices, especially in London. While in the last 12 months to April the average cost of dwelling in the UK rose just shy of 10 percent, in London it was almost double, with prices surging by 18.7 percent. Deutsche Bank analysts put London house prices at +61 percent from their 2009 lows.

One of the reasons behind the surge in house prices is beyond any doubt a shortage of supply. By the estimates of a report written by property firm Knight Frank, about 53,000 new houses are needed in London annually, which stands at stark contrast to current production of 33,400. This shortage is however not caused by decay in the number of existing properties; rather it is a consequence of a growing demand. In 2012 London grew according to the statistics published by ONS on a rate that is double the national average, reaching 8.3 million and in 2013 the population was increased by further 104,000 inhabitants. Clearly, there is a growing disparity between supply and demand.

The crux of London’s rapidly rising cost of housing does not lie solely in the lack of supply, but is also driven by an external factor, represented by hefty overseas purchases from rich investors, coming mainly from East and South East Asia.

According to a study conducted by Civitas back in 2012, from the total number of property purchases in London, 85 percent were made with foreign money. Savills has recently informed on its website that the number is not as high as and that over the past 18 months only one third of all prime house purchases were made by international buyers. But not all purchases are made only to prime properties and old refurbished houses are also being bought with foreign money. Another study by Knight Frank shows that the last two years prior to June 2013, 69 percent of buyers of new properties in the central London who were not British.

The discrepancy in these data is caused by varying definitions of what is considered as an international or foreign purchase? An investor, who is say from Germany and has lived and worked in the UK for considerable time, is in some statistics deemed as a foreign buyer.

No matter what the actual number is, there can be no doubt that foreign millionaires are indeed driving prices up, even if they represent only 32 percent of all buyers. This was being increasingly reported and argued in the past 6-12 months by a number of news outlets as well as investigative reports.

More oil was added to fire by a blog written by economics editor of Sky News Ed Conway, who on his blog site known as The Real Economy points to a cunning practice by foreign investors,where many of the so-called cash purchases are backed by loans from foreign banks, as apart from storing value in prime dwellings, foreign investors also use London’s housing market as an investments opportunity, which again, only drives prices up.

Most interestingly, as argued by one of the blog commentators, many new flats are sold over the actual price, with the difference being masked as a fictitious rent for a future period of time. In other words, a property that has a value of£ 500,000 is sold for £600,000 and the difference is paid back by the owner to the buyer, usually via a form of fictitious rent. Apart from other negative effects, this also artificially inflates the cost of dwelling and drives prices up. According to Nationwide, an average dwelling sells in London these days for more than £400,000.

Furthermore, the foreign investors can enjoy a loophole in the tax system, exempting them from capital gains tax. The Chancellor of Exchequer George Osborne said in late 2013 that this would change from April 2015. Despite the rationale behind this step, it comes a bit late and it still does not limit the wealthier foreign competition from outbidding UK citizens in a search of property thus driving prices further up.

The Tories realise the benefits from foreign wealth flowing into the economy, but at the same time they must not cross the fine red line between working for their citizens and competing for foreign wealth. Their rhetoric is very likely to change with the upcoming elections in 2015.

With London’s construction of new houses lagging and prices surging due to foreign investments, the symptoms of an asset bubble (inflation) will continue for a considerable time, especially with ongoing geo-political tension, such as the one in Ukraine, where many oligarchs search for safe investment harbours. Moreover, such competition could drive British buyers to the outskirts of London and its neighbouring areas, thus impacting with increased demand also other towns and cities.

There can be no doubt that London is becoming an increasingly popular city. But can it meet the demand? British politicians are starting to act and aim to promote an idea of ‘powerhouse of the North’. For now, all is safe and no real threat persists, but the tide will carry in with its increasing trend until proper barriers are put in place or until…

By Rudi Vrabel

Tags: , , , , , ,

Categories: Europe

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