London property - clear and present danger
We have previously written a detailed article about the risks that we currently see in the London property market. As an attention grabbing summary, we stated that there is a high chance that the London property market could see a price collapse – and that this collapse could be swift and dramatic.
To distill our analysis into a few bullet points, we stated:
The London property market is supported by (pre-dominantly) Asian investors (it certainly isn’t supported by the City’s investment bankers any longer!).
These investors are pre-dominantly investors who are either (a) looking for a safe home for their funds; (b) speculating in the market because prices are rising; or (c) long term buy to let investors.
Buy to let investment in Central London no longer makes any financial sense. In real terms (after inflation) and after taxes and costs, most rental property does not generate a positive return (in other words, the investor is suffering a loss).
If interest rates rise:
- UK based buy to let investors will almost certainly start to suffer increasing losses on London rental property due to higher mortgage payments.
- The exchange rate between Sterling and Asian currencies will start to strengthen meaning that it becomes more expensive for Asian investors to purchase London property so continued high levels of investment are unlikely.
The maximum LTV at 0.75%pcm is 60% although higher LTVs will be considered if additional security is provided.
Finally, the cherry on the cake, the UK Government is raising taxes on foreign investors (capital gains are now applicable on foreign property owners who dispose of UK property) and potentially on domestic buy to let investors (a mansion tax is still being debated).
The problem that we were concerned about is fairly simple – should Asian investors start to pull out of London property and prices begin to fall, will this lead to an avalanche of other Asian investors heading for the exit (they are, to a significant degree, speculators after all)?
You do not need to have a PhD in financial economics to understand that a bubble gets inflated slowly, but bursts quickly. The reason for this, as Warren Buffet says, is that confidence is gained one person at a time, but people panic together. I’m also sure that we have all heard the financial adage “don’t panic, but if you are going to panic, panic before anyone else”. Therefore, if you believe that the London property market is supported by foreign investors and speculators, then you should be very concerned about a sign of a slowdown as this could herald the point at which some (savvy) investors decide to offload their entire London property portfolio (and ring the bell to signify the top of the market). Who is going to buy these properties that rent out for a loss when prices are slipping? Answer – no-one, the prices have to fall until the rental return makes sense.
Having written the previously mentioned article at the back end of 2013, I thought it would be interesting to see how the fact pattern has changed in mid-2014, and whether we think the tipping point is close.
Firstly– how are London property prices faring? Badly, according to many news outlets – “asking prices fall 0.5% in June” according to Savills, while in July a RICS survey found that (by a majority of 10%) their surveyors thought that London prices would fall over the next three months.
Secondly– How is Sterling faring against key Asian currencies? Very well (which is bad for London property). The graph below shows how the exchange rate between Sterling and the Chinese Yuan has appreciated steadily from about 9.2 last summer to around 10.6 today. What this means is that it is now about 15% more expensive for a Chinese person to buy a London property than it was a year ago just because of currency appreciation. If you also take into consideration the 16% growth in London house prices during that period (according to Rightmove), it is actually over 30% more expensive.
Thirdly– are interest rates going to rise soon? The consensus is now “yes, and sooner than expected”. Interest rate increases this year are now perceived to be highly possible, if not probable. The recent jump in UK inflation to 1.9% has further increased expectation of early rate rises.
So, in summary, if you believe that the London property market is supported by foreign investors (the evidence is overwhelming), that some of them will run for the hills when the market turns (the speculators will undoubtedly) and that the current interest rate / exchange rate dynamic will continue to make London less attractive as an investment and bring the tipping point closer – then you, like us, should worry.
Director, Funding 365 Limited