Thursday, March 29, 2012

Boom, bust and the price of property

The release of the latest revision to GDP growth in the UK makes grim reading. The British economy slowed by more than expected, and the outlook for recovery is flickering at best. Incomes have not kept pace with inflation, and the increase in taxes and cuts in government services has helped to cause a sharp contraction in the general British standard of living. Even for those on well above average incomes, costs such as insurance, university tuition fees and now energy prices are really hurting the middle class. For those below median income it is house rents and petrol prices which are beginning to have a crippling impact. The standard of living in London even for those on median income levels is now exceptionally poor. 

So how come housing costs in Central London have continued to rise?

The short answer is that it is not the British buying. Russians, Arabs, Chinese and others have been buying bolt holes in London, that is certainly true, but more than that, it seems that these buyers are putting together portfolios of properties: buying several at once. London property as an asset class has become like old master paintings and classic cars, an investment class in its own right, and international investors have rushed to get in.  However the economic consequences for the UK look like becoming dire. The historic ratio of average house prices to average earnings was for many decades between 3-3.5 times. Now the ratio for London is already headed back to the peak of seven times that marked out the height of the housing bubble. From the point of view of the British economy, London has detached itself from the rest of the country. Yet, the workers who are the foundation for services in the capital are being pushed ever further out.. Even the best paid professions now find they must pay exceptionally high compensation in order that the talent they wish to attract will not suffer an unacceptable fall in living standards if they move to London. As these costs mount, London is losing the competitiveness  that made it an attractive centre in the first place. In short the situation in London looks like a classic bubble.

The only question is when and how this time bomb can be diffused. Perhaps, post the Olympic Games, we may see an adjustment, but despite the fact of London being an international city- indeed probably the premier global  city in Europe- the disconnect between the asset prices of London and those of the rest of the UK can not be sustained. Either a sharp recovery takes place in the rest of the UK or there is a sharp fall in London.

Given the entrenched problems in the British economy at present, my money would be on the latter option. 

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