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London’S Property Price Bubble Is Poised To Burst - Cass Business School

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Guest post by Cristiano Bellavitis: London's property price bubble is poised to burst

December 19, 2013 by Thorsten Beck | 0 comments

This is a guest post by Cristiano Bellavitis, PhD student at Cass Business School, on a familar topic – housing prices.

Fears of a looming house price bubble have grown in recent months. But two affordability ratios – the house price-to-earnings and salary-to mortgage payments ratios – could suggest London prices are heading for a fall.

House price-to-earnings ratio

The below graphic (1983-2013) shows the relationship between house prices (left axis) and the house price-to-earnings ratio (right axis). The left axis is an index (not absolute values) comparing prices in 1983 (level 100) with those of today. The right axis is calculated by dividing the Halifax seasonally adjusted standardised average house price by average earnings.

Historically, the average house price-to-earnings is 5.39. We calculate the house price-to-earnings ratio as a proportion of the ratio where we think the housing market is overheated. When the blue line is equal to 1, it means that the house price-to-earnings ratio is equal to 5.39 times average earnings.

As the graph shows, once prices approach this level, they have fallen shortly after. This happened both in the 1988 crash and in the more recent crisis of 2007. For homeowners, the worrying sign is that house prices are once again above this critical level, fluctuating at heights comparable to those of the two biggest property crashes.

housing1-yxf4e4.jpg

Mortgage affordability ratio

Furthermore, the mortgage affordability ratio is also sending negative signals. At the moment, low interest rates and the Government's Help to Buy Scheme are supporting the property market, a trend that is likely to continue in 2014. However, interest rates will rise sooner or later.

Currently, the average two year 70% fixed mortgage costs about 2.5/3% for the average buyer. At these rates, according to Halifax, an average individual has to spend 37% of their earnings on mortgage repayments. This figure is pretty healthy as it is below the 43% historical average.

However, if mortgage rates increase by 1%, this proportion would go up to 41.5% of earnings, and if the rates continue to a normal level of approximately 5%, the average Londoner will have to spend almost 50% of their salary on mortgage repayments. If we compare these figures with those at the beginning of the 2008 property crash, we can see mortgage repayments were very similar, at roughly 51%.

If history repeats itself, then these two factors could suggest that the London house market is on the verge of a sharp fall.

housing2-1h2fp61.jpg

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Put the red line up to 4 and any kind of affordability has gone out the window !!!!

Put it to 3 and we're back to bank collapses

Put it to 2 and we see mass repo's

Put it to 1 and the housing market collapse.

Put it an 0.5 and you're prolonging the agony and stoking up problems for the very near future :blink:

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Guest unfunded_liability

His entire argument is based on house price-earnings ratio and salary-to mortgage payments ratio. If these ratios were important in the current paradigm the housing market would have collapsed long ago.

No mention of private and corporate BTL, beds in sheds, 20 sharers per house, hot foreign cash raising prices, or UK property seen as the prettiest horse in the global financially-repressed glue factory.

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His entire argument is based on house price-earnings ratio and salary-to mortgage payments ratio. If these ratios were important in the current paradigm the housing market would have collapsed long ago.

No mention of private and corporate BTL, beds in sheds, 20 sharers per house, hot foreign cash raising prices, or UK property seen as the prettiest horse in the global financially-repressed glue factory.

Well no because the current mortgagee is spending just 37% of earnings on mortgage payments (because of the low rates), which is fairly 'normal' historically speaking. By your logic the low rates have little affect on the low number of defaulters and repossessions which is absurd.

Foreign cash is a factor such but it's a thinly traded market, it won't take that many defaulting Londoners for the market to shift. Despite the frictionless, weightless money from overseas, real people still live in London and they have real mortgages to pay.

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Guest unfunded_liability

Well no because the current mortgagee is spending just 37% of earnings on mortgage payments (because of the low rates), which is fairly 'normal' historically speaking. By your logic the low rates have little affect on the low number of defaulters and repossessions which is absurd.

Foreign cash is a factor such but it's a thinly traded market, it won't take that many defaulting Londoners for the market to shift. Despite the frictionless, weightless money from overseas, real people still live in London and they have real mortgages to pay.

I did say "in the current paradigm", which includes record low interest rates maintained through QE.

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Well no because the current mortgagee is spending just 37% of earnings on mortgage payments (because of the low rates), which is fairly 'normal' historically speaking. By your logic the low rates have little affect on the low number of defaulters and repossessions which is absurd.

Foreign cash is a factor such but it's a thinly traded market, it won't take that many defaulting Londoners for the market to shift. Despite the frictionless, weightless money from overseas, real people still live in London and they have real mortgages to pay.

You're missing one crucial point....These figures are based on the incomes stated when the loans were taken out... it was ( and might possible still be ) possible to take out loan by lying, these are termed, LIAR LOANS.

Also, I'd expect a fair chunk of new lending quickly switches to interest only.

Lastly, no young person in their right mind are buying houses now, it's all "savvy investors"...these invesments tend to send void 5 weeks year, making them less affordable.

The article is right, the London bubble is about to pop, not sure their reasoning is as cynical as mine though.

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Guest unfunded_liability

You're missing one crucial point....These figures are based on the incomes stated when the loans were taken out... it was ( and might possible still be ) possible to take out loan by lying, these are termed, LIAR LOANS.

Also, I'd expect a fair chunk of new lending quickly switches to interest only.

Lastly, no young person in their right mind are buying houses now, it's all "savvy investors"...these invesments tend to send void 5 weeks year, making them less affordable.

The article is right, the London bubble is about to pop, not sure their reasoning is as cynical as mine though.

Sadly I personally know several young'uns and anecdotally several more who are desperate to buy their first property, which they see spiraling ever further from their reach. BOMAD feature heavily in their deposit finances.

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Sadly I personally know several young'uns and anecdotally several more who are desperate to buy their first property, which they see spiraling ever further from their reach. BOMAD feature heavily in their deposit finances.

BOMAD must be MAD. BOMAD will not be bailed out in the way B's were.

Parents using their unearned equity to keep the pyramid going is a sure sign on the sustainability of the whole thing and that they are self-ponzi-fying the housing market.

Edited by TheCountOfNowhere

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BOMAD must be MAD. BOMAD will not be bailed out in the way B's were.

Parents using their unearned equity to keep the pyramid going is a sure sign on the sustainability of the whole thing and that they are self-ponzi-fying the housing market.

Sooner or later even BOMAD will not be enough; I do not think it can raise longer than 6 months. And HtB2 is at least 4.5% and going only up.

Chelsea and Kensington.jpg

Hackney.jpg

post-7729-0-67269000-1389282043_thumb.jpg

post-7729-0-68147800-1389282054_thumb.jpg

Edited by Damik

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Sooner or later even BOMAD will not be enough; I do not think it can raise longer than 6 months. And HtB2 is at least 4.5% and going only up.

Weeks and months now rather than months and years, if you ask me.

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BOMAD must be MAD. BOMAD will not be bailed out in the way B's were.

Parents using their unearned equity to keep the pyramid going is a sure sign on the sustainability of the whole thing and that they are self-ponzi-fying the housing market.

The Bank of Dumb and Mad.

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housing2-1h2fp61.jpg

Given 2008 was not a proper crash as it didn't represent a return to affordability (at least, not across the entire country) then the section preceeding the last proper crash in the mid-90s would seem to be more of guide as to how far mortgage (un)affordability could go before precipitating a crash :(

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Also worth considering that affordability based on monthly income/payment measures has been manipulated by the banks with extended mortgages up to terms of 35 years, plus "borrow now, worry later" IO mortgages that look more affordable than the 25 year repayment products people who bought before the madness tend to have.

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Great, but the London property market stopped being driven by homebuyers ages ago. It's mainly investment and foreign money now, so those ratios aren't really relevant.

Theoretically this could actually help drive a crash: if a small number of owner occupiers end up being unable to afford their mortgages and are forced by circumstance into distressed sales these will lower prices for the rest of the market as the notional value of any property is set by the most recent transaction prices; and as investment and foreign money will be focused on returns they will be more likely to spook and try to get out of the market, before prices fall further, than other owner occupiers would (as those who are coping with their mortgages will still need somewhere to live and will also have a greater emotional attachment to their properties than investors are likely to)

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Great, but the London property market stopped being driven by homebuyers ages ago. It's mainly investment and foreign money now, so those ratios aren't really relevant.

So basically sentiment which can change very quickly.

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Great, but the London property market stopped being driven by homebuyers ages ago. It's mainly investment and foreign money now, so those ratios aren't really relevant.

Indeed. So the CGT for foreigners will kill this market this year. Why would anyone give away 1/4 of the made profit???

Chelsea and Kensington.jpg

post-7729-0-92306300-1389470547_thumb.jpg

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