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Deutsche Bank: We Can Already See How London's Insane Property Bubble Will End

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I don't see any references to this fascinating research piece from Deutsche Bank so decided to post it.

http://uk.businessinsider.com/deutsche-bank-calls-the-top-on-londons-insane-property-bubble-2015-10?r=US&IR=T

It's in a PDF here on page 29

http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000368569/Konzept_Issue_06.pdf

Deutsche Bank has called the top of London's runaway housing market in a blisteringly pessimistic note sent to clients on Thursday.

In the bank's sixth "Konzepts" paper, Sahil Mahtani argues that a combination of rising interest rates, the Bank of England's tinkering with the market, and the increasing "politicisation of the housing issue" means London's insane price rises can't continue — and price falls could be likely.

What's more, Mahtani argues there are "multiple catalysts to suggest that 2015 is the turning point" and concludes ominously: "London’s property is unlikely to enjoy the next thirty years as it did the last."

The rise

Mahtani begins by illustrating just how spectacular the rally in London property prices has been over the last few years, with some stunning facts:

  • Every £1 invested in London property in 1990 is now worth £5, double the performance of the FTSE 100.
  • In the last sixty years, London house prices have only fallen 3 times: during the Volcker recession of the early-1980s; the sterling crisis of 1992; and the 2009 financial crash.
  • Conservative estimates put average London house prices at 13 times average gross incomes.
  • London residential mortgage debt amounts to a quarter of the country’s total.

London's housing market is huge, expensive, and hot. It's not hard to find stories of property insanity in the capital and popular opinion holds that its a flood of foreign investors buying up homes and leaving them empty to accumulate value that has sparked the boom.

Mahtani says it's simple supply and demand — the supply of homes has failed to keep pace with demand from buyers, be they foreign or otherwise.

But crucially Mahtani sees a second, overlooked factor for spiraling prices — buyers believe house prices will keep going up. People are willing to pay silly prices on the expectation prices will keep rising and they can cash in themselves later. That in turn bids up prices.

The fall

But the second cause is a worryingly self-fulfilling practice that isn't sustainable. What's more, Mahtani thinks economists are underestimating just how much perception effects prices.

He points to the Hong Kong property crash of 1997, when prices dropped 40% in just over a year, as evidence for what happens when the wind changes direction on public opinion.

Here's Mahtani:

A shift in expectations about future supply was much more instrumental in bringing about the downturn. The post-handover government had made it known that it would welcome a decline in property prices and would increase supply by 85,000 units a year. In retrospect, at no point during the next five years did housing completions reach 35,000 annually. Yet because the decision had credibility, it changed expectations and the 85,000 figure is still cited today as a reason for the market decline. The government announcement precipitated a change in psychology that diminished the speculative increment in the market.

It didn't matter that supply increased nowhere near as much as promised — the "psychology" had changed and that was enough to send buyers running.

Interest rates are bound to rise soon in the UK which will take out a lot of the momentum in the property sector. But Mahtani believes something similar to Hong Kong could also happen in the UK, caused by state and Bank of England intervention.

Mahtani says the Bank of England is beginning to see housing "more like a utility and less like a financial asset," because Governor Mark Carney sees mortgage lending as a key component of bank stability and the wider financial system.

That makes it more likely the Bank will put in place more measures to rein in certain lending and buying practices. This will likely have an outsized impact on London because of its huge weighting in UK property debt. Here's Mahtani:

The most advanced practitioners of macroprudential policy are Hong Kong and Singapore where loan-to-values for buy-to-let properties are capped at 50 per cent, foreign purchases of property are hit with 15 per cent stamp duty and second and third home buyers face differentiated, punitive treatment. In this approach, housing becomes more like a utility and less like a financial asset. The Bank of England appears to be moving in this direction.

Secondly, and perhaps most importantly, housing is growing issue for both the left and the right. Only 40% of today’s 25- to 34-year-olds own homes, compared with two-thirds in 1991, and Mahtani says both parties are trying to address this in a bid to win over the next generation of voters.

2787717300_464c8a4ca6_b.jpgflickr: muddyclayThe redevelopment of Battersea Power Station is one of the most high-profile residential developments in London.

The Conservatives have already moved to increase stamp duty at the top of the market and cut tax benefits for buy-to-let landlords, which has taken some of the air out of the top of the market. This could be just the start.

Mahtani argues that the more house prices rise out of step with earnings, the more it will "sow the seeds of its own correction" by increasing resentment and discontent amongst would-be home owners.

He says: "The fate of house prices may well be decided in the political face-off between younger voters and the elderly harnessing their political power to prevent price declines to their house-cum-pensions."

Ultimately, Mahtani says, we may have reached a point where "policy intervention will favour stabilising or reducing prices."

The aftermath

If you're a would-be buyer, all this is great news. But for people who have recently bought it's another story.

As in Hong Kong, Mahtani thinks that even if policy intervention is only meant to put a lid on things, it could end up sending prices into reverse.

He says: "Again, all that needs to happen is for investors to think price outcomes are asymmetric, with low upside and large downside." In this way a self-fulfilling cycle in the opposite price direction could emerge.

Homeowners would then find themselves in negative equity, freezing much of the market as people sit on their property until the price gets above water again.

Another issue is interest-only mortgages. Mahtani writes: "Over a third of those with mortgages have interest-only loans, with the first sizeable wave of principal repayments due in 2017-2018." That could lead to a wave of repossessed homes, again driving prices down.

Mahtani says that ultimately it's "a losing battle to call an end to the froth in this market. But perhaps we are close to the turning point."

In short, either prepare for more afforadability or brace for impact because London's property market is heading for a big shake-up, according to Deutsche Bank.

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I don't see any references to this fascinating research piece from Deutsche Bank so decided to post it.

http://uk.businessinsider.com/deutsche-bank-calls-the-top-on-londons-insane-property-bubble-2015-10?r=US&IR=T

It's in a PDF here on page 29

http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000368569/Konzept_Issue_06.pdf

Deutsche Bank has called the top of London's runaway housing market in a blisteringly pessimistic note sent to clients on Thursday.

In the bank's sixth "Konzepts" paper, Sahil Mahtani argues that a combination of rising interest rates, the Bank of England's tinkering with the market, and the increasing "politicisation of the housing issue" means London's insane price rises can't continue — and price falls could be likely.

What's more, Mahtani argues there are "multiple catalysts to suggest that 2015 is the turning point" and concludes ominously: "London’s property is unlikely to enjoy the next thirty years as it did the last."

The rise

Mahtani begins by illustrating just how spectacular the rally in London property prices has been over the last few years, with some stunning facts:

  • Every £1 invested in London property in 1990 is now worth £5, double the performance of the FTSE 100.
  • In the last sixty years, London house prices have only fallen 3 times: during the Volcker recession of the early-1980s; the sterling crisis of 1992; and the 2009 financial crash.
  • Conservative estimates put average London house prices at 13 times average gross incomes.
  • London residential mortgage debt amounts to a quarter of the country’s total.

London's housing market is huge, expensive, and hot. It's not hard to find stories of property insanity in the capital and popular opinion holds that its a flood of foreign investors buying up homes and leaving them empty to accumulate value that has sparked the boom.

Mahtani says it's simple supply and demand — the supply of homes has failed to keep pace with demand from buyers, be they foreign or otherwise.

But crucially Mahtani sees a second, overlooked factor for spiraling prices — buyers believe house prices will keep going up. People are willing to pay silly prices on the expectation prices will keep rising and they can cash in themselves later. That in turn bids up prices.

The fall

But the second cause is a worryingly self-fulfilling practice that isn't sustainable. What's more, Mahtani thinks economists are underestimating just how much perception effects prices.

He points to the Hong Kong property crash of 1997, when prices dropped 40% in just over a year, as evidence for what happens when the wind changes direction on public opinion.

Here's Mahtani:

A shift in expectations about future supply was much more instrumental in bringing about the downturn. The post-handover government had made it known that it would welcome a decline in property prices and would increase supply by 85,000 units a year. In retrospect, at no point during the next five years did housing completions reach 35,000 annually. Yet because the decision had credibility, it changed expectations and the 85,000 figure is still cited today as a reason for the market decline. The government announcement precipitated a change in psychology that diminished the speculative increment in the market.

It didn't matter that supply increased nowhere near as much as promised — the "psychology" had changed and that was enough to send buyers running.

Interest rates are bound to rise soon in the UK which will take out a lot of the momentum in the property sector. But Mahtani believes something similar to Hong Kong could also happen in the UK, caused by state and Bank of England intervention.

Mahtani says the Bank of England is beginning to see housing "more like a utility and less like a financial asset," because Governor Mark Carney sees mortgage lending as a key component of bank stability and the wider financial system.

That makes it more likely the Bank will put in place more measures to rein in certain lending and buying practices. This will likely have an outsized impact on London because of its huge weighting in UK property debt. Here's Mahtani:

The most advanced practitioners of macroprudential policy are Hong Kong and Singapore where loan-to-values for buy-to-let properties are capped at 50 per cent, foreign purchases of property are hit with 15 per cent stamp duty and second and third home buyers face differentiated, punitive treatment. In this approach, housing becomes more like a utility and less like a financial asset. The Bank of England appears to be moving in this direction.

Secondly, and perhaps most importantly, housing is growing issue for both the left and the right. Only 40% of today’s 25- to 34-year-olds own homes, compared with two-thirds in 1991, and Mahtani says both parties are trying to address this in a bid to win over the next generation of voters.

2787717300_464c8a4ca6_b.jpgflickr: muddyclayThe redevelopment of Battersea Power Station is one of the most high-profile residential developments in London.

The Conservatives have already moved to increase stamp duty at the top of the market and cut tax benefits for buy-to-let landlords, which has taken some of the air out of the top of the market. This could be just the start.

Mahtani argues that the more house prices rise out of step with earnings, the more it will "sow the seeds of its own correction" by increasing resentment and discontent amongst would-be home owners.

He says: "The fate of house prices may well be decided in the political face-off between younger voters and the elderly harnessing their political power to prevent price declines to their house-cum-pensions."

Ultimately, Mahtani says, we may have reached a point where "policy intervention will favour stabilising or reducing prices."

The aftermath

If you're a would-be buyer, all this is great news. But for people who have recently bought it's another story.

As in Hong Kong, Mahtani thinks that even if policy intervention is only meant to put a lid on things, it could end up sending prices into reverse.

He says: "Again, all that needs to happen is for investors to think price outcomes are asymmetric, with low upside and large downside." In this way a self-fulfilling cycle in the opposite price direction could emerge.

Homeowners would then find themselves in negative equity, freezing much of the market as people sit on their property until the price gets above water again.

Another issue is interest-only mortgages. Mahtani writes: "Over a third of those with mortgages have interest-only loans, with the first sizeable wave of principal repayments due in 2017-2018." That could lead to a wave of repossessed homes, again driving prices down.

Mahtani says that ultimately it's "a losing battle to call an end to the froth in this market. But perhaps we are close to the turning point."

In short, either prepare for more afforadability or brace for impact because London's property market is heading for a big shake-up, according to Deutsche Bank.

true, and it's very nice of deutsche bank to point this out.it is not exactly news.

deutsche's exposure to derivatives is rather more important.

UK housing market valuation is about £5Trn I think.

Deutcshe derivatives exposure(i hasten to add that this is just one bank) is estimated between $2 and $75 Trn.....even a halfway house on this figure is $30Trn( or £20Trn)..that is collossal.

imagine what a 40% write-down on that will look like if we are going to see a rise in interest rates.

even a small nudge up will send the speculators fleeing,and take 20% off the value in a matter of a month.....and that is a liquid market, values could easily plunge like the nasdaq.

Edited by oracle

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I suppose everyone is guessing - his guesses are as valid as any other.

My guess is that when push comes to shove they'll do anything to maintain the value of assets (which is pretty much means house prices) - I don't think they have the option of gradual deflation any more - I'd go so far to say that they'd be more likely to let the currency crash than asset prices.

But I really don't know anything... Maybe Carney is poised to increase interest rates and destroy the pensions of all those BLTers. Who knows.

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Mark 'i see a wolf' Carney has been saying rates will rise for months and months and months and months now and before that Merv was saying rates will rise 'soon' in 2011.

GDP 'growth' rate falling so the recovery that was not strong enough for rates to rise, is not as strong as it was before when rates could not rise because the recovery was not strong enough. Rates are more likely to fall unless the recovery improves so we really need some 'new QE' to stimulate GDP growth.

Beat me to it. Absolutely no chance of them raising rates for the forseeable, more likely cut. We are in "suspension of reality" mode. Needs some kind of massive external shock to force a change.

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the prices are so insane now it won't take a rate rise to collapse prices. the smallest of events could now spark a calamity.

prices want mad in the last 2 years, people for some reason don't think prices can come down to a lever they were at for 5 years.

wishful thinking is a wonderful thing, until your fairy godmother tells you to wake up.

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true, and it's very nice of deutsche bank to point this out.it is not exactly news.

deutsche's exposure to derivatives is rather more important.

UK housing market valuation is about £5Trn I think.

Deutcshe derivatives exposure(i hasten to add that this is just one bank) is estimated between $2 and $75 Trn.....even a halfway house on this figure is $30Trn( or £20Trn)..that is collossal.

imagine what a 40% write-down on that will look like if we are going to see a rise in interest rates.

even a small nudge up will send the speculators fleeing,and take 20% off the value in a matter of a month.....and that is a liquid market, values could easily plunge like the nasdaq.

Over-priced property is normally the issue that causes economic crises. The nominal value of banks' derivatives is an irrelevant sideshow which whips up too many into a state of excitement (the nominal value of DB's derivative book is probably closer to $2tn for what it's worth, with a net value of about $50M or so, I reckon).

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the prices are so insane now it won't take a rate rise to collapse prices. the smallest of events could now spark a calamity.

prices want mad in the last 2 years, people for some reason don't think prices can come down to a lever they were at for 5 years.

wishful thinking is a wonderful thing, until your fairy godmother tells you to wake up.

Totally agree. I can't see rates rising for a very long time but house prices have risen to the point where it is clearly unsustainable regardless

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The points I found interesting were:

1. On average, quoted UK mortgage rates increase by

around 50 basis points in response to a 100 basis point increase
in US swaps. Counterintuitively, the US tightening cycle will hurt
British households more than their American counterparts that
rely on long-term fixed rate mortgages.
So if the Fed starts tightening, the UK will be quickly dragged along with it
2. In any case, physical supply and demand
mismatches are often a poor indicator for future house price
moves. This follows from the fact that housing is not only a durable
consumption good but also a financial asset, and is therefore
influenced by future price expectations and financing, as much
as by physical supply.
He's effectively saying most of the market is driven by sentiment and the expectation of increasing prices. If that's punctured then the whole edifice can quickly collapse.
I believe vested interests within the UK political and financial establishment will seek to prevent any crash but an external event could upset the applecart. Or perhaps in their attempts to dampen the boom, they will miscalculate and tip things too far, causing a much bigger move than anticipated.

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It is at the point now where even a 50% fall in asking prices would still not actually see sane prices.

In Cambridge ONE MILLION POUNDS gets you a terraced new build in a not great location

http://www.rightmove.co.uk/new-homes-for-sale/property-55561805.html

It's got to the stage where the heroin addict will either die from the methadone they're been prescribed for far too many years or the cold turkey will as good as kill them. They had the chance to wean the junkie off heroin 7 years ago, but they took the option that makes the junkie happy by keeping them high instead of the tricky option of curing them.

The tyranny of the majority is little better than the tyranny of the likes of Stalin or Hitler but is far more subtle, people vote for what in the long term might not be in their own best interests but keeps them happy now whilst sacrificing others. It's like getting Turkeys to vote for Christmas by telling them they'll take centre stage at a Turkey dinner on the 25th December, which sounds very tempting when you don't realise they'll be eating you.

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Exactly,it has come to a point now that good news or bad news irrespective the prices would fall nonetheless ,they are so out of touch with reality.Was on a Job advert site today and companies are still paying very much the same what they were paying 5 years ago,so don't understand who is going to pay these prices and for how long,the longer 2007 + 30% runs on, the more the ppl sucked into it and the greater the shock one reality dawns.avoid property like the bubonic plague right now.

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And just to add with the impending job cuts,economic deceleration and slower/negative growth,it is even more inconceivable that 2007+30% could sustain much longer rate hike or rate cut. The rates are already next to nil,so how much negative could BOE go.Carney,Osborne et al can't do nothing abt this as the story unfolds,it also remains to be seen if Osborne has any interest in sustaining the London mega bubble any longer,after all the young now are going to be 5 years elder by the next election and no political leader can afford to ignore such a vast segment of voters all wanting hpc.

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Lastly sentiment is the biggest driver of them all ,once prices start falling everybody is going to rush for cover.property ain't going to be hot property anymore, we need to remember it is the same country which could not withstand 2007 prices at 5% and nothing has changed at a fundamental level since then ,we just need to bide our time patiently,time to buy will come but now ain't the right time ,especially within M25

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It hasn't sold yet, but you can sense the panic, last sold prices for 2014-2015 in the same complex are all hovering around the 600-900K mark, though I wasn't able to check for exact specifications.

It wouldn't be a surprise at all if this comes down another 100K, at which level it should be at the same level as it was in 2011-2012.

Remember it is widely known fact now that the prime central London volumes are at as low a level as in 2009. The rats are leaving the sinking ship, and nobody wants to jump on to rescue it.

The law of gravity applies everywhere, the rate of descent is far greater than the rate of ascent.

The irony of this fall is that 550K for a single bed is still utterly, utterly ridiculous.

200K and I could be interested.

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Half a million quid for a boxy one bed flat with a bedroom so small you can hardly fit a bed into it and a kitchen in the living room. That is the price after recent reductions too! What utter insanity. Who is buying this?

http://www.rightmove.co.uk/property-for-sale/property-35989266.html

That place comes with so many multiple mirrors giving infinite repeating reflections I dread to think what effect it could have on someone with a schizoid personality.

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Totally agree. I can't see rates rising for a very long time but house prices have risen to the point where it is clearly unsustainable regardless

I've recently turned down work in London due to cost/time of commute or cost of moving to London.

repeat that a few thousand times and the place is going to collapse.

the best bit is, when London collapses so will the shires

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I was back in Cambridge again today, it is very similar to London but in miniature and prettier.

I have been saying the insanity in Cambridge will come to an end for years now, but every time I am there something proves me wrong.

The building there has now gone supersonic, every run down area, dilapidated building or any home that can be knocked down and grown or doubled or better is being done. There are luxury pads now that only the Chinese and Arabs are buying now, and there a many of the so called slave labour eastern europeans who are now getting in on the act.

After leaving today I told myself I just do not understand finance or debt or investment anymore, and I have no understand of human behavior, how is this happening.

weird, since Cambridge was particularly hit hard in 2008 pm chances are it will be hammered soon.

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