What Does a Stagnant London Property Market Mean?

London house prices aren’t exactly falling down, but they aren’t exactly rising either.  Statistics vary depending on timescale, source and the exact nature of the data, but overall the consensus of opinion is that, at the very least, the London property market is fraying at the edges.  So what does that mean in practical terms for investors?

Why is London’s property market slowing down?

In order to determine what to make of this situation from an investment standpoint, the first question to ask is: “Why is this happening in the first place?”.  There are several possible reasons and more than one could apply at once.  Let’s take a look at three of them and see what they mean for investors.

Brexit

Assuming that any slowdown in the economy is due to the prospect of Brexit may already be a cliche (or at least on the point of becoming one) but in this case, it may be a factor.  Home buying is a long-term commitment and if people are unsure of what is going to be happening in their lives over the next few years, they are more likely to put off major purchases such as houses.  Admittedly this applies across the country (and indeed the world) but London is arguably more exposed to Brexit than anywhere else in the UK due to it being the de facto headquarters of the UK’s financial services industry.

From an investment perspective – the population of London is over 8 million, the population of the UK is around 65 million.  In other words, about an eighth of the people who live in the UK make their home in London.  Barring any major shocks, it’s hard to see how this could change enough to sink the property market, which means that, over the long term, London almost certainly still has good long-term prospects.  It is up to individual investors to decide whether or not they want to commit to London for the long term or look elsewhere.

Competition from other parts of the UK

Back in the 1980s London had Margaret Thatcher, yuppies and power dressing, while the north of England had Boys from the Blackstuff, Educating Rita and Bread.  While this disparity made great fodder for comedy, it created tensions in real life and long before George Osborne formally kickstarted the Northern Powerhouse initiative, the government was using its influence to try to boost the northern economy.  Around 10 years previously, in 2004, the licence-fee-funded BBC announced its intention to move part of its production to Salford.  Fast forward to today and not only is the north of England going full steam ahead, it still has lower house prices than London, making it a very attractive destination for new companies, existing companies wishing to set up new operations and anyone for whom work is an activity rather than a place.

From an investment perspective – forget the “grim up north” jokes and take the north of England seriously as an investment destination, but remember to check any proposed investment thoroughly on its own merits before parting with your cash.

The “Olympic effect” is coming to an end

The 2012 Olympics fired the starting gun on a massive programme of regeneration in London, particularly east London and led to a huge rise in house values in certain parts of the city.  That was then, this is now.  The Olympic magic dust has settled and has become the new normal.

From an investment perspective – this is par for the course with any new infrastructure improvements, which is why astute investors tend to be interested in properties where infrastructure development is likely, but has not yet been factored into house prices.

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Finding Balance As Markets Lurch

While it’s been questioned whether or not the saying “May you live in interesting times.” is actually an English translation of an ancient Chinese curse, it’s hard to question the suggestion that the times in which we are now living are very interesting indeed.  Barely a day seems to go by without headlines commenting on how markets are reacting to the latest piece of bad news.  Sometimes these are just storms in teacups, but there are arguably four key issues which could influence investment and investors for the foreseeable (or unforeseeable) future.

Donald Trump

Say whatever you like about Donald Trump, nobody’s ever going to accuse him of being boring.  From an investment perspective, it’s worth noting that what politicians want to do and what they can actually do in reality can be very different.  For example, Trump pledged to repeal Obamacare but so far has been unable to fulfil this pledge due to political opposition (he has only managed to roll back a small part of it).

North Korea

Similar comments apply to Kim Jong-un of North Korea.  While he may, in theory, be absolute ruler of his country, the fact is that his country is a very small one surrounded by countries which are more powerful in every meaningful way and it is highly questionable how long he or his country could survive without at least some form of support from China and/or Russia.  While neither of these countries is likely to take kindly to what they perceive as U.S./U.N. interference in their area of influence, it’s to be hoped that neither actually wants open warfare either, nuclear or otherwise.

Spain

The current unrest in Catalonia should surprise nobody who has any knowledge of European history or current affairs on the continent.  Catalonia has its own identity including its own language and at this point in time it is arguably the powerhouse of Spain’s economy (although some would point to the fact that this was not always the case and highlight the fact that the 1992 Olympics received a lot of funding from the Spanish central government).  In theory, it is impossible for Catalonia to secede from Spain.  In practice, if calls for independence grow loud enough, it will be very hard for them to continue to be ignored by the EU.

Brexit

At this point in time it’s anyone’s guess what form Brexit will take.  Some people still believe there is a possibility, however slim, that it will never actually happen.  Others believe that the UK is on course for a hard Brexit.  Either could be right or we could end up with a “transitional deal” or similar which puts the UK somewhere in the middle.  Given the lack of clarity around what is going to happen, attempting to make predictions about the eventual outcome of the Brexit at the present time is arguably an exercise in futility at best and potentially dangerous to investment at worst.

Riding the winds of change to positive returns

From an investment perspective, when it comes to dealing with the winds of change, it can be worthwhile remembering that there are certain elements which remain constant in people’s lives regardless of what happens in the world around them.  For example, the need for basic necessities such as shelter, food and water will always be in demand regardless of the prevailing political winds.  This means that investments which relate to them tend to be reliable performers over the long term.  Of course, each investment still has to be analysed on its own terms for its quality and its suitability to your situation, but even in “interesting times” there is still the potential to earn good returns.

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Brexit and the costs of construction

By now the refrain is probably fairly familiar, the UK needs more homes, preferably affordable ones.  This means that homebuilding has to be a priority for any government, which could becoming a major problem for those in power if Brexit leads to a significant increase in costs for home builders.

The cost of a home is essentially dependent on three factors: the cost of the land (and associated permissions); the cost of materials and the cost of labour, which itself can be subdivided into two categories, namely the cost of human labour and the cost of equipment.  All of these costs can be influenced by government actions, but it is highly debatable whether or not any government could fully control them.

Land costs

There is little the government can do to influence the price at which landowners sell their land.  Compulsory Purchase Orders (CPOs) can only be used in very specific circumstances and even then can be hugely controversial and subject to significant delays if the landowner chooses to put up a fight.  The government can, however, influence the ease and therefore cost with which new developments can be approved and also the terms under which they are approved, e.g. what percentage of the development has to be classed as affordable housing.  It is hard to see how this, in and of itself, would be impacted by Brexit.

Material costs

It’s at this point that the question of building costs gets more interesting.  The UK is the only country in the world to use GBP, which means that if homebuilders have to import materials, then somewhere along the line a currency exchange is going to be involved, which means the value of the pound sterling becomes a factor.  If homebuilders buy in materials priced in the supplier’s currency, then they take the risk of currency fluctuations.  If homebuilders aim to negotiate to have the supplier bill them in GBP then it is to be assumed that the supplier will factor the risk of currency fluctuations into the sales price.  On top of this, there is the question of import duties.  These do lie within the government’s control and the government could, feasibly, choose to allow home builders to import the supplies they need without taxes being paid, but then they could choose to use taxes on building supplies as a bargaining chip in other trade negotiations.

Labour costs

This is where the situation gets even more interesting.  It’s probably common knowledge that the construction industry has benefitted greatly from the supply of labour from the EU, particularly eastern Europe.  In a post Brexit world, the homebuilders will first of all want to know if these people can stay and, if so, if they will want to stay.  Human nature being what it is, it’s probably a fair bet that the answer to the latter question will depend on whether or not the workers see it as being worth their while, which leads back, at least in part, to the issue of the value of the pound.

If there are issues securing human labour, then homebuilders may look to automated solutions, such as the “robot bricklayers” which are already on the market, but the economics of these will depend on various factors, again, including the value of the pound and, of course, the decision as to whether or not to impose import taxes.

It should also be noted that in addition to the economic issues, there may be practical issues, which determine whether or not automation is a feasible choice as each site has its own characteristics and small-scale builds may, literally, not be able to accommodate significant equipment.

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Brexit & The Property Market 1 Year On

The Brexit referendum of 23rd June 2016 feels like a long time ago. It took almost 10 months for Article 50 to be triggered (on the 29th March 2017). While this marked the start of the two-year negotiating period, the start of the actual negotiations was delayed by the fact that the UK parliament called a general election for 8th June 2017. Hence we now find ourselves about a year on from when Brexit was first decided and it’s interesting to take stock of the situation.

Home sales are down but is Brexit the only reason?

According to figures from HMRC, housing transactions in the second half of 2016 were 9 per cent lower than in the second half of 2015. Given the timing, it’s hard to dispute that the result of the Brexit referendum would have played a part in this. At the same time, however, it’s an open question as to whether Brexit itself was the only reason or even the main reason. Taking a step back in time, the Summer Budget of 2015 saw a change to mortgage interest relief for landlords, which had the potential to cause a significant negative impact to the finances of higher rate taxpayers who were also landlords. Shortly after this, the government also announced the “Right to Rent” scheme, which was rolled out in February 2016. Both of these changes were pre-Brexit and both could well have motivated at least some landlords to exit the market or at least reduce their portfolio, which could potentially account for at least some of the drop in transaction volume between 2015 and 2016.

House-price inflation in London stalls

Overall, London is still experiencing house-price inflation, just at a lower rate than in recent years. Again, Brexit could well be a factor in this, particularly the fact that the City is openly nervous about where it will stand in a post-Brexit world. At the same time, however, it should be noted that the 2012 Olympics led to parts of London being significantly regenerated, which caused substantial house-price inflation. During the intervening five years, these increased prices have become a new reality and there is nothing of the nature of the Olympics currently on the horizon to give house prices another boost. At the same time, successive governments have been investing in the north of England, with the Media City initiative beginning long before the concept of the Northern Powerhouse was first mooted. Northern cities such as Manchester have been experiencing house-price inflation at higher levels than London, which suggests that at least part of the slowdown in the London housing market, could be the new competition from further north.

The mortgage market carries on

Arguably the biggest shake-up of the mortgage market in recent years came in April 2014 as a result of the Mortgage Market Review. In very simple terms, lenders now have to look beyond a borrower’s headline income and analyse the real-life affordability of a loan over the long term. Given that Brexit is effectively a step into the unknown, it’s hard to see these rules changing to become less strict at any point in the near future, so in that sense, it’s likely to be business as usual regardless of what form Brexit takes (or even if it’s cancelled). Where Brexit could potentially impact the mortgage market is if it results in upward pressure on inflation. This would not only impact affordability calculations in and of itself, but also place the Bank of England under pressure to raise interest rates and therefore the cost of financing, which would probably be most unwelcome to those with existing mortgages and could potentially discourage people from entering the housing market or moving to bigger properties.

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Why Brexit Might Not Be That Bad

It’s official (almost), the wheels have been set in motion to trigger Article 50 and start the process of taking the UK out of the EU. Understandably, there has been a great deal of media coverage about what this will all mean and while, on the one hand, the future is anybody’s guess, on the other, when trying to determine what will happen, it’s often helpful to look at the fundamentals.

Fundamental 1 – London is a property market apart

London is home to the city, which has been quite open about its concerns regarding leaving the EU. Other European cities have also been quite open about their desire to lure businesses away from their London bases. There are, however, a number of reason to refrain from panicking about a property crash in London, for example:

1 – While it would probably be painful for the city to lose access to the European market, it has global reach so it is highly doubtful that the blow would be terminal.

2 – Even though London and the city are often spoken of as though they were one and the same, in actual fact there is far more to London than the city. The creative industries are one obvious example of this, as is the fact that many digital technology and other “disruptive” companies, have chosen to make London their base. These cover a broad scale from industry giants such as Apple, to niche start-ups. In principle, these companies could be lured away by other cities with equivalent infrastructure and continued access to the single market, however in practice there are a number of reasons why they should stay put.

3 – The UK has a very flexible labour market including a thriving freelance economy, which is great news for companies who need to get work completed but want to avoid the commitment of taking on employees (at least until they have a clearer idea of where they stand). It also tends to be at least relatively accommodating of disruptive business models. Paris, by contrast, has been locked in a battle with tech giant Amazon, which is unlikely to have passed unnoticed by any technology companies who may have been approached about moving there.

Fundamental 2 – The UK is an attractive export market for other countries

While some pundits have speculated that certain EU members may be prepared to sacrifice their own export potential in order to make an example of the UK and deter other countries from leaving the bloc, it’s a wide open question as to whether this would be a feasible ploy in real-world conditions. In simple terms, such an approach carries the risk of causing job losses and this may go down badly with the (voting) public. Even if such a scenario did occur, it is highly likely that other countries would look to fill the gap, which would create reciprocal export opportunities for the UK. This is important for the post-Brexit outlook of regional economies which are based on agriculture and/or manufacturing.

Fundamental 3 – Long-term value will always attract investors

While the weakening of the pound makes it more expensive to import raw materials, it also means that anything priced in sterling becomes more affordable in real terms to international buyers. This includes finished goods (for export), shares in UK-based companies and, of course, property. The fall in the value of sterling could, therefore, help to provide a short-term boost to the UK economy during and after the Brexit process. Over the long term, it is a reasonable expectation that as the UK economy stabilises, the value of sterling will rise again until it is, eventually, back to its pre-Brexit levels.

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