Housing in south London seen from above. Photo: Getty
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Five signs the London property bubble is reaching unsustainable proportions

It's not difficult to see that London is facing a house price bubble. It's harder to say when it might pop.

Ed Conway is Economics Editor of Sky News. This article first appeared on his website, and is crossposted here with his permission

One of the biggest misconceptions in economics is that it’s difficult to spot a bubble. On the contrary: spotting a bubble is actually pretty easy. The difficult thing is predicting when it’ll go pop.

So let’s not beat around the bush. London is facing a house price bubble. House prices in the capital are rising at unsustainable rates. On almost every reasonable measure of affordability (we’ll get to them in a second) London property prices are at or beyond what would normally be considered danger levels.

The sensible questions to ask now are: how long the bubble continue inflating, how will it come to an end (a pop or a long period of relative deflation) and whether it will cause systemic financial turmoil elsewhere. It’s these questions the Bank of England’s financial stability team are privately investigating as they watch the rise in regional UK house prices with a mild degree of horror.

Evidence of bubbly activity in London’s property is nothing new. We first reported on the growing gulf in house prices about a year and a half ago. About six months ago our update showed that the affordability levels in the capital were at unprecedented levels (of unaffordability).

Since then, things have only become even more pronounced. Let’s run through the evidence.

1. Prices are rising very fast

Nationwide have reported that house prices in London are rising at a rate of more than 18 per cent – the highest rate since 2003. According to the building society the gap between London and the rest is greater than it has ever been before (though it was at a historic level even before the latest iteration of its survey).

2. Prices rises are no longer just in “prime” areas

What’s particularly interesting about the numbers is that what previously looked a lot like a well-contained bubble in prime London property prices (eg the smart parts of town where overseas investors are particularly keen to buy) has spread out into other parts of the capital. Just look at the table below: the biggest increases were in Brent and Lambeth, rather than Westminster and Hammersmith & Fulham. Though Kensington & Chelsea prices are excluded from the Nationwide numbers, Land Registry data suggest house price growth has slowed there too.

However, rising prices are not, on their own, evidence of a bubble. Prices in Manchester were also rising by around 18 per cent over the past year. What makes London different is the performance of house prices in comparison with peoples’ ability to afford them. Now, there are a few ways to judge whether house prices are at sustainable levels. One is to compare them to the rise in other prices around the economy – in other words working out the real level of house prices, adjusted for inflation.

On this basis (see the above chart, which looks at real vs absolute prices in the London market since 1988), London house prices are still a touch below the levels they reached in late 2007. The recent rise looks far less pronounced. The important thing to note, however, is that remain considerably higher than they were in previous decades.

This is a useful yardstick, but a far better measure of affordability is to compare house prices with people’s earnings – after all, their capacity to afford a home will depend in large part on how much they earn. On this measure, the disparity between London and the rest (and, for that matter, history) is striking.

4. House prices vs earnings are at historic highs

According to this chart, house prices in London are now more unaffordable (compared to earnings) than ever before in recent statistical history. It’s often thought that the “safe” level for house prices vs earnings is about three times, and that once you get beyond four times you’re moving into difficult territory. These numbers show that for the first time, the average London house price is now eight times the average first-time buyer’s salary.

However, what this measure doesn’t show you is the impact lower interest rates have had on families’ mortgage payments. The Bank of England has cut Bank rate to 0.5 per cent; mortgage costs have fallen sharply in the past year or so thanks in part to Funding for Lending. And as a result, even though the absolute level of house prices is higher than ever before, is higher than ever before vs salaries and the necessary mortgage amounts are greater than ever before, the monthly mortgage burden faced by most first-time buyers is not.

5. Mortgage burden hardly dropped in London

This chart shows you mortgage payments as a percentage of take-home pay by region. As you can see, mortgage payments still account for an average of more than half of first-time buyers’ salaries, but this is considerably lower than in 2007 or, for that matter, the late 1980s. It’s this chart that many people refer to when arguing that house prices at their current levels remain sustainable. The problem with this argument is it ignores the fact that whereas in most periods when the mortgage burden was 50 per cent or more Bank rate was close to 5 per cent (or double that in the early 1990s), it is currently at a 320-year low. The only way is up.

Moreover, what’s striking in this chart, and in most of the others above, is how different the London story is to the rest of the country. Housing affordability in the capital is at its worst level ever, on most metrics. Even on the mortgage burden metric it is far, far above most of the rest of the UK, and never fell as much as it did in previous corrections.

It was possible to argue, until relatively recently, that this was merely a “prime central London” phenomenon – money rolling in from overseas investors to pay for nice, sparkling new apartments in Battersea. Not any more: prices across the capital are rising at unsustainable levels – not just in prime areas. There is growing evidence that households in London are having to take on unprecedented levels of debt to stay afloat – almost a fifth of new mortgages being taken out in London are for more than 4.5 times the buyer’s salary.

In other words, this is already a systemic financial problem. The London bubble has been growing for some time (and, by the way, Help to Buy is likely only to have had a marginal effect on this phenomenon, though it certainly won’t help). Other prices of the UK may well face their own bubbles, but right now they are not in that kind of territory. So contrary to what some commentators claim, there is no nationwide bubble. London is another matter entirely.

House prices in the capital cannot keep rising at this rate. At some point, either buyers will be unable to afford property or investors will be unwilling to accept falling yields (they’re already coming down) and will realise capital appreciation can’t carry on forever (whatever currency you’re buying in). However, saying all of the above is no guide as to when the moment of capitulation will come. No-one knows. It could be months; it could be another few years. The path will depend in large part on which party wins next year’s election and whether the winner imposes a mansion tax. It will depend on when interest rates go up and how quickly. 

Either way, it’s high time the Bank of England, and, for that matter, the Government, put a little bit more time into thinking whether they need more tools to try to deflate the capital’s bubble safely and smoothly, without making the rest of the UK’s regions suffer.

Ed Conway is Economics Editor of Sky News. This article first appeared on his website, and is crossposted here with his permission

Ed Conway is the Economics Editor for Sky News. He tweets @EdConwaySky and his website can be found here.

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Air pollution: 5 steps to vanquishing an invisible killer

A new report looks at the economics of air pollution. 

110, 150, 520... These chilling statistics are the number of deaths attributable to particulate air pollution for the cities of Southampton, Nottingham and Birmingham in 2010 respectively. Or how about 40,000 - that is the total number of UK deaths per year that are attributable the combined effects of particulate matter (PM2.5) and Nitrogen Oxides (NOx).

This situation sucks, to say the very least. But while there are no dramatic images to stir up action, these deaths are preventable and we know their cause. Road traffic is the worst culprit. Traffic is responsible for 80 per cent of NOx on high pollution roads, with diesel engines contributing the bulk of the problem.

Now a new report by ResPublica has compiled a list of ways that city councils around the UK can help. The report argues that: “The onus is on cities to create plans that can meet the health and economic challenge within a short time-frame, and identify what they need from national government to do so.”

This is a diplomatic way of saying that current government action on the subject does not go far enough – and that cities must help prod them into gear. That includes poking holes in the government’s proposed plans for new “Clean Air Zones”.

Here are just five of the ways the report suggests letting the light in and the pollution out:

1. Clean up the draft Clean Air Zones framework

Last October, the government set out its draft plans for new Clean Air Zones in the UK’s five most polluted cities, Birmingham, Derby, Leeds, Nottingham and Southampton (excluding London - where other plans are afoot). These zones will charge “polluting” vehicles to enter and can be implemented with varying levels of intensity, with three options that include cars and one that does not.

But the report argues that there is still too much potential for polluters to play dirty with the rules. Car-charging zones must be mandatory for all cities that breach the current EU standards, the report argues (not just the suggested five). Otherwise national operators who own fleets of vehicles could simply relocate outdated buses or taxis to places where they don’t have to pay.  

Different vehicles should fall under the same rules, the report added. Otherwise, taking your car rather than the bus could suddenly seem like the cost-saving option.

2. Vouchers to vouch-safe the project’s success

The government is exploring a scrappage scheme for diesel cars, to help get the worst and oldest polluting vehicles off the road. But as the report points out, blanket scrappage could simply put a whole load of new fossil-fuel cars on the road.

Instead, ResPublica suggests using the revenue from the Clean Air Zone charges, plus hiked vehicle registration fees, to create “Pollution Reduction Vouchers”.

Low-income households with older cars, that would be liable to charging, could then use the vouchers to help secure alternative transport, buy a new and compliant car, or retrofit their existing vehicle with new technology.

3. Extend Vehicle Excise Duty

Vehicle Excise Duty is currently only tiered by how much CO2 pollution a car creates for the first year. After that it becomes a flat rate for all cars under £40,000. The report suggests changing this so that the most polluting vehicles for CO2, NOx and PM2.5 continue to pay higher rates throughout their life span.

For ClientEarth CEO James Thornton, changes to vehicle excise duty are key to moving people onto cleaner modes of transport: “We need a network of clean air zones to keep the most polluting diesel vehicles from the most polluted parts of our towns and cities and incentives such as a targeted scrappage scheme and changes to vehicle excise duty to move people onto cleaner modes of transport.”

4. Repurposed car parks

You would think city bosses would want less cars in the centre of town. But while less cars is good news for oxygen-breathers, it is bad news for city budgets reliant on parking charges. But using car parks to tap into new revenue from property development and joint ventures could help cities reverse this thinking.

5. Prioritise public awareness

Charge zones can be understandably unpopular. In 2008, a referendum in Manchester defeated the idea of congestion charging. So a big effort is needed to raise public awareness of the health crisis our roads have caused. Metro mayors should outline pollution plans in their manifestos, the report suggests. And cities can take advantage of their existing assets. For example in London there are plans to use electronics in the Underground to update travellers on the air pollution levels.

***

Change is already in the air. Southampton has used money from the Local Sustainable Travel Fund to run a successful messaging campaign. And in 2011 Nottingham City Council became the first city to implement a Workplace Parking levy – a scheme which has raised £35.3m to help extend its tram system, upgrade the station and purchase electric buses.

But many more “air necessities” are needed before we can forget about pollution’s worry and its strife.  

 

India Bourke is an environment writer and editorial assistant at the New Statesman.