London Calling: Bad News For Home Buyers

The demand for housing in London has outstripped supply since the post-war period, making housing unaffordable to a majority of the city’s low and middle-income families. And although the house price growth of the last two decades has reversed itself recently, it is far from clear that London’s housing problems are in any way diminished. The opportunities for first-time buyers to get into the game may be worse than at any time in recent decades.

In some ways, the London housing market is unique. The buy-to-let market is almost entirely dominated by private individuals, rather than by big investment funds. For instance, in 2006, two-thirds of the buyers of new private homes in the city were mostly small investors, and the remaining were owner-occupiers. Over half of the buyers are UK-nationals; the rest are of foreign origin. Overseas buyers have been attracted by the idea of holding investments in Sterling, a currency historically seen as stable and appreciating. For instance, South Africans have been enthusiastic investors in London housing as a hedge against the Rand. The city is made up of 3 million dwellings, most of which were built before the 2nd World War, and so the market is almost entirely for second-hand property . In fact, newly built housing in any year constitutes less than half a percent of total stock in London.

The city is also unusual in that most Londoners are 20 to 39 year-olds. The city’s in-migrants tend to be young, while out-migrants are likely to be older. As a result, not only has the number of households been growing faster than the overall population, but the average size of the household has been falling. The supply of three or more bedroom-flats has shrunk rapidly as a proportion of total supply; it fell to 14% in 2007-08, less than half the level 10 years ago. The supply of new one and two bedroom flats, however, has mushroomed over the same period. This trend is set to continue: of the 570,000 to 710,000 additional households that London will have by 2026, three quarters will be single person households.

Initial evidence that sub-prime mortgages were defaulting in greater and greater numbers in the United States in February’07 did not seem to have an impact on the UK housing market up until November of that year. The following months witnessed the crash of house prices, which continued their free fall into the final quarter of 2008. According to the Department of Communities and Local Government, properties in the UK lost a record 11.5% of their value over the year ending January’09, although the rate of house price deflation eased slightly in the last quarter. In London, house prices fell by 16% over the same period (the average house price in Greater London is 53% above the UK average).

Prior to that, the United Kingdom enjoyed a major house price boom for a decade. Growth was fueled primarily by low interest rates, which kept the costs of mortgage finance low, and by shortages in the property market. Financial deregulation and the entry of banks into the mortgage market in the 1980s and 90s meant increased competition and easy availability of mortgage finance. Add to this stable and growing employment in the city, rising incomes and expectations that interest rates would remain low, and the house price boom was hardly surprising. The boom meant that housing became increasingly unaffordable for Londoners.

But even the recent recession-related fall in house prices and the slump in sales have not necessarily translated into better opportunities to get a foot on to the housing ladder. On the contrary, the current credit crunch is compounding the problem. Falls in house prices in recent months have been accompanied by tightening of mortgage access criteria. Even if a mortgage can be obtained, average deposits and payments remain much higher than average incomes. The average first-time buyer needed to borrow 3.27 times their average income (joint or individual) in 2008, as compared to an income multiplier of 2.42 in 2000, or 2.31 in 1990. Research also shows that Londoners are increasingly dependent on help from family, since deposits can be prohibitive.

Recent analysis by the Royal Institute of Chartered Surveyors concludes that despite falling prices, London has seen the largest deterioration in housing market accessibility of any region, as would-be-buyers struggle to find deposits or secure affordable mortgages. Indeed, the volume of first-time buyers was 55% lower in August’08 as compared to a year ago, and it seems that in recent months they have been shut out of the housing market in growing numbers. A quarter fewer first time buyers are accessing the market now than at the bottom of the housing market crisis in the early 1990s, and levels are at their lowest for 30 years.

Although 80% of the housing in the UK is sold on the private market, the government plays an important role by intervening in the market through the provision of social housing, provided through housing associations or registered social landlords. There has been a dramatic surge in the demand for social housing as the recession has started to bite: the housing waiting lists have grown. According to the National Housing Federation, an additional 80,000 are expected to lack a home owing to recession-related repossessions and unemployment.

However, there are a few encouraging signs. According to government figures published in December’08, the number of new homes being constructed in London did not fall as much as one might have expected as a result of the credit crunch. This is heartening, seeing that house builders have been hit by lower prices, restricted demand, severe problems accessing credit and rising construction costs.

And surprisingly, according to primelocation.com, house prices in four of the five prime areas in London actually rose in February’09. Central London (3.24%) and West/South-West London (2.84%) saw the highest increase, although prices for property outside of London continued to free fall. The reasons for the rise could be a recent jump in sales. The investor interest pick up might be the result of yields on property rental looking attractive compared to record-low interest rates.

Rising rents, falling house prices and a potential glut of unsold new market homes can also provide an improved investment opportunity to larger institutions. In his Economic Recovery Plan, announced in December’08, the Mayor of London, Boris Johnson, put aside GBP 5 billion to be channeled into increasing the stock of affordable housing. The funds are also targeted at Londoners who are threatened with repossession, and to help would-be first-time buyers become home owners.

For the time being, the private rental sector has absorbed the re-directed demand from the housing market, as more people delay buying a home in the current climate of uncertainty. Rents in London have been strong, in some cases even rising over the last few months, especially in the face of diminishing supply of buy-to-let housing. And although the change in average price from Feb-March’09 for central boroughs in London was positive, some of the outlying London boroughs continued to experience falling house prices. Since movements in house prices in London tend to anticipate those across the United Kingdom, these changes provide an indication of what the rest of the country may expect very soon.

Megha Mukim is currently reading for a PhD at the London School of Economics. Prior to this she was a visiting fellow at the MacMillan Center for International and Area Studies at Yale University.