Is there a bubble in London property prices?


  • Author: John Fry
  • Date: 29 May 2014
  • Copyright: Image appears courtesy of iStock Photo

Recent house price rises have led many to question whether or not London property prices are sustainable. Whilst recent price hikes do look dramatic, they need to be discounted against inflation to obtain a more complete picture [1]. However, an inescapable truth is that when viewed against earnings, London house prices begin to look increasingly unaffordable. The average London house price is now eight times the average first-time buyer’s salary [2]. In addition there are also wider concerns about the sustainability of the mortgage market, and the stability of the system as a whole, in the light of a likely interest rate rise [2].

thumbnail image: Is there a bubble in London property prices?

Housing and stock market bubbles loom large in the recent memory. As we have seen, house prices can have a disproportionately large effect upon the banking sector and upon the health of the wider economy as a whole. However, it is important to recognise that bubbles are not a purely financial phenomenon. Television programmes, websites, newspapers and books all reflect an important social dimension to the story and pay testament to the United Kingdom’s national obsession with house prices. Amidst all the excitement, it is all too easy to forget that bubbles can cause a lot of human misery – even before they burst. House price rises over the last decade mean that many ordinary people, especially in London but also in other parts of the United Kingdom, have been priced off the property ladder. Furthermore, it is also important to recognise that house prices in London may also have a knock on effect on house prices in other parts of the country (some peculiarities of the London property market notwithstanding).

A commonly expressed view is that London prices have been distorted by a massive influx of foreign capital [3]. There is thus a sense in which London is an international city and so its property market may be fundamentally different to other parts of the United Kingdom. In the light of the government’s recent Help to Buy Scheme, there are also concerns that increased numbers of first time buyers and easier access to mortgages have also contributed to the heating up of the market. At a fundamental level, increased reliance upon credit may also make the housing market more unsustainable in the long term. House price rises over the past year exceed the average annual London salary even before paying tax [3] – highlighting what at times can be a very emotive issue. Recent anecdotal evidence, raised by a reviewer, points to a competitive mania whereby buyers have felt pressurised into making offers 15-20% above the asking price further fuelling talk of a bubble.

The average London house price is now eight times the average first-time buyer’s salary...House price rises over the past year exceed the average annual London salary even before paying tax...

However, the evidence in favour of a London housing bubble is far from clear cut. One dissenting view is that looking at the asking price rather than the actual sale price may help to exaggerate the true extent of real price rises [4]. In contrast to other data sources, house price data available from the Land Registry is more accurate and is based on the actual price paid.

Here, we use data available from the Land Registry [5]. The Land registry produces an index of the average London house price based on the actual sale price paid. We adjust for inflation using the Retail Price Index. This is the approach used inter alia by the Nationwide Building Society [6] one of the key providers of house price data for the United Kingdom.

A plot of London house prices adjusted for inflation is shown below in Figure 1. Generally London house prices have risen steadily over time – even allowing for inflation. This notwithstanding there is a noticeable downward spike in prices at the time of the 2008 crash. Thus, recent price rises seem to, at least in part, represent a retracement of past falls. There are, however, notable differences between house prices in London and those in the rest of the United Kingdom. In particular, prices in the rest of the United Kingdom appear much more volatile and altogether less predictable. Furthermore, house prices in London seem to recover from the crash more quickly than in other parts of the country.

Figure 1: Inflation-adjusted average London house prices (Jan 1995-March 2014).

Using a mathematical model developed in [7], we tested for a bubble in London house prices. The results are ultimately very sensitive to the time interval chosen to fit the model. Maximum likelihood ratio tests (not reported) found evidence of a bubble from March 2009 to March 2014 (the last period for which data was available). However, we found no evidence of a bubble using data from March 2010 to March 2014, from March 2011 to March 2014 and from January 2012 to March 2014. This suggests that if we ignore the fact that the 2008 crash happened, then the price rises that occurred from March 2009 onwards would constitute a bubble. However, using data from 2010 onwards shows that once the recovery is underway the evidence for a bubble is much less compelling.

In conclusion, recent house price rises in London have rightly raised concerns of a speculative bubble. However, we do not have strong evidence of a bubble in prices. Firstly, behind the headlines, recent price rises are less spectacular once you look at historical price paid data and adjust for inflation. Secondly, using our mathematical model, rather than a speculative bubble, it seems best to view recent price rises as encompassing part of the post-crash recovery.

Even if there is currently no bubble in London house prices, serious problems remain. The ever-increasing gap between house price and wages, especially in the light of recent price rises, coupled with potential sensitivities to expected interest-rate increases, raises serious questions about the market’s long-term sustainability. Furthermore, is it ethical that house prices remain so far above the wage levels of millions of ordinary people?

Time and again throughout history, economies have proved to be very difficult to manage. Our situation is no different. The apparent absence of a bubble in London property prices should not mask the serious structural imbalances that remain. However, it is difficult to see how future reforms may address the two fundamental problems; house prices are now very high multiples of average wages and the apparent vulnerability of the housing market to expected future interest rate rises.

[1] Fry, J. M. (2013a) Is there really a new bubble in UK house prices? Statistics Views Website, Wiley
[2] Conway, E. (2014) Five signs that the London property bubble is reaching unsustainable proportions. New Statesman
[3] Prynn, J. (2014) London living through biggest house price bubble ever. London Evening Standard.
[4] Hamill, J. (2014) The one piece of data that could pop London’s housing bubble. Forbes
[5] The Land Registry
[6] Nationwide Building Society
[7] Fry, J. (2012) Exogenous and endogenous crashes as phase transitions in complex financial systems. European Physical Journal B 85 405

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