Sunday, 13 October 2013

The temples of the gods of capital

The London property market is booming. Property prices have risen by 9.7% in the last year and there is no sign of any decline. Such large price rises are, of course, only happening in London, not the rest of the UK, where property price rises are lower the further you are from London (in Scotland prices are actually falling). But the same is happening in other large cities such as New York. Prime real estate in big cities has never been so expensive - and so desirable.

Yet people are leaving London, apparently. Both the FT and the NY Times carry opinion columns by disgruntled journalists who have decided the cost of property in London is way too high and are moving elsewhere. And they report that others are doing so too. Here's Michael Goldfarb in the NYT:
"Matt, who had been looking for a house for more than three years, summed up the reason for leaving best: “I don’t want to be a slave to a mortgage for the next 25 years.” Given the astronomic rise in house prices here, he wasn’t speaking metaphorically."
So if people are leaving London, how do we explain such enormous price rises? Ordinarily we would expect what the NYT calls "London's great exodus" to cause prices to fall, not rise. But there is a simple reason, and it is due to the new role of property in the global economy. London's prices are rising at the same time as its residents are leaving for one simple reason. Property in these city centres no longer exists to provide homes for ordinary people. It exists to provide safe, high-yielding assets for the rich.  As Michael Goldfarb points out:
"This is what happens when property in your city becomes a global reserve currency. For that is what property in London has become, first and foremost."
The surplus of capital in the global economy, coupled with a growing scarcity of other safe assets, makes property in big cosmopolitan cities around the world an attractive prospect for risk-averse investors - and they are flooding into it. The FT reports that 82% of prime real estate sales in the centre of London were to overseas cash buyers. Not that they live in the properties they buy, of course. No, they rent them out. Well, at the moment they do, anyway. Though if people are leaving London, rental values on London properties should be falling. Well, they aren't - but the rate of increase is slowing, despite the huge increase in house prices:

(source: GLA London Housing Market Report)

So if rent rises are slowing, why are property prices increasing so fast? The Telegraph thinks Help To Buy might have something to do with it - it suggests that the movement from renting to ownership could cause rents to fall by as much as 5%. But the chart above shows that rises in rental values have been slowing since the beginning of 2013. That seems to be much more likely to be due to greater supply of rental property on the market relative to demand.

If the principal aim of a property investor is not to generate income from rentals, but to make money through capital appreciation, then rental values don't matter if the property itself is appreciating. An annualised return of nearly 10% is really pretty good. You could leave the property unoccupied and still get that return. So if you aren't planning to keep the property very long, it may not be worth your while letting it at all. However, if the plan is to keep the property as a longer-term investment, it does need to be occupied, or at least managed. Property that is not cared for by humans who have a vested interest in maintaining or improving it deteriorates. So it may be that the London market will see substantial falls in rental values while house prices continue to rise. Having a tenant caretaker protects the value of your investment.

Izabella Kaminska posits a nightmare future in which London, and other big cities, become "ghost cities":
"Imagine the scenario many years along: streets and streets of vacant properties and offices, because there’s simply no one left who can afford the rents that can make renting worthwhile for landlords. And even though high prices have encouraged large volumes of new supply to be created by developers these have ended up mostly in the hands of wealth-preservationists, going straight into dark inventory stores.
"The capital city retains value only as a retail showroom, a cultural tourist spot and/or an arts and social hub for visitors or legacy occupants. But it has all the same been significantly dehumanised because almost no-one can afford to work there. The workers have either been replaced by robots and technology, or forced (unwittingly) into servitude to a faceless overseer who grants them permission to live rent free. Yes, yes.. think Jean-Luc Godard’s Alphaville.
"Meanwhile, inevitably, the outskirt flourished as people from the city relocated to more affordable rural or regional parts of the country. This was facilitated by the internet which increasingly enabled people to work from wherever they choose."
But is this really a nightmare? Throughout history, humans have built large and beautiful places for no-one except a chosen few to live in. These places were (and still are) visited by thousands, and they were cared for by paid permanent staff, some of whom lived within their confines - and some of whom, indeed, were not allowed to leave. I refer, of course, to the various forms of temple that humans have built over thousands of years. Temples built as homes for the gods: temples where people congregate to worship their gods: temples to which devotees bring their offerings of money and goods. In days gone by, temples (cathedrals, henges, mosques, whatever you want to call them) were the focal point of the community. They were often centres for trade: markets and cathedrals are closely related - and of course Jesus threw the traders out of the Temple in Jerusalem. And they were places of refuge: people in trouble could find sanctuary in the temples of the gods.

It seems as if we are once again building temples to the gods - this time, to the gods of capital. We are making of our city centres beautiful places where people can come to worship the gods, bringing their offerings of money to spend in the art galleries, the museums, the theatres, the restaurants and the bars: places that are centres of trade, particularly in the goods of the gods (money and property): perhaps places where people who use the goods of the gods for illicit purposes can find sanctuary. Of course, these beautiful places must be maintained, so perhaps eventually there will be a class of people whose job it will be to look after the property of the gods - employed by management companies to live in the beautiful places, caring for them and maintaining the illusion of a vibrant human city. Such people would never be able to leave the city.....they would be tied tenants, owning very little but provided with the best accommodation in the world. Modern-day Levites, if you will. Or perhaps a new form of enclosed religious community.  And the rest of society could only visit the city, never live in it. Real life, except for the chosen few, would be somewhere else.

I suppose this is a nightmare, really.

Related reading:

House Price Index, July 2013 - ONS
The illogical pricing of property - Pieria
There's no point trying to live in London - Christian Oliver, FT (paywall)
London's great exodus - Michael Goldfarb, NY Times (paywall)
Dark Inventory, Death of a City edition - FT Alphaville
Modern gods and human sacrifice - Coppola Comment


  1. Is there any other country selling national assets; industries, public services and now homes, to overseas 'investors' at the level we do in the UK? Even today our government representatives were inviting the Chinese to invest in a new airport in Manchester and build new nuclear power stations for us. Boris Johnson was tweeting the fact that two of the UK's best known brands are active in China; Jaguar and Twinings. Of course Jaguar is now owned by an Indian conglomerate and Twinings' owner will sell when the price is right. It seems our temples will all be 'branch temples' owned by someone else.

    1. No-one ever said the gods were British. Indeed, in today's global financial marketplace, the gods really have no national identity at all.

  2. Scared money seeking a real asset to weather the coming storm of currency crises. I note those in the East are somewhat smarter, as gold bullion flies into China and the middle east at ever increasing rates. Poor sterling savers won't know what hit them until it's too late.

    1. The current path of the gold price does not support your argument. I think this is reaching for yield, not seeking safety. The safe asset marketplace is compromised not by currency risks but by capital destruction due to very low yields.

  3. I share the concern over London's rising housing costs, but I don't think the facts support your particular analysis. First of all, whatever the New York Times says (on the basis of a few anecdotes) there is no 'great exodus' from London. Net migration from London to the rest of the UK is relatively low at the moment, and has been ever since the credit crunch, presumably partly due to difficulties getting mortgages as many of these moves would have been into owner occupation in the suburbs. The result is that London's population is growing by over 100,000 people a year, an extremely fast rate in historical terms. The number of jobs in London is also growing very fast, much quicker than in the rest of the UK. So a lot of the increase in housing costs can be explained by reference to traditional domestic demand factors.

    Secondly, the rents chart does *not* show that average private rents are falling - it shows that their rate of growth has fallen, from around 2.5% to around 2% a year. And because this data includes ongoing tenancies, which tend to see little or no rent increase from year to year, the rents for new tenancies are increasing at a significantly faster rate. So the chart does not represent evidence of a rising price-to-rents ratio.

    I'm not saying overseas demand isn't having an effect (it clearly is) or that prices aren't rising faster than rents (they might be, it's just hard to say). But what I would say is that London's housing trends can be largely explained by the age-old factors of rising demand and limited supply.

    1. Jim,

      fair point on the chart - it is indeed a rate of change. My mistake, I will correct.

      On the rest, I don't think a 9.7% rate of increase of London house prices is explained by immigration or job increases. If it were, we would expect to see South Eastern house prices rising at a similar rate - since much of the South East is a London commuter zone - and we don't. South Eastern house prices are rising at about 2.6%. I think you will agree that is a very considerable difference.

      So I'm afraid, apart from your correct observation about the rate of change of rents, I disagree with your analysis.

    2. But the proportion of South East residents who work in London is far, far smaller than the proportion of London residents who work in London, so if what we're seeing is a jobs boom in London then we would expect a greater effect on London's housing market - and that's exactly what we do see.

    3. I disagree. The housing market lags the job market by quite a bit. What we WOULD expect to see in a jobs boom would be rising rents, not house prices. And as I have already pointed out, the rate of rise of rents is actually slowing despite the job market recovery. It simply does not stack up.

    4. The reason for population growth whilst there is an owner-occupier exodus is that previously owner-occupied homes (3 to 5 person occupancy) are being bought by BTL landlords who will have 5 to 7 occupants in each house, based on observations in my area. The propensity for a crash lies in the nationality of the occupants, who are transitory occupants. One serious terrorist incident (or 2 or 3 lesser ones) will lead to many 'going home' and collapse in rents and house prices.

      Happened in early '80s (I know only too well) in Central London, when residential prices literally 'bombed'. If it were to occur again, it would affect a far larger area.

  4. I think there is a lot less here than meets the eye. the reason that the infamous "property bubble" was so dangerous and ended in disaster for one and all is that houses were in many case being bought by over-leveraged and poorly financed buyers. People, in fact, who knew that they were in a bubble, but bought anyway, confident that they could "flip" whatever property they bought before they ran out of cash to pay the mortgage.

    But that's clearly not the case here. The (shudder) rich are, as you say, treating London property as a reserve currency, and converting cash into property. In fact, they may even be demonstrating a lack of confidence in money by investing it in real property, just as Germans did in the period 1918-23.

    But so what? All we are seeing is rationing by price. The rich can afford to buy London property, and in the process push prices up so far that the non-rich quit the capital in a huff.

    Is that really a problem? Couldn't moving a few software start-ups and hedge funds to the provinces actually be a good thing? Couldn't that inspire the further development of tech and finance hot-spots in exotic locations such as Reading, for example, or racy Slough?

    In fact, isn't the growth of London in the past few decades, and its dominance over the rest of the UK, really quite good evidence that London property has been far too cheap in the past and London itself too affordable a city?

  5. Correct me if I'm wrong, but this capital could be pulled out just as quickly as it is coming in, should better investment opportunities arise - international investors and funds are just looking to make money and presumably have no emotional attachment to London. Therefore there is a serious downside risk, which I suppose is the inevitable result of housing becoming a speculative asset class.

    Simon West

    1. Indeed it could. This makes the property market more volatile and more liable to crash.

  6. Good article and valid comment from Simon West. What are average rental yields in London? I'm guessing fairly low? When gov't bonds finally rise to a respectable level maybe international investors will reallocate money there or wherever else they deem fit. Until then is a bubble expanding?

  7. The Telegraph says large parts of London yielding less than 4%

    This is higher than I had assumed. I'm guessing rental yields will have to fall further (either from falling rents or rising property prices) before the situation changes. The 5% drop in rental yield caused by the Help To Buy scheme probably won't be enough to influence the property investment case much.

  8. Whilst I do agree that some investors don't care about rental yields, there are many who do. It would be foolish to disregard the productive capacity of the asset. Highest possible total return should be the aim.

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