Buying Property in London
(Please note there is a podcast of
this blog should you prefer to have it read for you. Look to your
right, and click the link.
I have been asked to give a view on the London property market.
It’s very difficult to give an overall view on the market because
different people are looking for different returns, and over differing
time scales, and with differing attitudes to risk, income, and
lifestyle. Because of this let’s start with a purely academic view.
The UK is technically on the edges of recession. The trade situation
may have improved slightly, but two things are still in the danger
zone. First, the general debt situation in the UK is dire, and getting
worse. Household debt is still very nigh, and government spending is
totally out of control, with the national debt through the roof, and
rising exponentially. There is no way this debt bubble can be contained
unless it be through massive commitment to fracking, and refining the
oil/gas, and exporting it in huge quantities. That is not possible in
the near term. The earliest any meaningful export quantities could hit
the bottom line is ten years from now, and I think even that is wishful
The second problem is that despite a slight improvement in trade, wages
are still in a downtrend.
Let’s look at these two problems before we go any further. They bring
with them totally differing spinoffs. The problem with government debt
is that it would only take a couple of points’ rise in interest rates
to put the interest payments on that debt in the danger zone. Quite
frankly, if interest rates rise, the interest on the national debt
becomes too high to pay. The government has to either default, or suck
the money out of the economy, or fire up the printing presses. The only
feasible way out is to print. That will eventually devalue the currency.
Whatever option is chosen for this problem it will leave either the
country in recession, or the currency in decline. Neither scenario is
good for the property markets.
With households having high debt levels, and incomes rising slower than
inflation, there is less money in the piggy bank to pay higher mortgage
prices. That means house prices should not be rising. If we are likely
to see higher interest rates that would also make the monthly cost of a
mortgage more expensive, and would therefore mean that prices would
have to retreat to balance the monthly outgoing. It isn’t the price of
a house that is crucial, it is its cost.
With this in mind let’s go back and remind ourselves of a few golden
1 House prices don’t go up when incomes are going
down or static. Throughout most of the country prices are not rising.
London seems to be an exception. That exception cannot continue. This
is not the beginning of another boom but an anomaly, and an anomaly can
only stretch so far. How far, I don’t know, but I wouldn’t trust it
much further, certainly not much further than the next election.
2 On a simple mathematical model, you would buy a
house when interest rates are high and falling, not when they are low,
and can only go up. You should buy value. That means all the successful
property investors think for the long term. That means you can be in
the market for a long time, and out of it for a long time. Investing in
property in this respect is no different from investing in stocks. You
buy low, and sell high. You buy when there is blood in the streets, and
sell into euphoria. This is even more important in the property market.
You can’t wait for a top. You have to sell before a top. You are
looking for willing buyers. They will cease to be so willing the minute
there is a hiccup in the rate of price rises.
3 Have a look at where London sits in the list of the
world’s most expensive real estate. Most of the indices show London in
the top three, behind Monaco and Hong Kong. How much higher can prices
go? It would seem to me that London has hit a peak. I certainly
wouldn’t bet on it overtaking the top two cities.
The next thing to look at is what kind of a world we are living in. For
most of my life I have been able to use metrics that were designed to
operate in free market conditions. I invented a lot of them myself, and
they have served me well over the years. The trouble is we no longer
have free market conditions. Not only do we have artificial conditions,
but we have artificial statistics. The most outrageous are those touted
in the US, where inflation is quoted at just over 1%, while real
inflation is hovering around the 17% mark. You have unemployment listed
at 6.6% whereas the real level is around 23%. How can anyone plan with
such politically skewed data?
We have an economic rebound in the UK based on debt. Debt is
traditionally a drag on the economy. It has to be paid out of future
profits, so those profits are already mortgaged. We have a housing
market that has moved higher on a bubble created by the government.
They instituted a scheme whereby people who could not afford mortgages
were given mortgages so they could buy houses. That moved the housing
market upwards, and put a lot of people in hock for amounts they won’t
be able to pay in the future, especially when interest rates rise. I
will come back to this problem.
There is no economic rebound in Europe, and Europe is the UK’s biggest
export market. That means there is scant chance of a much stronger UK
The stock markets in the West have been rising for the past five years.
The general view is they we have reached a top. Currently the US
markets have been posting good gains, and the indices are still within
an upward trading channel, however, I was looking at the S&P index
only last week and noted three tops. The second top made a lower high
and lower low than the first, and the third a lower high and lower low
than the second. That is traditionally an indication of a tired market
that is topping out. In any case, bull markets don’t tend to run for
much more than five and a half years.
In the UK, we are a long way from the highs, and there is certainly not
much buying pressure at the moment. We could very well be entering the
doldrums, or a downward lurch in the markets. If that is the case, and
the stock markets have topped out, then that will also feed through
into the rest of the financial world, making people feel poorer.
In short, there don’t seem to be any positive indicators around.
Everything points either to a continuation of the same, or a falling in
the measures of wealth.
Let us have a look now at a couple of purely mathematical models. There
are two that I like to use to measure what I call intrinsic value. The
first is the Affordability Index. It was a very valuable measuring took
when I first invented it while at college many years ago. During the
last five years it has become less valuable as we are living in a false
economy where the statistics we collect mean very little. But let’s see
what we find.
Those of you who have read my book
may recall it is
based on something my mother told me as a child, and which related to
the amount of income that any family could afford to spend on
accommodation, hence the title, Affordability Index. Basically, the
index has in the past shown the cut-off points where people will batten
down the hatches when something becomes too expensive. We are only
concerned with London prices, but the London index shows that the
average person will not spend more than a little over half their income
The average net salaries of a working family in London combine to about
£40,000. That means the most an average family are likely to pay
for a home is £25,000 a year, or a little over £2,000 a
month. Running costs, repairs, council tax, and the like cut a nasty
swathe into that figure, and the amount available for a mortgage would
likely max out at around £1,500 a month.
If you now check out what 25 year mortgage you could get with a payment
of £1,500 a month, you end up with a rough idea of how far house
prices can go. For this exercise we are looking at a three bedroom
property with a London postcode address.
With a 5 year fixed rate the amount you’d have to pay a month on an 80%
ltv mortgage over 25 years is £1,450, for a house costing
£350,000. You’d have to stump up the £70,000 deposit. If
you could only raise 10% deposit your monthly outgoings would rise to
…… oops, you might have problems going higher.
The bad news is that the average price of property in London is now
over half a million pounds. From where I’m sitting the maths won’t
stack up on price rises.
Let’s look at an alternative way of getting intrinsic value. The
average person buys a house with mortgage assistance. You can’t get
mortgages if you don’t earn the money. A typical mortgage calculation
allows a family to buy a house based on three times the lead earner’s
wage, plus the second earner’s wage. Let’s keep it simple and multiply
the average London wage by 4. That gives us £160,000. Typically
you need to put up at least 10% of the purchase price, but preferably
20%. In short, the average family is going to have serious problems
buying anything that costs more than £200,000. That’s less than
half the price of an average home.
Prices may go up from here, but any rises are obviously unsustainable.
Now let’s look at the time bomb that exists when you get a mortgage in
a low interest rate environment.
I can’t predict when interest rates will rise, but they can’t stay
where they are forever. I have already hinted at what I think will
happen in a previous blog. Some time in the near future China will
float the renminbi. It will rise in value. At some stage after that
floatation China will be insisting that its currency becomes fully
tradable. Later, they will be backing it with gold, as they appear to
have more gold than any other country in the world, and I suspect that
includes the US, which I don’t think has much left in Fort Knox.
This move in the international currency scene will probably start some
time next year. At what stage that move will put extreme pressure on
the dollar is unknown. It may take a decade, it may take a few years,
it might take a few weeks. What it will ultimately mean is an increase
in interest rates for beleaguered currencies, which will put a big
strain on economic development and government finances. It will also
affect the property markets.
As I say, this may still be years away, but I’m not waiting. I suspect
we have at most another couple of years before the first signs appear
that western currencies are going to take a downward lurch. I am not
sending out a sell alert at the moment, but I am saying Don’t Buy!.
There is one other way of obtaining an intrinsic value of a property.
Once again, I spell this out in my book on property investing
The basic theory
is disarmingly simple. If I live at 1 Windsor Drive, and you live next
door at Number 3, and our houses are much the same, then we should be
paying roughly the same money for our homes. Let’s say you rent and I
buy. Effectively you are paying rent for the home, whereas I am paying
rent for the money. Those figures should be similar. In short, your
rent should roughly equal my interest payments. If they don’t, then the
one who is paying the higher rate is likely sooner or later to wonder
why he is poorer than his neighbour, and do something about it. A 20%
difference is too much, and will lead to either the renter buying, or
the buyer selling in order to rent.
First, get a rough idea what the property you are interested in will
sell for. Then check the rental level. You can get a rough idea from
I have been using a particular property as a guide for the past twenty
years. Let me do the maths. I am talking about a central location in
what I call inner West London. The property is a 3 bed apartment with
good access. It’s worth, supposedly, £275,000, and can be rented
for £1,600 a month. Leaving aside mortgages, that comes out to a
straight ROI of approximately 7%, which is not bad. That is gross of
course, not net, so the real return is going to be less, but it is
still a reasonable figure for a long term safe investment.
But what about the correlation between buying the place and renting it?
An interest only mortgage on £275,000 at current rates of
approximately 5% comes to £13,750 a year. The rent comes to
£19,200. The price of the house can rise quite considerably from
here. The only snag with that idea is that the average worker would not
be able to get the mortgage in the first place. This leads me to the
conclusion that London rents are too high and should fall, not that
house prices can rise.
On the other hand, in theory, the buyer can afford to spend the same
amount on his living accommodation as the renter. That means he can
notionally afford £1,600 a month, which is almost £20,000 a
year. That means at current interest rates he should be able to afford
a house costing £375,000. In short, our sample house price can
rise quite substantially.
What to make of this apparent paradox? The full reason is given
in my book on the housing market, which you should read. House prices
have been skewed by the availability of finance. You can’t buy houses
with minuscule deposits. And you can’t get mortgages without the income
to support them. When mortgages are plentiful and nobody worries about
deposits, you can buy more expensive houses. When mortgage lending is
tight, house prices need to contract accordingly. Currently, mortgages
are reasonably tight, so house prices should stay lower to match that
Let us now go back to the interest rate. At 5% the cost of money is
low. When rates go up, the cost of the borrowed money goes up. The cost
of a mortgage on that £375,000 at 5% is £33,750 a year.
With rates at 7% it leaps to £41,250. If life was tight at the
lower rate, it will be suicidal at the higher rate.
With wages still sagging behind the level of inflation, how would
anyone cope with that kind of rise? Buying a house at current interest
rates is the equivalent of taking out a bet that interest rates won’t
be rising any time within the next decade or so. That’s fine if you
like gambling. You may get away with it for the next three to five
years. Beyond that I wouldn’t take the bet at all.
If you do the right sums, working out where we are is relatively easy.
You don’t need to know where we will be in three, five, or ten years
time. You just need to know what you and your fellow wage earners are
likely to be able to afford, together with a reasonable view on the
direction of interest rates. (A small clue here: they can’t go down.)
My conclusion is, I guess, obvious. We are in an artificial
environment, and various outside stimuli have raised house prices
beyond where they would otherwise be. There has been a small boost to
the London housing market from foreign purchases, but that is not a
long term trend. The underlying economic situation is against any
significant rises in property prices. Any rises that occur will have
been artificially induced and therefore subject to reverse.
Long term, house prices can’t rise until incomes rise to allow for a
higher level of spending. As an investor I would not buy into the
current market. For buy-to-lets there are many towns across the country
where returns are far better. Don’t even think of buying to flip. For
longer term investments the better returns are also not in London.
Here again is the link to my book on property matters, which goes into
all these metrics in some detail, and provides you with spreadsheet
formulae to help you do the maths on any proposed deal.