Investors Should Fear The London Property Bubble

The desire to purchase a home in London is universal. Prices have risen by 8% in the previous year, and have risen by 57 percent since 2009. Has anybody forgotten about the late 1980s property bubble?

For the rich, owning a house in London has become a prestige symbol. It’s not only about job opportunities, culture, a dynamic lifestyle, the top schools in the world, a reliable legal system, or the English language. Despite its illiquidity, London property is seen as the ultimate safe haven in times of economic uncertainty.

RISK OF INVESTMENT

Limited bank financing and a 7% stamp duty rate on houses worth more than £2 million haven’t helped the market, although capital values have continued to rise. This makes little sense to an investor. While home prices have risen by 8% in the previous year, rental yields have suffered and have fallen by 3%.

From an investment standpoint, the comparable benchmark would be government ten-year gilts, which now yield 2.54% or currencies such as the Swiss Franc or even gold. All of these financial assets are substantially overpriced.

Longer-term dangers to London property values include a shift in UK tax policy after the election, regulatory changes that drive employment out of the city, and geopolitical developments that affect bank lending. Furthermore, London’s real estate is threatened by the domestic economic recovery.

 London property

INTERNATIONAL POSSIBILITIES

Property prices in London have risen mostly as a result of cautious overseas purchasers. Investors have been progressively increasing their allocation to London property as a result of continuous geopolitical events, financial market instability, low-interest rates, and, more recently, pound weakening.

While the market has historically been sustained by a shortage of supply and overseas purchasers, local buyers, notably in the buy-to-let rental sector, have contributed considerably to demand. However, with high unemployment in the United States and worries about job security, demand among domestic professionals (and consequently rental yields) has begun to dwindle. International purchasers have taken up some of the slack, but their influence on rental yields – rather than capital appreciation – has been negligible.

So, despite the longer-term dangers and falling rental returns, can home prices continue to rise? The answer is a cautious yes as long as there is a supply deficit, market uncertainty, and sterling stays relatively weak.

AN EXPENSIVE ASSET

However, in comparison to other financial asset classes such as stocks, bonds, and commodities, property prices and risk seem to be pricey. However, when compared to other big international cities throughout the globe, the property value seems to be acceptable. Long-term rental growth in London is expected to be approximately 4% each year.

This compares well to ten-year UK gilts, but not so well to UK stock markets, where prospective P/E ratios are well priced at 11.8, and dividend yields are a healthy 3.8 percent.

Despite the present housing bubble, London continues to be a popular destination for overseas purchasers. We support diversification across all financial asset classes in wealth management, and at present prices and rental returns, we would not be devoting major fresh money to London property.

Investors might consider London property exposure in comparison to more liquid government bonds and large-cap shares with high dividend yields. Despite present values, the property bubble is unlikely to explode as the economy recovers. However, as stocks rise and government bonds fall, prices and rental rates will stay range-bound.

Investors must be aware of the danger of illiquidity while owning property. Equities, not London property values, would benefit from a more optimistic economic climate and better corporate profitability.

If you do decide to purchase real estate, keep in mind that it is currently in a bubble. Take into account your location and time period, and be wary of illiquidity. Recognize that you may be purchased at the peak of the market, and that property investing is a long-term investment. We can’t help but assume that the easy money in the London housing market was made a long time ago as investment managers.

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