What’s driving the surge in prime London property prices?

Prime London property prices have surged in recent years and are now 16% higher than their previous peak in March 2008. This article examines what’s driving prices up and what could bring them back down.

The value of property in London’s prime locations continues to surge. Rightmove, Britain’s biggest property website, reports that the average price of properties in the city’s nine most expensive districts rose 3.4% in November and according to property consultant firm Knight Frank LLP luxury-home values are now 16% higher than their previous peak in March 2008.

Prime Central London (PCL) is generally agreed to be a collection of nine separate districts which include Notting Hill, Chelsea, Mayfair and Westminster.

Map of London’s prime residential areas

Map of London’s prime residential areas

Source: Development Securities & Fathom Consulting

PCL represents less than 0.5% of UK housing stock but 2.5% of its value, and the average PCL property is worth £1,163,000 million (Mean price December 2011) around 6 times the value of the average UK property.

A recent study investigating prime London property conducted by Fathom Consulting found that less than 50% of those living in PCL were born in the UK. That compares with 65% for London, and 88% across the UK as a whole.

Interesting also is the fact that during the period 2007 to 2011, in terms of the value of properties purchased. 61% of PCL buyers came from outside the UK. The bulk of them, some 43% came from Europe and MENA (Middle East North Africa).

Prime London property prices continue to outperform those of the wider UK market. According to Rightmove year-on-year asking prices in England and Wales were up 2% in November, while those in London were up 8.8% from a year earlier.

As the chart below shows, despite their outperformance prime London property prices remain closely related to the wider UK market.

UK house prices (index Q1 1995 = 100)

UK house prices (index Q1 1995 = 100)

Source: Fathom Consulting, HBOS & Zoopla

What’s driving the surge in prime London property prices?

Since 1995 the surge in the value of prime London property can largely be attributed to the collapse in the value of the British Pound, and “safe-haven” in-flows, most notably from Europe.

The collapse in the value of the British Pound versus other major currencies and on-going QE-induced weakness has been a huge catalyst for PCL property. Since January 2007 the Pound Sterling has lost more than 18% against the Euro, 19% against the US Dollar, 45% against the Japanese Yen, 39% against the Swiss Franc and 31% against the Canadian Dollar.

To those with increased relative purchasing power, the weaker pound makes property (and other sterling denominated assets) more attractive.

“The prime central London property market continues to attract wealthy foreign buyers,” said Miles Shipside, commercial director of Rightmove. “This is especially true in the international property hot spots of the City of Westminster, where a Mayfair or Belgravia address is a pre-requisite for the world’s wealthiest. The best of London is increasingly in ‘international only’ reach.”

The other major factor that has contributed to the surge in PCL property is the on-going debt crisis in the Eurozone.

With financial markets pricing in a 75% probability that Greece will leave the Euro, which could trigger a breakup of the currency union, depositors are taking steps to protect their wealth.

The chart below shows the steady decline in the value of deposits in Greek banks as money is moved outside the Eurozone (and in some cases outside the banking system altogether).

Deposits in Greek banks (Billions of Euros)

Deposits in Greek banks (Billions of Euros)

Source: Thomson Reuters Datastream & Fathom Consulting

Prime London property is attractive as a “safe-haven” and helps those with wealth hedge against the devaluation or breakup of the Euro.

What could bring London property prices down?

The Fathom Consulting study examines two scenarios under which PCL property could decline in value. The first is a re-run of the 1970’s oil shock in which the supply of oil is suddenly restricted, for example due to a conflict in the Middle East. Fathom estimate that a sudden oil supply shock would push PCL property prices down by just over 20% in real terms.

The second scenario, and likely a bigger risk, is the breakup of the Euro. The study concludes that a Euro break-up would result in a serious banking crisis that would trigger a dramatic fall in global equity prices, and that without massive Bank of England (BoE) intervention, sterling would rise sharply.

This, in turn, would alter the value equation in favour of Paris, Frankfurt or Rome since that would look cheap, while those in London would be relatively expensive. The “safe-haven” value of London property would also disappear once the break-up had occurred, since no-one insures against an event that’s already happened.

The bottom line

The performance of PCL property in recent years has been spectacular, and although it is unlikely to be immune from future crises, in a world of competitive currency devaluation, stagnant economic growth and poor stock market performance, PCL is still a tangible asset with intrinsic value.

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