A couple of weeks ago, I was invited to London, England to participate in Citywire’s round table discussion about global equity funds.
The discussion took place at The Four Seasons Park Lane, one of London’s poshest addresses. As we were having lunch, we began to talk about London’s egregious property prices. Someone mentioned that it was fairly typical for people working in London to spend 60% of their salaries on housing expenses. This took me somewhat by surprise. I knew that London housing costs were very high, but I figured that salaries were commensurately elevated. Evidently not so. Moreover, it turns out that many skilled foreign workers who head to London to further their careers come to decide that their overall quality of life was far better back at home, and decide to return.
Underlying these dynamics are some very basic, yet powerful economic concepts. First of all, one of the reasons that London property has experienced a boom is due to wealthy foreign buyers and investors. Foreign capital has flocked to the ‘safety’ of London real estate – especially the high end sector. This foreign demand coupled with domestic demand has far surpassed supply, thus resulting in higher prices. Given the demand at the higher end of the market, new project developers were incentivized to cater to the luxury segment in order to maximize their profits. Demand, after all, encourages supply.
However, one thing that developers were not accounting for was the effect of lower oil prices on the what seemed to be an unlimited fount of foreign capital. As capital becomes scarce, it tends to become more discerning. When foreign money was pouring in, the British government tried to calm the flow by implementing a number of disincentives such as higher stamp and property taxes on high end real estate. However, in doing so, they sent the message to foreign capital, that it is, relatively speaking, not as welcome as it once was.
What should also be troubling for high end London property investors is that the British Pound has taken a beating recently. Investors must forever be weary of currency effect, and the British Pound has fallen over 10% since last summer vs the US Dollar:
Putting it together you have:
1) reduced demand
2) disincentives for investment
3) a falling base currency
Its no wonder that developers have begun to offer 20% discounts to investors:
LINK: London Luxury-Apartment Slump Triggers 20% Bulk Discounts
And so it begins…