World View: After Brexit, London’s Real Estate Bubbles Are Collapsing

EU referendum. A London taxi driver waves a Union Jack flag in Westminster, London after Britain voted to leave the European Union in an historic referendum which has thrown Westminster politics into disarray and sent the pound tumbling on the world markets. Picture date: Friday June 24, 2016. See PA …
Press Association via AP Images

This morning’s key headlines from

  • UK residential real estate market hit hard by Brexit
  • The UK housing bubble may finally be collapsing
  • UK commercial real estate market hard hit by ‘Brexit clauses’

UK residential real estate market hit hard by Brexit

UK house prices, 1991 to present
UK house prices, 1991 to present

According to anecdotal evidence collected in a survey by the Royal Institution of Chartered Surveyors (RICS), the residential real estate market in the UK, especially in London, is crashing.

The findings have to be viewed with caution, since prices increased slightly in June, albeit more slowly than in the past. Since the Brexit referendum occurred on June 23, the June prices surveys don’t tell us much.

But the findings that the RCIS announced on Thursday are considerably more dramatic, because they measure changes in buyer sentiment since the Brexit referendum:

  • New buyer enquiries “declined significantly” in June, with 36% more respondents reporting a fall in interest. This is the lowest reading since mid-2008 when the financial crisis was in full swing.
  • The market saw a further decline in sales with a third successive monthly drop in activity. Respondents expect this trend to continue with 26% more respondents anticipating a further drop in sales across the UK over the next three months. This is the most negative reading for near term expectations since 1998.
  • In London, 46% of those surveyed were seeing prices slashed.

According to RICS, the South of the UK has been the hardest hit, with anecdotal evidence suggesting that both the Brexit referendum and tax changes are having an impact on sentiment.

According to RICS, London remains the only region where respondents are seeing prices fall, with this largely being concentrated in the central zones. Near term price expectations are now in negative territory across the whole of the UK with 27% more respondents across the UK expecting to see prices fall rather than rise over the next three months.

RICS points out that only after the initial shock of the Brexit referendum has passed will we get a clearer picture of how the market is faring. Royal Institution of Chartered Surveyors (RICS) and Business Insider

The UK housing bubble may finally be collapsing

As the chart at the beginning of this article shows, UK housing prices are still at bubble levels. As I’ve written a number of times in the past, the global housing bubble began in 1996, at the same time as the “tech bubble,” and accelerated in the 2000s, reaching a peak in 2007.

The housing bubble then deflated, causing what we now call “the financial crisis,” but as the above chart illustrates, the global housing bubble did not fully deflate, and the housing bubble continues to this day.

According to a UBS report published last year, the global housing price increase was 130% from 1996 to 2007, but the subsequent price decline was only 30%. The UBS report blames this on the “gigantic cash injection” from central banks around the world, through quantitative easing and, today, negative interest rates. According to the report:

Through quantitative easing, central banks have more than tripled the global monetary base since 2008. This gigantic cash injection has lowered real interest rates and slowed the global housing market corrections that began in 2007. The average price decline amounted to 30% in real terms. However, this did not offset the preceding price increase of 130% since the mid-1990s. The correction was thus milder than in previous cycles, setting the stage for today’s overheating housing markets.

When inexpensive financing is combined with bullish expectations, real estate prices eventually uncouple from the real economy. We have seen this in the current cycle, particularly in the world’s leading financial centers, where housing prices are now, in many cases, fundamentally unjustified. The risk of a real estate bubble in these cities has risen sharply. While it is not always possible to prove conclusively the existence of a bubble, it remains essential to identify the signs of one early on.

According to the report, the world’s most expensive real estate market was London, though Hong Kong is not far behind. Many European cities, including Geneva and Amsterdam, are overvalued. In the United States, San Francisco is the most overvalued, with New York, Boston and Chicago trailing behind.

As I wrote in “25-Jun-16 World View — Fallout from Brexit: Impact on geopolitics, economics, and stock markets”, the danger is from a long-term crash because of a vicious cycle involving forced selling.

It is impossible to predict exactly when the London housing bubble will collapse, but it’s 100% certain that it will collapse at some point, because every bubble in history has collapsed, usually causing enormous pain. It is possible that we are seeing the beginning of a major real estate collapse right now, but it is also possible that central banks will find a way to pour massive new amounts of liquidity into the real estate markets to keep the bubble going. After the “gigantic cash injection” described by the UBS report quoted above, central banks are not about to stop now. The sky’s the limit.

One thing to watch out for is that there is a great deal of resistance among mainstream economists, politicians, journalists and analysts to even imagine a collapsing bubble.

We saw this ten years ago, when mainstream financial analysts, economists and journalists would say, “Housing prices can’t go down — people have to live somewhere!” and “Banks won’t foreclose — it’s not in their interest to do so!” and “These housing construction firms know what they’re doing, and they wouldn’t be building houses if it were just a bubble!” It wasn’t until 2009 that mainstream economists began saying that there had been a housing bubble years earlier. (See “26-Dec-2015 World View — ‘The Big Short’ – an infuriating movie about the financial crisis”)

So expect the usual slew of excuses from mainstream economists this time, and don’t be surprised if, as usual, they don’t have the vaguest clue what’s coming. UBS Global Real Estate Bubble Index (2015-PDF) and Money Week (3-March-2016) and Bloomberg (6-April-2016)

UK commercial real estate market hard hit by ‘Brexit clauses’

Since commercial real estate is often used for investments, Britain’s commercial property market is being harder hit than the residential housing market.

Even before the June 23 referendum, some buyers wrote “Brexit clauses” into their contracts to purchase commercial real estate in Britain. These clauses, which are now being invoked, allow buyers to walk away from deals if the Brexit referendum passed, which it did.

Many commercial real estate investors do not plan to occupy the properties they acquire, but are purchasing them as investments. This is particularly true of Chinese property investors, who simply need a place to park their money.

Because of Brexit, many employees working in London may have their jobs moved to the continent. This means that there will be empty offices in London, reducing the value of these buildings to these Chinese investors.

Until the effects of Brexit are well understood, which may not be for two or more years, commercial real estate investors are looking for “safe havens” in other countries. Thus, London’s loss could mean other cities’ gain. Realtors in Canada, Australia and the US are pitching their countries as safe havens, as Chinese buyers view Britain as too risky. South China Morning Post (Hong Kong) and Reuters

KEYS: Generational Dynamics, Britain, London, Brexit, Royal Institution of Chartered Surveyors, RICS, quantitative easing, Hong Kong
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