London property market: Is this a glimpse of Auckland’s Future?

Catching up with friends living in London the stories are remarkably similar to those in Auckland but on a whole other level. The city is awash with tales of hard working young people unable to save fast enough to get on the property ladder. My only friends that managed this Herculean feat are a young professional couple who bought a slumhouse in London’s unfashionable East End. And the supposed cause is similar too – ‘foreigners’ (however defined) buying all the property. 

So what can London tell us about Auckland’s future? 

There will always be more demand than supply
The enduring popularity of London ensures that demand for housing has outstripped supply for decades. The limitations of land and transport congestion have meant that supply is constrained to increase only slowly – far more slowly than demand. 

The results of this are two fold. First – as in any market the price increases to choke off demand. In this case the prices are not just house prices but also rent. As these rise, people simply can’t afford to live in London, particularly if they can’t command a wage that covers the costs of living – namely housing and transport. 

The second impact is migration. Generally the pattern in England is that London sucks in the new immigrants – much like Auckland does. As supply of housing has become increasingly constrained, London hasn’t stopped attracting immigrants, instead it spits out an equal number of English people. In other words, every time London house prices reached new records the locals chose to sell up, move out of the city, and live off the proceeds. We are starting to see this pattern in Auckland, and it will happen more. 

So far, this is no big deal. If anything it is the market responding to the circumstances. In London Monopoly terms, we can’t all live in Park Lane and Mayfair. The price clears the market. 

The real problems begin when housing becomes an investment, rather than a house
However, this alone does not explain the London property market. All my young professional couple friends can afford to live in London – they can pay rent – but they can’t afford to buy. This is because house prices have grown way out of whack with the rental market. Sound familiar? The same is true of many places in New Zealand – but particularly Auckland. The value of the asset has grown out of whack with the returns that asset can generate (rent). That is a sure fire sign that investors are banking on capital gain. 

This is a clear signal that housing has become primarily an investment in London, as it is becoming in Auckland. This is best illustrated by the ubiquitous anecdotes that fly around London housing conversations. Russian oligarchs, Saudi oil barons, Chinese tycoons all have a pad in London. Do they live there? No. Do they rent it out? Hell no. Do they have more than one property? Probably – after all who knows which suburb their daughter might want to live in when they go to University?

Is there any proof that this is happening? Data is better than in the UK than in New Zealand, but still poor. We know that around a third of property purchases in London are made by foreign buyers. We don’t know how many houses lie empty. 

Why is this? In shaky, uncertain times, London housing is seen internationally as a safe place to stash your cash – it is up there with gold. Since 2009, London property prices have risen 70% – at a time when wages in the UK have been stagnant. The belief is that prices simply won’t go down, so every billionaire has one or more London properties in their portfolio. This is exactly the direction that Auckland is heading in, but no politician has the guts to stop it. 

Fiddling at the edges
Like New Zealand, Britain does little more than fiddle at the edges of these problems. And now the London real estate market is so out of kilter it literally is too big to fail. If someone tried to sort the problem now it would bring the whole house of cards crumbling down – including the banks. 

Some of the populist policy responses have made the problem worse. To keep teachers and nurses in London the government has decided to help them buy houses, to the extent of going in as part owners. That does nothing to dampen house prices. 

In some respects Britain does more than New Zealand to curb the investment excesses in housing. Rates are relatively high here – they collect far more revenue than their equivalents in New Zealand. However, rates levels don’t reflect property prices, so mansion owners pay a tiny proportion of the value of their property in rates.

There is also a ‘stamp duty’, effectively a transaction tax for the sale of houses that rises with the value of the house. There is even an inheritance tax; although in practice the truly rich can avoid paying it so it falls on the unsuspecting middle class who have got rich on the back of the property market and neglected to plan a tax efficient way of passing it on to their kids. 

Finally, there is a capital gains tax on investment housing (not the family home) – at a lower rate than income taxes. This alone is proof that the Labour/ Greens proposal at the last election would have done nothing to stop the rot in Auckland. 

Reform options
With the dip in the Russian and Chinese markets and the revival of the British pound, there are signs the trend is easing. Sadly for us the falling New Zealand dollar may mean that international sights turn on Auckland instead. Why wait and allow the whims of international speculators determine our future? A much better solution would be to ensure that property is no longer viewed as an investment.

There are moves afoot to change the game in the UK. A number of ideas have been mooted in the wake of the Global Financial Crisis including:

• A tax on mansions over a certain value;
• A tax on imputed rental;
• Linking rates to property value; and
• A land tax.

Some of these proposals start to resemble elements of the Comprehensive Capital Income Tax that we have proposed. They also exist in certain European countries, places where housing is notably not seen as an investment – instead it is simply a place to live. In coming weeks I will be looking more at how European cities have ensured this is the case. 

Geoff Simmons is an economist working for the Morgan Foundation. This post first appeared on Gareth's World.