The world's money and people are pouring into the capital. Don't knock it.by John McDermott / November 14, 2013 / Leave a comment
© Jason Hawkes
Tell us how you would fix London and read suggestions from experts such as Simon Jenkins and David Lammy
In April 2012, JP Morgan published what is perhaps the most important report on the world’s money since the end of the financial crisis. Heavy on faux profundity and light on verbs, The Realization argued that when it comes to asset management, we are entering “A new world. A new normal. A tectonic shift.” Investment portfolios typically hold only a mix of stocks and bonds. However, the former is too volatile and the latter yields too little, a result of quantitative easing (injecting money into the economy) in the west, and capital flows from the east, according to JPMorgan. It is time to get real, the bank suggested. “The real assets category offers investors ‘optionality’ in a world of uncertainty.”
Ironically, optionality is not a real word. But in practice JP Morgan recommended its clients make hundreds of billions of dollars of direct investment in, for example, commodities, ports, toll roads, power stations, railways, container ships, farmland, timber sites—and property. The global real estate market is worth $14 trillion, it noted. Better get in quick, then: “a select group of investors is at the vanguard of what, we believe, is a rare structural shift.” Others are already cashing in! “Early movers should continue to be rewarded in the midst of an (r)evolution in asset allocation”.
If there is a fever among the managers of the world’s money, it is more than matched by Londoners’ hysteria over the price of housing. Incidental chats gravitate towards tales of invidious costs. Little wonder: sale prices rose 10 per cent in the year to July, according to the Office for National Statistics; and by the same in October, according to Rightmove, the property website. Everyone seems to want to know how much you pay. Zoopla’s property search app is downloaded more frequently than Tesco’s. The government’s Help to Buy guarantee is lubricating a city beset by property fetishism.
And soon enough, it all becomes the foreigners’ fault. “This is what happens when property in your city becomes a global reserve currency,” Michael Goldfarb wrote last month in an incendiary and widely read New York Times op-ed. Goldfarb, an American foreign correspondent and author living in London, is as far from a xenophobe as one could imagine. Nevertheless, many share his fears of the consequences of Realization-style capital inflows—a middle-class exodus and possibly something much worse. In Britain, we are used to worries about foreign labour. Concerns about capital flows are a relatively new phenomenon. But today, in London, it seems as if housing has become the new immigration.
As in that debate, it is important to get down to what is real. London is one of the great global cities, attracting people and money from around the world, which makes it more expensive. It is vital to the UK economy. Britain could do with more London and more Londons. But it costs too much to live here. It must be a city where anyone can make it. Otherwise it is bad for the capital and the rest of the country. Most overseas property investors push up prices but they also bring benefits. They should receive no preferential tax or regulatory treatment. Empty homes should be hit hard. But what matters most is that London fixes its own problems, which are fundamentally about supply, land and planning. If it cannot then it will really start to look more like a liability than an asset.
In London, Peter Ackroyd thought of his city as a living thing. A less lyrical way to think of it is as a population machine. In come young workers from home and abroad, and any children they may have while they are here. Out go older workers, mostly to the rest of the UK, usually in search of homes to own. Or they die. If there were a new exodus, as Goldfarb asserts, we would expect to see evidence of this in statistics telling us how many people are joining and leaving the metropolis.
After the Second World War, London’s population declined steadily from more than 8.5m just before the war to under 7m in 1981. Then, London was poorer, whiter and older than it is today. The repopulation of the past three decades, which accelerated at the beginning of this century, means the capital now officially holds 8.2m people: 3.2m in the 13 inner boroughs and City and 5m in the 19 outer boroughs. In the past decade it grew by a total of 14 per cent compared with 7.1 per cent for the rest of England. The Greater London Authority (GLA) forecasts that there will be 9m people by 2020 and 10m by 2039.
It may sound contradictory but the expansion over the past decade took place alongside the departure of about 250,000 people every year to the rest of the UK. During the same period, 150,000 to 200,000 people arrived every year to London from the rest of the country, meaning that domestic emigration from the city was greater than domestic immigration. What keeps London growing is international immigration and, especially, lots of babies.
In fact, since the crisis, the rate of domestic departures has slowed. Among twenty and thirty somethings, it has reversed. In the five years before 2008, an average of 10,700 more people of that age left London for the rest of the country than arrived. In the five years afterwards, an average of 15,400 more twenty and thirty somethings arrived than left the capital.
Rather than a middle-class movement out of the city, the clearest trend is an increase in poverty in the outer boroughs and the gentrification of parts of inner London such as Hackney and Brixton. This is a version of the American trend described by the urbanist Alan Ehrenhalt as “the great inversion.” The government’s welfare reforms are catalysing this long-running process. The city’s highest unemployment rate used to be in Tower Hamlets, now it is in Barking and Newham. London poverty increasingly encompasses those in work and those privately renting.
So long as they are places of opportunity, cities will always attract poor people—the danger is that poverty becomes entrenched on the fringes and that London increasingly becomes an engine of growth and success available to only a few. In an era when cities are ever more important to our economies, this would be a tragedy.
A bourgeois exodus may be premature at best but London still looks like a rentier city. And in order to understand what foreign investment is really getting itself in for (in both senses), it is essential to understand the underlying aspects of the market.
The ratio of house prices to earnings is one of the standard measures of housing affordability. In 1997, the ratio of median house price to median earnings was 3.98 in London and 3.54 in England as a whole. The respective figures now are 8.57 and 6.74. These put home ownership in much of the capital (and beyond) out of the reach of people without wealth, high pay, or a willingness to live in Barking.
Unsurprisingly, more and more Londoners are turning to renting. The number of Londoners who own their own home fell by 6 per cent in the past decade. Nationally, about two-thirds of Britons own their own homes. In London, it is about one half. This makes the private rental market—the only sector to see any significant growth in units in the past decade—all the more important. It too is extravagantly expensive. A rule of thumb for affordability is that rent should be no more than 35 per cent of net income. For every London borough the median ratio is more than 50 per cent.
Overcrowding is increasing. Average household size rose from 2.35 to 2.47 persons over the decade, while remaining constant in the country as a whole. This may not sound like much but it marks the first change in a decades-long trend towards smaller households. Across the capital, Londoners are spending more on less housing.
This is what happens when demand rises in a supply-constrained market. Just to keep pace with population growth, London needs to build 32,600 houses per year, according to the Greater London Authority. It is not meeting the target. There are many reasons for this supply failure but fundamentally it comes down to planning and land.
Ever since the Town and Country Planning Act of 1947 (yes, 1947) there have been too few incentives for land use. In a recent paper on Britain’s planning problems, economists Christian Hilber and Wouter Vermeulen note that the UK has the second highest house prices per square metre in the world. Only Monaco is dearer. Britain also builds the smallest new homes in the western world. Both of these aspects reflect the underlying value of land and the difficulty of developing in and around the city.
We are not even building on much of the land that already has planning permission. In a remarkable report for the GLA published in 2012, Molior, a consultancy, found that 45 per cent of permitted homes are in control of firms that are not builders. “To state the obvious, builders intend to build their sites; non-builders do not!” it says.
We are left with a situation where, in the words of Molior, “there are only two ways to get development land: pay more than anyone thinks it is worth, or work for many years alongside a land owner, helping them to get permission.” In the meantime, so long as demand remains high, the owners of land and property, behaving totally rationally, continue to benefit at the expense of those without wealth. This is a deeply unfair situation—both on younger generations and on the poorest.
It is little wonder that renowned north American urban scholars Richard Florida and Ed Glaeser both told me that London’s future prosperity depends on reforming its land use and fixing its housing supply. This possibility, and the inequity underlying it, is what should make concerned citizens such as Goldfarb really angry—we have the greatest city in the world and we risk making it too parasitical to flourish.
All of which brings us back to the bloody foreigners. Is it their fault? In 2012, foreigners bought 38 per cent of resale properties in prime London, a designation which captures the posher parts of zone one. This is a high share but not unheard of—the same percentage was seen as recently as 1990. And today, 35 per cent of Londoners are foreign-born. (Britons are also busy—the French buy Kensington, we buy the Côte D’Azur.) Ninety-three per cent of prime resale buyers live or work in the UK. In the most expensive streets, lined with trophy assets of Russian plutocrats, lights may never be on, but the darkness is often exaggerated.
It is in the new build sector where we see the clearest evidence of investors acting on something like the Realization thesis. Eighty-five per cent of new builds in prime central London are owned by people from overseas. Buyers from Russia and other former Soviet Union countries dominate the very top end of the market. Asians are buying at the relatively lower prices. About two-thirds are buying primarily as an investment (for rental income and for an eventual capital gain), rather than a second home or a place for the kids, according to a survey by estate agent Knight Frank.
We are, though, talking about a lot of money—most of it cash up front. According to another estate agent, Savills, £7.1bn of “international equity” was spent on London houses in 2012 and £37bn since 2006. To put this in context, £7.1bn is about 39 per cent of all the mortgages lent in the city in 2012, according to the Smith Institute, a think tank.
Naturally, this has given rise to worries about whether London is vulnerable to the withdrawal of this capital. Such a situation is plausible: the pound could rise in value, overseas economies could collapse, politics could change in Russia or the eurozone (west London estate agents are some of the world’s greatest political risk consultants), another country could become a hot spot, or British politics could become increasingly populist and turn on foreigners. But it would take a lot and London should be more resistant to hot money turning cold than east Asia in the late 1990s.
Whatever happens, there is no doubt that overseas buyers have boosted prices, though it is impossible to put a precise number on their impact. “The most important driver behind price growth has been growing demand for London property from international buyers,” said Knight Frank in 2011, when the domestic market remained firmly in the doldrums. “Equity funnelled in at the centre migrates down London’s wealth corridors. So, as billionaires displace multi-millionaires from the top addresses so they in turn displace millionaires,” said Savills in the same year.
Nevertheless, with the domestic market showing signs of recovery too, it is important to remember that prime resales are only a part of the story. “I can see how foreigners are driving prime but I’m not so sure that this drives the rest of the market,” says Henry Overman of the London School of Economics. Credit is flowing again to domestic buyers and demand is picking up. Moreover, prime rents are actually starting to see a slight decline, suggesting that we may have reached a limit of sorts.
Christine Whitehead, also of the LSE, adds that in the new build sector, overseas investors are ensuring that construction is going ahead that otherwise would not. Glaeser agrees that this is a good thing. It reminds him of how the Japanese bought American property in the 1980s, “which allowed Americans to buy Japanese cars.” Implicit in this argument is that so long as foreigners are holding the risks of new build investment then the downside lies mostly with them, rather than Britons.
There can be little doubt that overseas buyers are playing a big and growing role in London property. However, some perspective is in order. It reflects the fact that our city has become more global in labour as well as capital. They should have to pay the same capital gains tax as British residents, and leaving properties vacant should be punished via the tax system. But remember that this is not simply a London problem. Try to rent a flat in Stockholm or Vancouver. And it is somewhat hypocritical for people to argue that we need more houses and then criticise those who fund new builds. Most important of all, it is our market dysfunction—especially our land use policies and our regressive system of property taxation and regulation—that foreigners are investing in.
The rise in London house prices, which has all but driven the average price growth across the UK, is considered by some a symbol of a bigger problem: that the city is simply too dominant and too much economic activity is concentrated in the capital.
Britain’s regional disparities stem from at least the 19th century, according to the Northern Economic Futures Commission, which last year produced a comprehensive study of the north-south divide. Aside from a short period after the Second World War, economic outcomes have diverged. Now London and the southeast are growing faster again. London, southeast England and east England account for 38 per cent of employment in the UK but 83 per cent of jobs growth over the past year, according to Citigroup. Across the other nine regions the aggregate level of employment is still below the pre-crisis peak. Consumer confidence is significantly higher in London.
One could look at these figures and conclude that this is a terrible imbalance, or we could ask how to make this happen in the rest of the UK. There is a case that the City (big C) may be too big but a terrible case that the same could be said of the city (small c). The question of whether there is too much London, “is a non-issue at best and a dangerous one at worst,” Florida writes via email. It is “very dangerous for a country to hold back its most productive metropolitan areas,” Glaeser says.
Density is the currency of urban economics. Bring people, especially creative, industrious, high-skilled people, closer together and productivity increases. Glaeser’s rough estimate is that a 10 per cent increase in density leads to a 0.6 per cent productivity gain. The bigger the share of the gain that goes to the person rather than her boss or more pertinently her landlord, the better that will be for everyone. How to make London bigger and denser yet cheaper to live in should be the crucial aim of policy.
Another objective should be figuring out how to grow Britain’s second cities. Although he admits this is a slightly silly exercise, when Overman looks at the size of British cities and market signals, he is more inclined to see too many small northern cities rather than a dastardly huge metropolis. If London is already like New York then Birmingham and Manchester could be more like Chicago and Boston.
This is a feeling shared by those such as Howard Bernstein, Chief Executive of Manchester City Council. “Ultimately, the fundamental flaw in the whole notion of the north-south divide is that it assumes a zero-sum game where what is good for one place is bad for others, and vice-versa. This is an idea we need to jettison once and for all,” he says. Successful northern cities should be given the budgets and power to prove him right.
The alternative is that London simply becomes too expensive and people and businesses go elsewhere. The problem with that is there is no guarantee they will go to Manchester rather than Madrid or Mumbai. It is in Britain’s wider interest to ensure that London continues to be one of the world’s great cities. This may mean being tougher on those overseas buyers who contribute little to the city’s economy. But we should not confuse efforts to equalise the treatment of foreign and domestic house buyers and to punish AWOL oligarchs with an actual strategy for housing.
If foreign investors want to fund or build new houses at their own risk then we should welcome that. It is vital that there is more London for everyone—and that means re-zoning land, building more homes, and doing so urgently. For there is another Realization that matters: unless we do, the London we all love is at risk.
Michael Goldfarb, New York Times, 12th October
Writing in the New York Times, in an article circulated across two continents and which caused great debate in London, Michael Goldfarb, left, an American living in London, set out his concerns at what he sees as an unhealthy development in the character of the capital.
“This is what happens when property in your city becomes a global reserve currency,” wrote Goldfarb.
“The [London] property market is… a place for the world’s richest people to park their money at an annualised rate of return of around 10 per cent. It has made my adopted hometown a no-go area for increasing numbers of the middle class.”
“The city is essentially a tax haven with great theatre, free museums and formidable dining. If you can demonstrate you have a residence in another country, you are taxed only on your British earnings.”
“I wonder whether those just parking their money here by buying real estate will ever be able to provide the communal sensibility to help the city survive the inevitable shocks it will experience in years to come.”