Big cities should expect house price falls

New financial curbs spell bad news for housing in London and regional capitals.

When it comes to house prices, the three most important features are location, location and location.

Bright lights, big city

Location really is king. Property gurus have long argued that it’s far better to buy the worst house in the best street than the best house in the worst street.

Likewise, demand for property is usually highest in areas with the best-paid jobs. Higher wages help to support higher house prices -- and wages are highest in our nation’s capital. Hence, house prices are much higher in London and other major metropolitan centres than in rural areas.

You need only look at house prices in, say, London to see the lure of big cities. Here’s how London house prices rose during the 1996-2007 boom, versus the rest of the UK:

Average house price from 1995 to 2007

Source: Halifax House Price Index

As you can see, there are no surprises here. Historically, property prices in Greater London -- with eight million residents -- have risen faster and stayed higher than anywhere else in the UK.

In the above 12-year boom, the average price of a property in London almost quadrupled, rising 295% to over £302,000. For the UK as a whole, the average price more than tripled, rising 221% to almost £226,000.

Also, at the end of 2007, the average home in London cost 1.54 times the UK average, a ‘capital city’ premium of 54%. Back before the Nineties boom, this ratio was 1.25, so the London premium added only a quarter (25%) to the UK average in 1995.

One big problem for high-end buyers

Of course, I expect this trend (for London to outperform the rest of the UK) to continue. In my view, strong demand for property in London and other major cities will keep prices elevated in these regions for decades to come. However, I can see one fly in the ointment: various regulatory crackdowns on banks and other financial firms.

On 7 July, the EU Parliament approved new laws to crack down on excessive bonus payments and risk-taking by financial firms, particularly banks. These curbs come into force next January, so they’re less than six months away.

This is the first time that bankers’ pay has been regulated by the EU, although the Group of 20 countries agreed less onerous curbs on bank pay last year. In addition, City watchdog the Financial Services Authority (FSA) is reviewing bank-pay rules in order to reduce systemic risk and help to prevent future bailouts by taxpayers.

Here’s a summary of the EU curbs on bank pay to take effect in January 2011:

• Only 30% of an upfront bonus can be paid in cash (reduced to 20% for ‘large’ bonuses).
• At least half of a bonus must be paid in some combination of shares and contingent capital, which must be held for a certain period.
• At least two-fifths (40%) of a bonus must be deferred for three to five years (60% for large bonuses).
• If performance turns out weaker than expected, then a bonus claw-back will apply.
• Each bank must set an upper limit on the size of staff bonuses, relating to salary.
• Bonus curbs for bailed-out banks are even stricter.
• These rules also apply to foreign banks operating in the 27 states of the EU.

In short, these rules are the EU’s attempt to clean up the worst excesses of the City, favouring stability over recklessness.

Lastly, banks will be hit by a £2 billion-a-year levy to take effect from 2011, putting further pressure on their profitability and reducing their ability to pay mega-bonuses.

Lower pay means lower prices

We know that high pay and strong demand act to inflate London house prices. Similar effects are seen in other regional capitals, such as central Edinburgh, parts of Glasgow, Birmingham, Leeds and Cardiff.

More than a million people are employed in financial services in the UK, with around a third of these working in the City and Canary Wharf. Although the majority of these won’t be hit by the new EU rules on bank pay, the big hitters are set to suffer.

Therefore, curbs on financial firms are sure to have an impact on house prices in areas with the highest exposure to top-end financial services. While this shock will be felt most in upmarket London, a ripple effect could spread out across the UK, as premium-home buyers see their cash pay fall. In effect, pay cuts could translate into price cuts in the middle to upper reaches of the housing market.

All that remains to be seen is how the biggest earners in London and other regional financial hubs react to these crackdowns. Will house prices fall as a result? I expect they will, so watch this space...

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