Thursday, 22 May 2014

Is there a London Housing Bubble?

The latest figures showing London house prices up 17% in a year can only fuel speculation about whether London is experiencing a housing bubble.

Tim Harford and Simon Wren-Lewis have both provided thoughtful commentary on this in the last few weeks (as, I am sure, many others). I don't have anything much to add to the debate on whether there is a bubble. As Tim Harford makes clear, I'm not sure how we'd know. But, to some extent, it seems to me that all this debate about whether or not there is a bubble deflects attention from the more fundamental point: highly inelastic housing supply leads to both high prices and greater fluctuation in prices.

Indeed, the last time my colleague Paul Cheshire looked at the figures, the volatility of the UK housing market as a whole exceeded the volatility of the most volative metropolitan market in the US (at the time, LA). The recent housing market problems in the US may have changed the relative volatility for a few metro areas short term - but with London growing at 17% it won't be long before we reclaim our 'crown'.

Highly inelastic housing supply adds to volatility because any increase in demand gets translated in to rapidly rising prices.  Whether that demand comes from income growth, lower mortgage rates, easier borrowing, foreign buyers or some other structural shift, the result is large increases in house prices. This, in turn, tends to feed back in to demand as people come to expect capital gains. When structural factors shift in the opposite direction, or expecations change falling demand now translates in to falling house prices. Result - high volatility.

Even in Simon Wren-Lewis view of the world, where the underlying shift in demand reflects low expected yield on other assets (rather than a bubble), it's still the highly inelastic markets that will see the large capital inflows. At the very least, if supply was more elastic, this inflow of capital would lead to increased housing supply, lower longer run rents and more affordable housing.

Is there a bubble? Who knows? But let's try not to have arguments around that question detract from the far more fundamental question of what we can do to try to increase housing supply in the parts of the country where demand is high.