London Property's Vulnerable Side

JANUARY 10, 2012   THE WALL STREET JOURNAL

By HESTER PLUMRIDGE

How long can London's property market defy gravity? House prices in the capital rose in December, even as prices elsewhere stayed flat or fell, says the Royal Institution of Chartered Surveyors.

Prices in prime central London are around 16% higher than their September 2007 precrisis peak. Some forecasters predict a further 25% jump by 2016, as foreign investors continue to seek havens for their cash. But downward pressures are likely to intensify this year.

Foreign buyers account for more than half of the sales of London's most desirable residences, helping shield the market from a domestic downturn. Many have large chunks of equity to invest, so are less affected by the mortgage-lending squeeze. Recent sterling weakness against many currencies—down 20% against the dollar since the start of the crisis—has added to London's allure, while ultralow interest rates have kept a lid on distressed sales.

So long as the economic uncertainty continues, the torrent of foreign cash flowing into London property—an estimated £6 billion, or roughly $9 billion, in the 18 months through mid-2011—will likely be sustained. But the top end of the market is sensitive to the global picture. If the euro crisis is resolved or the world economic outlook improves, overseas investors might turn to riskier, higher-return assets. A rise in sterling or a fall in commodity prices are other possible factors.

London property isn't cheap by any measure. Yields are low—at 3.9%, compared with 5% in the wider U.K. housing market and up to 7% for prime offices in most European capitals. Soaring prime central London rents, up 25% since mid-2009, have provided some support to valuations, but an estimated 55% of "prime" tenants work in financial services, where heavy job losses are on tap. Yields are likely to remain flat into 2016, estate agent Savills says.

Meanwhile, the average house price in London is equivalent to 7.8 times earnings for a typical first-time buyer, compared with an average of 4.8 times across the country, website Findaproperty.com estimates. Such a disparity looks unsustainable, and provides a strong incentive for capital-dwellers to relocate and investors to seek better value elsewhere.

—Hester Plumridge

Write to Hester Plumridge at Hester.Plumridge@dowjones.com