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No UK housing bubble, just a London one: EY

London is at risk of a housing bubble – with average house prices more than three times higher than in Northern Ireland or the north east by 2018 -- but the rest of the U.K. looks set to escape wild gyrations in the property market, according to a report by consultancy EY.


Simon Dawson | Bloomberg via Getty Images

"Prices in most regions are below previous peaks in cash and real terms," the EY ITEM Club Special Report on Housing noted. "Both affordability and household debtlevels look much better than before the financial crisis."

However, it added: "The exception is London, where limited supply and strong demand have driven price-to-income ratios and income multiples back to previous highs, signaling the potential for overheating."

U.K. house prices rose at their fastest rate in over four years in December, according to the latest data from the U.K.-based Nationwide building society. House prices in the U.K. rose 1.4 percent in December and were 8.4 percent higher year-on-year, with the single-month increase the biggest since August 2009 with London house prices leading the trend, having risen 14.9 percent year on year.

"Prices in London are now 14 percent above their 2007 peak," Robert Gardner, Nationwide's chief economist said in the report, "with the price of a typical London home at £345,186 ($567,000)"

(Read more: UK house prices soar: Biggest jump in 4 years)

The report said that over the next five years, improving economic conditions -- along with rising employment and support from the government's Help to Buy scheme -- will guarantee growth in demand in the housing sector, but that increased supply from house-builders will ensure that prices across the majority of the country will be contained. Thus, the report concluded, U.K. house prices will riseby an average of 6.5 percent annually over the half decade.

"House prices in most regions are still well below their previous peaks, both in real terms and in relation to average incomes," the report stated, adding, "And household debt is at much more manageable levels than before the financial crisis."

(Read more: UK house prices show first monthly fall since January 2013)

The stronger employment and income growth rates in London - combined with limited supply - will force the U.K. capital to buck the national trend. House prices in the capital rose by over 11 percent in 2013 and the report argued that there was evidence of this surge taking place beyond central London's prime properties and spreading to the rest of the residential market.

"All of this marks London out as a special case demanding particular vigilance from policy makers," the EY report argued.

It was predicted that by 2018 the average London property will be just below £600,000 ($984,000), three-and-a-half times more than the average price in Ireland, and over 3.3 times the price in the north east.

EY argued that to restrain this bubble in London, policy makers should intervene in the market with actions directed specifically at London.

"The best option would be to police income multiples in the capital while allowing market forces to hold sway in other regions," the report stated, while the government should also implement measures that will increase the housing supply, such as planning reforms and public sector house-building.

—By CNBC's Kiran Moodley. Follow him on Twitter @kirancmoodley

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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