You Think the Real Estate Bubble Burst, Not in London and China

The London Real Estate Bubble Is Back—and It's Scary
By BRETT ARENDS WSJ

LONDON—The one-bedroom co-op apartment is only a short walk from Hyde Park, and it boasts high ceilings and a purely decorative balcony.

Yours for a mere $1.5 million. It seems quite a high price, especially for a property whose ground lease will eventually expire, leaving you with nothing.

If you're looking for something bigger, you can get a duplex with two bedrooms in the center of town ... for $3.3 million. And if you're willing to slum it a bit and cross the River Thames to the unfashionable South Bank, you can get a modern three-bedroom apartment with a genuine balcony, and views of the river, for $4 million.

Looking at the real estate listings here is like stepping back in time to that unreal, giddy world of three years ago—before Lehman, before subprime, before AIG. Back to a period when everyone was either rich or on their way, either from flipping condos or running hedge funds, and the only direction was up.

But these prices are now, and they contain an ominous message: The London real estate bubble, arguably the biggest one of all, still hasn't popped.

If history is any guide, it surely will. Burst bubbles typically fall a long way, in due course, and there is no reason to believe this one will be any different—despite the usual rationalizations you hear in this town today, and which you heard in, say, Florida in 2005 and Tokyo in 1988.

London real estate has actually bounced off the bottom in the last nine months. Prices are now down a mere 9% or so from their 2007 peaks, according to data tracked by mortgage giant Nationwide Building Society. The average home in London, including all those dreary outskirts that go on and on and on, is $436,000. That's even higher than it was as recently as 2006, when the bubble was in its late stages. In the fashionable center of town—where the properties cited at the top of this article are all located—the prices are astronomical.

Overall, British prices have only fallen about 12% from the peak. When compared to household incomes, they stand far higher than they did even in 1989, at the peak of the last property bubble.

This matters for everyone—including those who will never visit Britain and have no direct interest in the real estate market. That's because there's one big question hanging over the U.S. and world economy right now: "Is that it?"

In other words, is the crash over? Has the Great Recession come to an end? Are we now heading back, albeit slowly, to normal economic growth rates and rising assets? Or is this just the eye of the hurricane?

No one knows the answer for sure. (I don't either, but at least I admit it.) But London real estate prices are one of the most worrying signs that "That isn't it," and that there is a lot more bad news to come. The other shoe, to put it plainly, hasn't dropped.

Jeremy Grantham, chairman of Boston money firm GMO and a British expatriate, argues that the British property bubble may be the biggest since the infamous one in Japan 20 years ago. It's notable that when that bubble burst, prices fell from 1991 through 2005. They fell again last year. There were many false dawns along the way. Many assumed the crash was over the worst after the rout of the first few years .But the real damage came afterward, as prices kept sliding, year upon year.

People here will tell you that London is unique. Well, yes. But everywhere is unique.

A money manager this week explained to me that the London real estate market now functions as something of a global financial Laundromat: Properties are bought up by tycoons from Russia, the Middle East and elsewhere eager to get their money out of their own country. But so what? An overpriced market is still an overpriced market. Losing money on Mayfair apartments is no better than losing it to, say, a corrupt government.

Prices here were also buoyed by the hedge-fund boom. Perhaps that is back again. If so, it's something else to be worried about. Another speculative mania is the last thing we need.

But if London real estate is buoyed by the uniqueness of the town's economy, there is a disturbing degree to which the reverse is also true. This is a ridiculously expensive city to visit. I seem to hemorrhage money with every step I take. I was wondering, as I got out of a taxi the other night and severed the requisite two limbs to pay the fare, how I ever afforded to live here all those years.

The answer is, I couldn't—even though I earned a perfectly good salary. What made a difference was the money I made on my apartment, which doubled in value between 1997 and 2003. Two years after I sold it, in 2005, it had nearly doubled again. Remove this alchemy from the equation of ordinary Londoners, and the bars and restaurants and theaters would be a lot emptier.

Meanwhile, the British government is borrowing and spending on a huge scale to prevent an economic implosion. The national debt jumped by a fifth last year, surpassing 60% of annual output. In a sign of what is now driving economic activity, the average public-sector employee, according to official statistics, now earns about a fifth more than his private-sector counterpart.

The markets are certainly worried about the long-term implications of the U.K.'s spending binge. It costs twice as much to insure British government bonds against default as it does German or French bonds.

But if you looked at real estate prices, you'd never know it.

Write to Brett Arends at brett.arends@wsj.com