London’s 3 octaves of price

In the sections describing the factor model we see clearly that a large part of the relative performance of areas can be explained by systematic risk factors, and that these are a means to model the well-known ‘ripple effect’ in a rigorous quantitative framework. This is interesting, but does not directly answer the homebuyer’s question ‘where should I buy to get outperformance’? The reason is that the homebuyer typically is constrained - they already know the area where they have work, friends, and family and only want to know where to go within those constraints. As an extreme example, a young family of 5 can fit into a 2-bed apartment in prime London - I have had neighbours like this - but they are looking to time a move to somewhere better suited, and want to know the numbers. The question for them is: ‘if we delay a year can we afford a better house in the suburbs, or should we do it now?’. There is a temptation to look at recent history and mentally project it into the future, but what’s really needed is a forward-looking model.

London makes for an interesting example. There is a wide range of options from prime central London to the edge of the commuter belt, which maybe for practical purposes is about 1 hour out. This approximately extends to Brighton, Oxford, and Cambridge, and within our cases Colchester is pretty much at this limit. See for example for more detail. So near-enough to London we have five of the entire spectrum of nine (WC, NW, SE, CR, CO) actually feasible to live in and commute from. If perhaps we have a £1m budget and intend to invest to up this limit there is a very broad range of choices. Even within the London areas (E,SE,SW,W,NW,N,WC,EC) there are districts spanning approximately £4000/m2 to £28000/m2, a factor of 7, nearly 3 octaves in music. To pose this as a quantitative problem: we specify our investment horizon i.e. how long we intend to hold it for, add knowledge of the current phase (or equivalently the ‘hot’ price point in £/m2) and where that will have rotated to at the price horizon. This gives a price band of interest, and we should probably focus on the middle of it if possible to capture maximum cyclical performance from now to horizon.

Consider a fairly typical five-year horizon. Five years back in mid-2014 the phase angle was approximately 166 degrees, corresponding to a price of £9400/m2 - this subsequently rotated fairly steadily down to around 30 degrees now in 2019, which corresponds to a price of £1,400/m2 i.e. a very cheap level not found anywhere near London. Note that if the rotation were steady and the period is about 16 years, we would have foreseen a rotation of 23 degrees per annum and so a total change of 5 x 23 or 115 degrees, whereas we have seen 136 degrees - slightly more rapid than expected based on a simple constant rotation rate. Not having perfect foresight, we would have considered the sweet spot for a 5-year horizon to be around 166-2.5 x 23 = 109 degrees, which corresponds to £4200/m2. This is about the cheapest price in London, to be found in Thamesmead SE28/SE2, a new estate which because of its remoteness – and perhaps also its bleak ambience – has not proved a popular place in which to live. This has led to a spiral of decline and part of the district is now perceived as a ‘sink estate’. (

So had we thought cyclically, this is where we would have invested - or we could have gone further afield and found more remote, more superficially pleasant places perhaps, but lets just follow the logic through with this example. First consider the indices for the top quintile by price in W (West London), and compare it with the bottom quintile in SE (Southeast London). W quintile 5 is down about -0.04 in log terms, while SE quintile 1 is up about +0.28, so a relative performance of .32, which in normal percent is 38%.

Thamesmead and Chelsea

Figure 1: Thamesmead and Chelsea

Given that this is quite a dramatic result, it’s a good idea to do a ‘sanity check’ or data audit on a few datapoints. Taking repeat sales in the postcodes EC,WC,SW3,SW7 (central London, South Ken, Chelsea) and selecting ownerships starting 2014, ending 2019, we get 19 records. Ranking on return and looking at the central 3 to robustly reject the outliers, we see the median ranked 9/19 returned of -4.85%. this pretty much tallies with our index.

Turning to Thamesmead we take repeat sales in SE2 and SE28, and again select holding periods 2014-2019, giving 10 repeat sales. Ranking on return and looking at the central 3, the median return is 46.6% or a log return of 0.38. Again this pretty closely tallies with the index, bearing in mind the small sample in this fairly crude ‘sanity check’.

What should we conclude?

  • Our quick sanity check passes - the index returns are not at all out of line with the average realised return
  • Knowledge of the cyclical behaviour can identify economically significant differential performance (here about 38% over 5 years)
  • Prime central London is not always the best place to invest on a 5-year horizon, and this is forseeable based on a simple cycle, without complex modelling
  • There is a popular notion that the London has underperformed - but as we see here, that’s not so true in SE28
  • There is a popular notion that this is due somehow to Brexit - but really it is an entirely forseeable consequence of a long cycle
  • A couple of minor problems: you cannot buy a £1.5 million house in SE28, and you only get tax relief on one property
  • Lifestyle issues - obviously if you have 1.5 million budget for your flat then maybe you don’t care about the returns on it so much - really you only live once, and it’s a long way from SE28 to the Chelsea Arts Club
return.rank id bought sold bought.price sold.price return
8/19 EC-2Y-8--HD-907-FROBISHER-CRESCENT 2014-09-11 2019-05-14 745000 704000 -5.5%
9/19 SW-3--2--SX-1-THACKERAY-HOUSE-1-3-CULFORD-GARDENS 2014-04-24 2019-01-31 1525000 1451005 -4.85%
10/19 SW-7--5--RP-LOWER-GROUND-FLOOR-FLAT-2-28-QUEENS-GATE-GARDENS 2014-07-10 2019-05-02 1855000 1795000 -3.23%
Not Prime
4/10 SE-28-0--NW-7-BAILEY-CLOSE 2014-09-26 2019-06-20 180000 250000 38.89%
5/10 SE-2--0--DN-6-TREETOPS-CLOSE 2014-10-21 2019-07-03 228500 335000 46.61%
6/10 SE-2--9--EN-183-BRACONDALE-ROAD 2014-05-02 2019-05-21 235000 345000 46.81%

And finally: the phase described here has come to an end, and London’s primest sectors should henceforth outperform the rest for some time in the early 2020s unless there is a major tectonic shift as a result of either brexit - or perhaps a new socialist era.