Explainer - Why Are London House Prices So High?
The Scale of the Problem
£550,000 - that is the price of an average London home. The median full-time annual salary is roughly £47,000, meaning that the average home costs approximately 11.7 times yearly earnings. Rent isn’t a much better alternative, absorbing an average of approximately 41.6% of income. Faced with this situation, 64% of 18- to 40-year-olds say they are likely to leave the capital.
The question, however, is: how did we get here?
One answer is that demand has outpaced supply.
Why Demand Is So Strong
London’s demand is driven by agglomeration economies, or 'external economies of scale': economic advantages that arise when businesses and employees locate close together. Historically, proximity made communication and information exchange faster; today, even with digital technology, face-to-face contact in these dense networks continues to offer important advantages. Firms are able to benefit from large labour pools, strong transport and digital connections, specialist infrastructure, knowledge spillovers, and the ability to access legal, financial and professional services within a small area. These advantages attract further investment and workers, reinforcing London’s position as the UK’s principal economic centre, with London capital accounting for around 22% of UK GDP. However, while this supports higher wages and employment, it also intensifies competition for nearby housing.
Why Supply Can’t Keep Up
Housing supply is inelastic; when demand increases and prices rise, the building on new houses will be slow to increase. At its core, this is due to limited space - there are only so many houses you can build, after all. But the problem is less simple than that. Britain has a discretionary planning system, meaning that proposed developments are assessed individually rather than approved automatically when they meet a fixed set of rules, lengthening the approval process. Furthermore, green-belt protections, designed to contain ‘urban sprawl’, limit the land available for development across substantial areas surrounding London. Similarly, height and density limits and local resistance from so-called ‘NIMBYs’ can reduce the scale of projects and delay construction. However, planning regulations are not the only factor limiting supply. Construction costs, labour shortages, and building safety and environmental requirements can also raise costs or delay projects. When faced with these barriers, developers may decide that new projects are not worth the cost or risk.
Overall, London’s high house prices reflect the interaction between exceptionally strong demand, reinforced by agglomeration economies, and a housing supply that responds too slowly to keep up.
By Leona Bastianic
