Metropolitan London is the largest office market in the world (in capital value terms) and the dominant commercial real estate market in the UK economy. The United Kingdom real estate market in general, and the London office market in particular, experienced a boom in the early 1970s and a pronounced bust in 1974.
London's growth as a commercial and financial centre resulted in a constant increase in demand for office space. Growth gained momentum in the late 1950s, coupled with the accelerating trend of national companies to relocate their headquarters to the capital. Building regulations and fiscal policies, instituted by the 1964-1970 Labour government, aimed to discourage new developments in London and stifled the supply of new office buildings. Moreover, regional incentives prompted developers to relocate projects to the suburbs. However, despite incentives, major financial and business service firms were unwilling to relocate to peripheral regions and cities. The resulting supply-demand imbalance caused City office capital values to increase substantially – 110% in real terms between March 1968 and the market peak in June 1973, while West End real capital values rose by 58% over the same period.
The incoming Conservative administration under Prime Minister Edward Heath (1970-1974) relaxed building regulations and reformed tax policies to help encourage new construction and mitigate London’s supply shortage. In September 1971 the Competition and Credit Control plan removed lending ceilings and reduced reserve ratios for banking organisations. Moreover, to combat the sluggish growth of the UK economy and high national unemployment, the new administration instituted an expansionary economic policy. Taxes were cut, the Bank Rate (MLR) was reduced from 7.5% in 1970 to 5% in 1971, and the money supply increased (M3 rose by 73% from 1971 to 1973). The easy credit policy stimulated bank lending that flowed disproportionally to the property sector, increasing from £343 million in 1970 to £2.83 billion in 1973. Deregulation of the financial sector (instituted by the Labour administration in 1964) had facilitated the growth of secondary (or “fringe”) banks that were lightly regulated and monitored. These finance houses typically relied on short term, and therefore less stable, funding sources than well-established clearing banks. Competition for market share led to an erosion of lending criteria and downward pressure on lending rates.
As a result of abundant debt capital, London commercial property prices spiked rapidly, and development boomed. Despite rising inflation, property investment returns increased in real terms from an annual average of 1.55% (1965-1967) to 14.2% (1971-1973).
Dr Colin Lizieri, Grosvenor Professor of Real Estate Finance, University of Cambridge, looks at the macroeconomic backdrop and factors that contributed to the 1974 London office market crash