Wondering what drives property values? We take a look at how earnings growth impacts house price rises.

The link between house price growth and earnings in London has become “almost entirely dislocated”, although it remains strong in other regions.

House prices typically rise broadly in line with increases in earnings, with higher wages typically pushing property values up as people can afford to borrow more through a mortgage.

But in London, this link has been broken, with pay growth and house prices often moving in opposite directions, according to estate agent Savills.

Research by the group found that property values in the capital fell by 2% in the two years to September 2019, despite earnings increasing by 7%.

By contrast, while average earnings rose by just 1% in London in 2015, house prices soared by 11%.

The study found that the link between rises in earnings and increases in property values remained strong in other regions, particularly the North West, Yorkshire and the Humber and Wales, with the ratio of house price to earnings remaining in a narrow range of 7.6 times to 8.1 times during the past five years, showing performance was based on what people could afford to borrow.

Lawrence Bowles, residential research analyst at Savills, said: “Our analysis shows that housing affordability in London is far more stretched than in any other region.”

Why is this happening?

While property in regional markets is typically bought by local buyers, overseas investors account for a significant proportion of transactions in London.

As a result, the market is influenced by other factors alongside earnings, such as exchange rates and the global economy.

The London market has also been impacted more than regional markets by stamp duty changes, including an increase in the top rate at which the tax is paid, and the introduction of the 3% stamp duty surcharge for people purchasing a second property.

These factors have diluted the impact earnings growth has on the market.

Who does it affect?

The disconnect between house prices and earnings in London is bad news for people wanting to buy a home there.The fact that earnings growth has only a limited impact on property values has led to affordability becoming increasingly stretched.

Despite this, demand from overseas investors, who typically have deeper pockets, could continue to push London prices higher.

By contrast, in other markets across the UK, house prices tend to stagnate once property becomes unaffordable while earnings catch up.

What’s the background?

Despite the disconnect between London house prices and earnings growth, Savills predicts the market will remain subdued until affordability improves, predicting price rises of just 4% in the capital in the coming five years.

Across the whole of the UK, Savills thinks prices will rise broadly in line with average earnings growth, increasing by just over 15% between now and the end of 2024.