This article was written by Rose Grayston, who is senior policy officer of the illustrious housing charity Shelter. It originally appeared on Shelter’s indispensable policy blog, and I am grateful for permission to re-publish it here.
All the signs point to a slow-down in the London property market. Central London house prices dropped by 6.8% between 2015 and 2016, while the numbers of new homes under construction plummeted by 75%.  The problem is located almost entirely at the top of the market, with sales transactions collapsing by 86% for properties worth more than £10 million. 
Central London property values are eye-watering, far beyond the reach of most working London households. A fall in house prices might be welcome as a way to make housing more affordable. But unfortunately, the perverse incentives at play in the way housing is built mean that a slow-down in the market for luxury flats in Kensington and Chelsea can mean less affordable housing is built, not more, and the consequences may be felt right across the country. There are three main drivers of this:
- There will be less money for affordable housing where private developers stop building
- The way land is traded reduces incentives to build anything other than luxury flats
- Developers will build more slowly, reducing supply
There will be less money for affordable housing where private developers stop building
Grants from central government used to fund almost all the costs of building new affordable housing. This meant that when private development experienced a down-turn, social development could step in to fill some of the gap, keeping builders building and having a stabilising influence on the market as a whole. Such grants funded 75% of affordable housing development costs in the early 1990s, but now fund just 14%. 
The majority of finance for new affordable developments now comes in the form of Section 106 – payments or land given by private developers in return for planning permission from the council to build profitable market housing. So the more private development there is in a local area, the more money there should be to subsidise affordable housing for rent or sale.
As affordable housing has become increasingly dependent on Section 106 agreements rather than grant funding, any decline in new construction affects the whole of housing supply, including the bits we care most about – genuinely affordable homes for ordinary families. This means that unless the slow-down in luxury property development in central London can be balanced out by other kinds of private developer activity, there will be less finance available for affordable housing in the capital.
The way land is traded reduces incentives to build anything other than luxury flats
That shouldn’t be a problem: there is a huge need for more housing across the country, and especially in London. If luxury flats are getting harder to sell, developers should be able to build and sell something else and still make a profit. Right?
The problem is land. Landowners, advised by their agents, sell their sites for the highest possible price, based on extracting the greatest commercial value from the land. In the case of central London, this often means more luxury flats. Once developers have paid sky-high prices for land on this basis, the only profitable option open to them is to build those luxury flats and sell them for the highest possible price.
In this way, the price of land distorts construction away from meeting housing need. Estate agents Savills estimate that 58% of housing need in London is for homes costing less than £450 per square foot, but such homes represent just 25% of new builds planned between now and 2021. On the other hand, 2015-16 saw a significant oversupply of luxury flats as developers tried to recoup the high cost of land, with 1.6 starts for every 1 sale of a home priced above £1000 per square foot. 
Developers will build more slowly, reducing supply
But if the bottom has fallen out of the land market surely developers and landlords will readjust? Sadly not. Most landowners are likely to hold on to their assets in anticipation of recovery in the most profitable luxury market, rather than accepting a lower price that would allow different kinds of homes to be built.
In the current market, developers have invested heavily in land for luxury housing. If they build and sell these homes at a lower price, or if they build something else for a lower sale price, they risk not making back the money they spent on that land. Many developers will now instead choose to hold on to the land, restricting supply in an attempt to bolster prices, waiting out the market and building out slowly when prices start to recover. This will put even more pressure on housing supply and on affordability.
So what do we need to do?
We need to create a situation in which developers are incentivised to build affordable homes, not just luxury flats, to meet housing need across the country.
Shelter’s New Civic Housebuilding report sets out a vision for how we can achieve the new homes we need, based on clearer and lower land values. We’re calling on central government to update the rules on land valuation and enable public bodies to use their land holdings to build more affordable homes. In these ways, we can provide land at prices which enable development to respond to housing need, not just the highest bidder.
 JLL Residential update: Central London Development (March 2017).
 Reuters: “Sales of double-digit million pound UK homes fall 86 percent” (17 October 2016)
 Savills: London’s future homes and workplaces – the next five years (April 2017, p5).