Don’t worry, the office building boom doesn’t herald another recession

Back in the days of the dot-com bubble, Andrew Lawrence, a US property analyst, postulated a new theory of the economic cycle. The idea was simple: immediately after a recession, investors, business leaders and lenders behave cautiously. Their appetite for risk is limited, as they remember all too well the pain of the previous bust.

Eventually, however, as the economy grows, the more cautious lose out (and are eventually sacked), and the gamblers triumph. Eventually, everybody (bar a few geniuses) lose their heads and throw caution to the wind, just when the economy hits peak bubble and immediately prior to the next bust. The economy then collapses, the number of bankruptcies rockets and the next cycle begins.

Partly in jest, Lawrence proposed what he thought might be the perfect indicator that a bust was imminent: the Skyscraper Index. There is no clearer sign - or so the theory would have it - that human folly has reached its apogee than when developers and bankers race for the skies. In other words, if you want to predict the next crash, simply count the number of cranes and very tall buildings being erected; when the numbers start to surge, you know that the game will soon be up.

On that basis, it could soon be time to panic. The latest Crane Survey from Deloitte reveals that office construction in central London has jumped by 24pc in six months. There is now some 9.5m sq ft under development, of which 31 new starts contributed 4.4m sq ft. The increase in new starts was the second highest recorded by Deloitte in 20 years.

The good news is that the Skyscraper Index isn't actually a good predictor of bubbles and busts. Just like the idea that hemlines go up and down with the economic cycle, it’s a fun theory that falls down when assessed using proper statistical techniques.

Psychology does matter a lot to economics, contrary to what some theorists still believe, but booms and busts are primarily driven by loose monetary policy, a far more tangible force. One can, of course, argue that monetary policy has been far too expansionary for a while - a point I have made repeatedly - and some assets are undoubtedly over-valued, including government bonds. There will be pain ahead. But not all investments are over-priced, and there are no real signs that we are about to face an imminent overall economic implosion, unless of course something goes very wrong abroad.

The latest spate of office construction is also being accompanied by a large number of private residential towers, especially in London. But this doesn't signify a bubble either: supply is far too low and even more new homes need to be built. As to the new commercial property, some 37pc of the space in the new starts has already been pre-let. London is still doing very well, despite the possibility that some big banks, such as HSBC or Standard Chartered, may decide to leave.

Capital Economics’ prediction looks more sensible than that of the property perma-bears. The consultancy believes that City and West End rents will rise by 10pc-11pc this year and by 6pc in 2016. This would take them to record highs in nominal terms, Capital Economics points out. But when adjusted for inflation, City rents still look good value, though West End ones less so.

I’m no deluded optimist, far from it. There is much that is wrong with the UK economy. Growth in the first quarter was reported to be weak, though I suspect that the stats overstated any downturn. But the real issue is that the UK economy is suffering from many deep-seated weaknesses - poor productivity, insufficient skills, excess property costs and many other problems besides. All of these will have to be fixed. But the fact that more tall buildings are being signed off is entirely good news.

Allister Heath, The Telegraph