August 2010

Broader UK property market cooling…

Northern Europe may have been sweltering – in a heatwave during recent weeks, but in the UK the backdrop to the broader residential property market has been markedly cooler.

The Nationwide House Price Index fell 0.5% in July, with the building society citing “restrictive credit conditions and uncertainty about the future economic outlook” as limiting the pool of buyers, while simultaneously noting that “the imbalance between supply and demand is easing”. Nationwide also highlighted that transaction levels are still running at half the levels seen prior to the financial crisis and recession.

Elsewhere, UK residential property website Zoopla reported that a third of houses for sale on its site had dropped their asking prices – with an average cut of 6.0%. Meanwhile, the widely-watched monthly survey from the Royal Institute of Chartered Surveyors (RICS) confirmed the worsening backdrop; the survey’s headline three-month price change going into negative territory in July for the first time in 12 months. According to the RICS, surveyors’ future price expectations fell sharply too as new buyer enquiries fell and the average number of properties on surveyors’ books rose.

…but of little relevance to well-supported prime London market

As negative as these statistics sound, it’s important to remember that these relate to the wider UK property market while London property in general and prime central London property in particular are separate and very different markets. Camilla Dell, Black Brick Managing Partner, says: “The increasingly downbeat data and forecasts for the wider UK property market reflect the on-going strains within the UK economy. Mortgage finance remains difficult to acquire, widespread public sector job losses are imminent, tax rises are looming and the significant demand/supply imbalance of the last year is equalising. None of these is a major factor in prime central London property. In fact, the usefulness of the broader market’s main surveys’ is really in highlighting how different the principal drivers to prime central London property have now become.”

Clearly, prime central London property is not completely immune to the vagaries of the global economic cycle. Knight Frank’s Prime Central London Index dropped 0.5% in July, though the fall should be taken in the context of 14 consecutive monthly rises prior to July and the customary UK summer lull. Crucially, this unique asset class continues to enjoy a large number of long-term supports and our view continues to be that demand will remain strong for the best properties in the best areas.

These include long-term supply constraints governed by strict planning criteria, a broadening international demand base whose wealth is largely immune to the troubles of Western economies, cash-rich buyers unaffected by tightening bank lending standards and the increasingly self-fulfilling view that London remains ‘the’ place for the international elite to educate their children and to socialise.

These factors are also all at work in the prime central London rental market with a shortage of high quality properties helping to drive rental returns ever higher. According to recent research from Savills, rental values in prime central London rose 2.4% in the quarter to end-June and by 6.7% in South-East England.

Camilla Dell, Black Brick Managing Partner, says: “The strength of the prime rental market in London continues to attract investors. We have taken a number of calls from potential buy-to-let investors in recent weeks seeking better returns than are available from bank deposit rates. Though financing is never an issue for these international investors an increasing number are also taking advantage of low UK mortgage rates to potentially increase their returns.”

Changing global wealth dynamics underpins demand

All things considered, perhaps the biggest short-term risk to prime central London property prices may come from a continued strengthening in sterling against the US dollar and other global currencies. Currency commentators continue to point to the contrast between the UK’s improving economic data and generally weak data in the US – and between the UK’s aggressive public sector job and spending cuts, while the US considers the possibility of further stimulus measures to boost the flagging American economy.

But we don’t believe that international interest in prime central London is wholly reliant on currency benefits or overwhelmingly speculative in nature. According to recent report by Savills, the Ultra High Net Worth Individual population, whose wealth exceeds $30 million each, rose by 21.5% last year. This, combined with increased volatility in global stock markets has resulted in prime central London property being the favoured choice for many investors who view the capital as a safe haven.

The overseas buying category was once dominated by petrodollars from the oil-rich sheikhdoms of the Middle-East. The changing dynamics of the global economy and the transfer of wealth from developed to developing countries has resulted in both a significant increase in the number of very high net worth individuals globally and a significant broadening of the countries and regions from which their wealth originates.

Resurgent bank bonuses a positive

But if the pound does indeed strengthen and delay some of the more speculative investors, London’s financial services heavyweights are back in a position to take up at least some of the slack.

London’s position as one of the world’s pre-eminent financial centres has meant that the financial services sector has long provided a steady stream of affluent potential buyers and high-quality corporate tenants in prime central London. The credit crunch and the weakness of the pound reduced the importance of the financial sector to prime central London property, but recent corporate results suggest this may change. News of a sharp rise in profits across the global banking sector, and that bonuses in the City of London have risen 25% in the latest pay round is unlikely to be greeted with wholesale enthusiasm by the UK’s tabloid press or by the UK government. But the simple truth is that a relatively significant proportion of the estimated £10bn in bonuses paid to London-based bankers will inevitably be spent on property in general and prime London property in particular. In the short-term, this is clearly supportive news.

Looking forward, the fact that competition remains fiercest at the lower end of prime suggests any price fall in the coming months will be minimal at best in this segment. Our experience is that when the underlying demand is so high, short-term falls are never as large as potential investors hope or expect – if they materialise at all. If any segment of prime is vulnerable we believe it is the very top end above £10m where there is proportionately much greater supply to demand – and where discounts of 10%-15% off the asking price are becoming more commonplace. But overall we believe the long-term supports for prime central London property remain very firmly in place.