July 2008

Few things capture the English imagination as much as the weather. This summer, however, seasonal speculation has been usurped by a new national obsession – the housing market. Fast changing price forecasts and increasingly gloomy outlooks have pushed speculation to fever pitch, for which the best antidote is always a measured assessment of the facts and fundamentals driving the market.

The biggest influence on the broader UK housing sector this year has undoubtedly been the extreme tightness in the mortgage market. Access to borrowing has become increasingly restricted and mortgage approval volumes have fallen away dramatically, as the credit crunch affecting banks in the international financial markets makes its presence felt in the real economy. Britain’s biggest building society, Nationwide, announced in May that its net residential lending had fallen by 40% and other major lenders have followed suit in the rush to pull products from shelves. The extent of the deterioration was evident in June when the Bank of England announced that mortgage approvals had reached a new low, falling by 64% in May compared with the previous year. Meanwhile, the cost of finance has continued to rise amidst expectations that interest rates will need to increase over the coming months to combat inflationary pressures.

Against such difficult headwinds, it comes as little surprise that sales activity has slowed markedly from the frenzied levels of 2007. The Royal Institute of Chartered Surveyors (RICS) housing market survey found in May that 93% of their surveyors were reporting falling rather than rising prices, a marginal improvement on April’s data but nonetheless a strikingly uncompromising picture of the slowdown in the mainstream market. The major house price indices also made for grim reading. The Nationwide’s headline house price index reported a 0.9% drop from May to June, a smaller decline than seen in May but one which offered little hope for an imminent improvement in conditions. Even the previously resilient prime central London market paused for breath, with Knight Frank registering a 1.5% monthly decline in the sector and a fall in annualised growth to 12.8%.

But with an army of journalists penning daily obituaries for the UK housing market, the inside view strongly suggests that reports of its death have been greatly exaggerated. Certainly, few industry commentators are bracing themselves for a crash. Liam Bailey, Head of Residential Research at Knight Frank sets a measured tone when he observes that “we are not yet in a situation where there are a large number of forced sellers who have to accept sharply lower offers”. Similarly, the RICS survey finds that price weakness is not being driven by new supply coming on to the market, noting in May that new instructions to sell property declined for the fifth consecutive month and at the fastest pace since last June. This has been the experience of Camilla Dell, Managing Director of Black Brick Property Solutions, who has found that vendors of the highest quality properties are still refusing to lower their expectations. Interestingly, buyers continue to outweigh sellers in the prime central London market, albeit to a much smaller degree than in recent years. In its Spring Prime Market Bulletin, the research team at London property group Savills reports that the current level of 1.3 applicants per available property represents a small rise from the low levels of last December when there was just one applicant per property.

Given that much of the slowdown in sales activity has been a result of increased tightness in the mortgage arena, how have those sectors less influenced by conventional mortgage borrowing fared? At the very top end of the spectrum, the super prime market continues to go from strength to strength. In the first quarter of 2008, properties worth over £5m recorded a 1.7% increase in average values compared with the previous quarter, buoyed by a new breed of wealthy international buyers from the emerging industrial or commodity-rich economies, many of whom remain untouched by the credit crunch. Savills points out the super prime sector “is now behaving more like a separate market, driven by the global asset price bubble rather than the misfortunes of London’s finance sector”.

And as the gap between the super-prime and mainstream markets widens, so too does the differential between types of properties. Lucian Cook of Savills argues that “as the number of transactions fall, the quality of property is key; not only in determining whether it will trade but also at what discount to last year”. This focus on ‘best in class’ property will play a major role over the coming months, as those perceived to be average will be forced into greater discounts than their higher quality counterparts. Timeless factors such as location, proximity to noisy roads and the amount of modernisation required will be key negotiating tools for discerning buyers. Camilla Dell agrees that this theme is becoming increasingly prevalent. “In recent months the gulf between different types of properties has widened considerably. Period conversions in prime areas are showing impressive resilience despite the difficult conditions, whereas the prices of new build and off-plan properties in secondary locations are beginning to soften. This is where we expect to see the emergence of the first forced sellers, as developers with lending commitments struggle to secure forward sales.”

This highlights a rare opportunity for investors to enter the market at more attractive levels than have been possible for some time. Shunned asset classes quickly become investment opportunities and a key theme for the coming months could be the emergence onto the market of high quality properties at discounts to their long term worth. However, with few forced sales outside the development arena, aggressive negotiation will continue to be a key factor in securing good value deals with long term recovery potential.

Camilla Dell comments: “The long term structural fundamentals of the prime London market remain hugely compelling. But whilst London’s status as one of the world’s most enduring property hotspots is not in doubt, the more difficult conditions nearer term are giving rise to some really interesting investment opportunities. It is likely that the prime central London market will avoid a ‘crash’, not least because the majority of property owners in this sector are affluent and therefore are unlikely to become forced sellers. Nonetheless, even in the most desirable prime areas, vendors will at some point have to lower their short term expectations as the financial sector and the economy retrench. For investors with an eye to the future, it is an exciting time to gain a foothold in the sector.”

Non-doms remain a force in London

Last year the government created a storm with its decision to increase the tax burden on non-domiciled UK residents. The proposals were met by an outpouring of protest from the City of London, where the financial sector is acutely sensitive to any measures that threaten to erode Britain’s favourable status within the global business community. The stakes were high, but intensive lobbying resulted in significant concessions to the original proposals. Almost all the very contentious measures were watered down, and whilst the government intends to press ahead with the introduction of a flat £30,000 annual levy on foreigners who have been resident in the UK for more than seven years, it now appears that a mass exodus from the UK’s non-domiciled residents is unlikely.

Although the fiscal regime has become marginally less friendly to the 200,000 non-doms who enjoy the UK’s unique tax advantages, recent evidence shows that other factors are hard at work convincing wealthy members of the international business community that London is the best place in the world to maintain a non-domiciled status. Near the top of the list are the wealth of cultural riches and the enhanced career opportunities available in the capital. However, it appears that the slowdown in the property market is also helping to keep non-doms on these shores. A recent survey commissioned by Barclays Wealth found that many non-doms are refusing to sell their property investments when they might not achieve the best price, particularly as many regard these as long term investments.

This is providing a welcome fillip to the prime central London property sector, where non-doms have traditionally played an important role. Many are incredibly high net worth individuals and it is these types of buyer who, as Savills point out, “demand the very best property at the very best addresses and, very importantly, pay for them with capital made in global markets. Even if they are geared, they are not reliant on conventional mortgage borrowing.” Savills predict 3% growth in the £5m and above sector in 2008. Knight Frank explains that supply in this top end of the market is still restricted and purchasers are prepared to pay what it takes to secure the right property. “This shows that fears regarding the non-dom situation turned out not to be as serious as predicted.” Indeed, with year on year sales volumes of super-prime (greater than £10m) properties rising by 35% in the three months to May, this top end of the market remains in rude health. Black Brick’s Camilla Dell agrees that the potentially damaging combination of the credit crunch and new tax regime has had little impact on the international sector of the London market. “Last year, overseas buyers accounted for 79% of our client list but so far this year our clients have been exclusively international, primarily falling into the ‘owner-occupier’ camp. Many are from the emerging markets or oil-rich nations and their search for a home in London remains relatively unaffected by the credit crunch or changes to the UK’s tax regime. From our experience on the ground, the international influence remains a welcome force in UK property.”

News update from Black Brick

Black Brick Property Solutions began 2008 with a first birthday celebration and a reflection on our inaugural year. 2007 saw us secure almost £31m of highly desirable residential property and negotiate an average 6% off asking prices – an impressive achievement in an environment of unprecedented interest and intense competition for desirable properties.

We are now delighted to report on a flying start to our second year in business. Despite the very changeable market conditions we have already secured more than £45m of property, surpassing last years total in just six months. Most importantly for our clients, we are achieving some terrific value deals, with an average of 11.5% negotiated off asking prices so far in 2008.

We are committed to providing a first class search service and over the remainder of the year we will work tirelessly to ensure that our clients take advantage of opportunities as they emerge. In today’s more volatile environment, this means providing a comprehensive and independent valuation analysis at the earliest stage of the sale process, and negotiating hard to secure desirable properties at enviable discounts to their asking prices.