June 2011

Sealed bids and limited supply

Over the past months, we have repeatedly highlighted the breadth of supports to Prime Central London property prices. We have seen very little evidence to suggest that such demand will ease substantially or reverse in the immediate future. Rather, our client base has never been so graphically diverse as international interest in London property continues to intensify.

Our clients tell us that their interest in London property is driven by significant currency advantages, the desire to diversify, to increase exposure to a relative safe-haven asset, to relocate to a safe city with a vibrant international community, advantageous business links and excellent schools. Competition is therefore fierce for the best properties. Sealed bids are commonplace and we have recently taken part in a so-called ‘attended exchange’ where both parties’ legal representatives met in person to ensure the swiftest possible conclusion to the transaction. Set against a supply backdrop that has remained stubbornly constrained it is little wonder that prices continue to climb.

According to the Knight Frank Prime Central London Index, prices for prime London property jumped 1.4% in May. This leaves prices 8.3% higher than a year ago and some 33% higher than March 2009 in sterling terms. Knight Frank is quick to point out that currency fluctuations are still providing overseas buyers with what it calls “bargain prices”.

Camilla Dell, Black Brick Managing Partner, says: “For international investors prices of London’s most prestigious property continue to look attractive due to the on-going currency advantage. For those scouring the world for a unique asset with structural supports and a degree of safety that isn’t exorbitantly valued, Prime Central London continues to fit the bill.”

Rents still rising – but not yet stretched

Meanwhile the rental market in London’s most sought after enclaves remains buoyant. Knight Frank reported a 20th consecutive month of rental price rises in May. The latest rise means rents have risen 16.3% over the past twelve months due to limited stock, robust employment conditions in central London and the City, and the on-going difficulty in obtaining mortgage finance. Do these recent rises mean rents are now stretched? We don’t think so. Knight Frank recently highlighted that central London rents are only 21% higher than they were a decade ago. This compares to income growth in central London of 48%. From an affordability perspective, rents in London therefore do not appear overdone in a long-term context.

Camilla Dell, Black Brick Managing Partner, says “Certainly on a yield basis rents in prime London don’t look outrageously stretched and recent gains appear sustainable given the supply backdrop. We believe the continued tightness of mortgage markets is a key support to the rental market and see little anecdotal evidence from credit providers that lending conditions are about to be loosened significantly.”

All of which is in stark contrast to the wider domestic UK residential property market as a backdrop of modest decline prevails. The Halifax House Price Index rose 0.1% in May for a fall of 1.2% over the last three months and 4.2% over the past year while its Nationwide counterpart posted a 0.3% gain in May for an annual decline of 1.2%.

What if there is a fresh credit crisis or sterling strengthens?

Our central case remains that these market dynamics continue to hold sway and that prices of high end London homes will trend gently higher in the coming months. But what then are the possible but remote events that could change or counteract the powerful and secular factors supporting Prime Central London property?

A second global credit event on the scale of the collapse of Lehman Brothers would certainly act as a material headwind to price growth in Prime Central London property in the short-term. For example, a default by Greece would clearly trigger other credit events and impact interbank lending and the flow of capital to the global economy.

But there are even reasons here to believe prices of Prime Central London property would not drop as much as they did in the previous credit crunch. First, there is very little highly leveraged speculative money in Prime Central London property compared to 2008. Therefore a drying up of credit markets would have limited impact in a market where cash-rich buyers dominate. Second, the perception of prime property in general and of London in particular has changed in the wake of the credit crunch. In many quarters it is now seen as a relative safe haven from economic volatility.

In the last credit crunch, it was government bonds that were the beneficiary of the flight to safety. This time it appears that it is government bonds themselves that may be the catalyst for any downturn. Therefore in a fresh credit crunch, cash rich investors may look for other so-called ‘duration’ assets that offer a degree of protection. Supply constraints plus London’s position as a major financial and business centre suggest prime property in the UK capital offers exactly these much-desired characteristics.

There is little doubt that the weakness of sterling has been a key factor in attracting overseas buyers to London property. While in sterling terms prices in many of London’s most desirable enclaves have already surpassed previous highs, the relative weakness of the pound against both developed and emerging market currencies means overseas buyers are buying at local currency discounts of between 15% and 30% compared to the previous peak. A dramatic strengthening of the pound would, we believe, have a big impact on overseas demand but deliver great returns for those buying now.

Camilla Dell, Black Brick Managing Partner, says: “Property in Prime Central London has proven itself very resilient in the past. Yes, prices fell in the wake of the collapse of Lehman Brothers. But they did so for only a short period and on very low transaction volumes impacted by highly leveraged forced sellers. The ownership dynamic has changed significantly since that time. Prices have subsequently recovered sharply but London property retains a wealth of attractions as a safe haven asset without the supply issues of government bonds and with lower volatility than equities.”