The Impact on the Prime Market

18 July 2016, by Lucian Cook

Caution among buyers will require realistic pricing

 

Introduction

In the period of the past 18 months the prime housing markets across the UK have faced a number of headwinds. Chief among these have been taxation, primarily in the form of stamp duty, and political uncertainty.

As a consequence, from September 2014 to immediately prior to the EU referendum, the average price of prime property across London fell by a net figure of -1.4% and by somewhat more in prime central London (-8.0%) due to the significantly increased tax burden on high value homes.

Across the prime country markets, that have looked relatively good value for money by comparison, net price growth was contained to a relatively modest 3.4%.

It is too early to be confident about what the precise impact of the vote to leave the EU will be, though we can now identify the key drivers which will influence market conditions.

FIGURE 1

Pre Referendum Price Growth Since 2007/08 peak

 
Figure 1

Source: Savills Research

FIGURE 2

Pre Referendum Price Growth Since September 2014

 
Figure 2

Source: Savills Research

FIGURE 3

Pre Referendum Price Growth Past 12 months

 
Figure 3

Source: Savills Research

Key Drivers

The vote in favour of Brexit suggests that political and economic uncertainty is likely to remain a feature of the market for some time to come.

Of course it is not all negative news. We expect the newly formed UK government to be highly motivated to protect London’s position as a major global financial centre in any negotiations with the EU. Interest rates are expected to remain lower for longer. The weakness of sterling will present a buying opportunity for international investors.

Each and every one of these drivers is likely to shape the prime market over the medium term, though against the backdrop of a much less accommodating tax environment than the prime markets have previously enjoyed.

The diverse nature of the prime housing market means the effects will be uneven. The impact on each submarket depends on where it is in the cycle and the nature of demand which drives it.

Central London

The central London market had, until the changes in stamp duty of December 2014, seen the highest price growth of all the prime markets. However, as detailed previously, it has subsequently seen the biggest adjustment in response to tax changes (see Figure 2 above).

In previous cycles, the international investor profile has meant that weak sterling has acted as a catalyst for market recovery, with prices and the value of the pound tending to bottom out concurrently. Already we have seen the fall in sterling stimulate new international demand, particularly in the new build market.

However this time around, we believe buyers are likely to be more cautious about exploiting this currency-led opportunity given a less hospitable tax environment, which includes higher rates of stamp duty, greater exposure to capital gains tax and pending changes in the treatment of long term resident non doms.

This is likely to mean the market remains price sensitive over the short to medium term and that developers delay build programmes, tightening supply.

Prime Outer London

Having been less affected by the changed tax environment, prices in other parts of the prime London market are now higher in relative terms to where they were post credit crunch than central London.

This market is far more dominated by domestic buyers and the non-UK buyers active in this part of the market typically live and work in the capital.

Despite a widening in buyer profile over the recent past, the prospects for the City of London as an employer and wealth creator are critical. Uncertainty around this issue is likely to impact on buyer appetite in the short term at least.

Notwithstanding relatively high levels of equity, the greater use of debt in this market means budgets of those buyers are also constrained by tightened lending conditions. On the flip side, those with low loan to value mortgages will benefit from low interest rates.

 

 
Prime London prices

The Suburbs and Commuter Zone

Prior to uncertainty preceding the EU referendum, markets in the commuter zone began to benefit from an increased flow of demand out of London.

Importantly, the gap between prices in London and the commuter zone remains large. With those families looking to upsize increasingly cost conscious, this is expected to drive demand into this market. However, the scale of demand is likely to ebb and flow as sentiment responds to the changing political and economic news. For these buyers the continuing low cost of debt is likely to support prices.

Immediately prior to the referendum, values of properties worth over £2m located in the suburbs and the commuter zone were -2.5% below their level prior to the stamp duty reform of late 2014. As things stand, the most expensive property is likely to remain hampered by stamp duty, though property on the private estates of Surrey and Berkshire, popular with international families, may benefit from the effect of weaker sterling in a similar manner to central London.

Prime Country Markets

Beyond the commuter zone, price growth for prime housing stock over the last seven years has been substantially less than within London and its hinterland, although there are exceptions in some markets. Average values are yet to get back to their 2007 levels, being some -12.7% below their previous peak in the Midlands and North of England. Though not immune to the general effect on sentiment, it is expected that this will mean these markets are less sensitive to the implications of the vote to leave the EU.

Given the underlying uncertainty, we would expect the market to be dominated by needs based buyers in the short term. That is likely to mean the market for second homes remains relatively volatile as it also adjusts to the 3% stamp duty surcharge on additional property.

More generally, we would expect these markets to be influenced by the wider housing market, with much dependent on short term sentiment and the underlying medium term impact on the domestic economy. This is likely to further delay the ripple effect from London and its hinterland, though the extent of this delay remains to be seen.

Scotland

The prime housing markets of Scotland have operated in a greater level of general uncertainty than the rest of the UK over the past two years, given the independence referendum and the introduction of the Land and Buildings Transaction Tax. Accordingly, prices are still on average over -20% below their September 2007 peak, though this figure hides a divergence between the markets for prime urban property and country houses.

With Scotland voting to remain within the EU, there is the added risk of another independence referendum taking place. We know from past experience that a Scottish election or referendum can lead to some market uncertainty, but they have not had a sustained impact on buying decisions.

Overall Conclusions

The referendum vote to leave the EU is expected to result in added caution in the prime residential property markets. The fact the governing Conservative party has swiftly resolved its leadership post referendum will undoubtedly provide greater political certainty. However, there remain many unknowns regarding the future relationship with the EU.

Accordingly, the strength of the underlying economy, the prospects for the financial and business services sector and, in some cases, the cost and availability of mortgage debt also present unknowns.

Against this context, early indications are that a relatively high proportion of sellers have already adjusted their price expectations, and there remains a seam of demand for good quality, well priced stock.

This is reflected in the results of our survey of over 100 agents active in the prime housing market, which suggests greater caution among buyers than sellers and the possibility of a mismatch between buyer and seller expectations in the short term.

Nonetheless, this is not as pronounced as might have been expected with 40% of respondents indicating that sellers were already factoring in the possibility of house price falls over the next six months. Furthermore, evidence is that the vast majority of deals agreed pre- Brexit have been honoured. In cases where this has not been the case, it has been possible to renegotiate deals with a 5%-10% price adjustment.

This said, the true strength of market demand is only likely to become clear over a period of months. In the meantime, committed sellers will need to be both realistic and flexible in their price expectations, responding to changes in market sentiment.

MORE ON BREXIT: We will be publishing further reports on specific topics including Mainstream, Rental and Development markets

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