No growth for prime London property next year, but PCL will be up 26% after five years

Savills have just released their much-anticipated Residential Property Focus 2012 Q4.The excellent report tells a now-familiar tale of two markets, with prime London obeying a different set of (more international) rules to the rest of the UK. But the wealth ripple is coming.

0% house price growth forecast for prime London house prices next year.
Prime London house price growth to kick back in in 2014 (+3.5%).
Prime central London is expected to outperform all other market sectors over the mid term; house prices are predicted to grow by 26%by the end of 2017.
Commuter hotspots will be the only part of the prime property market to see any growth next year, as wealth ripples out of London. Expect +1% in Sevenoaks in 2013; five-year growth is likely to be 21% in inner commuter zones; 19% in outer zones.

Yolande Barnes, Savills’ director of residential research on central London property markets: “It became clear last year that the UK’s residential property market had polarised between prime London and the rest, and this distinction has become increasingly entrenched. We knew there would be a lull in prime central London price growth, but were not sure what the trigger would be. Increased taxation could prove to be the catalyst and it certainly will take time for the market to absorb the change.

Sellers may need to reduce their expectations for all but the very best properties in 2013

“There are still clear global reasons to invest in real assets and we are confident that London will remain on the shopping list of world city buyers.  Yields remain solid, the market remains stock constrained and the prospects for global wealth generation amongst core buyer groups are sound over the medium term. We have, however, noticed less urgency among buyers of late and even a stalling of purchasing plans until the rules surrounding taxation and stamp duty are made clearer. Sellers may need to reduce their expectations for all but the very best properties in 2013.”

And Barnes on outer prime London: “In the absence of significant new City wealth generation, we expect these prime outer London prime locations to be increasingly reliant on the displacement of wealth from prime central London.   Evidence of this trend is already clear in Fulham, for example, where international buyers now account for around 44% of the market compared to just 20 per cent two years ago.

Barnes on outer London and the ‘burbs: “Although the gap between prime London and prime regional prices has never been wider, buyers have lacked the confidence during the recession to exploit this gap. As the economy, and particularly confidence improves, we expect that this will begin to change, but it will require London and the prime suburbs to remain active and it could be 2016 before the effects of wealth migration are felt right across the UK’s prime markets.”

Understanding the reasons for the vastly different rates of post credit crunch recovery across the prime markets is key when predicting the market over the next five years, says Sophie Crick in the latest Residential Property Focus report from Savills.

In the 18 months between September 2007 and March 2009, all sectors of the prime residential market – whether prime or ultra prime, London or country – experienced sharp price falls of between 20% and 25%. Since that date, there has been a significant divergence in performance.

In the prime markets of London, a very strong recovery means prices have more than made up lost ground, standing at 14.6% on average above their level five years ago.

By contrast, in the country house market prices are on average 10.1% below their pre crunch level. These averages hide variation between different locations and property types in both markets.

Understanding the reasons for these differences, and considering how they will affect the market in the next phase of the housing market cycle, is key to formulating a view for the next five years.

Prime Central London

Central London has seen the strongest recovery. Prices are averaging 22% above their third quarter 2007 levels. The ultra prime market, which has become increasingly international, has risen even further.

the weakness of sterling made London look inexpensive in a global context

One of the key catalysts for the recovery was an exchange rate play as the weakness of sterling made London look inexpensive in a global context despite correspondingly strong investment prospects. This advantage has now largely been extinguished by the resulting price growth and a stronger pound.

The second key driver of international demand has been the ‘safe haven’ play. Economic uncertainty in the eurozone and political uncertainty in other world regions, such as the former Soviet Union and the Middle East, mean ultra wealthy individuals have looked to invest in an accessible market with a strong, long-term track record for capital growth. Many well-rehearsed factors have combined to put London in this enviable position.

There is little doubt that the UK tax environment has historically been one factor conducive to such investment, but in the past two years this competitive advantage has been put under pressure.

Property specific taxes, such as stamp duty, have increased as has the exposure of UK property to other taxes following the recent introduction of anti avoidance measures. Though not fundamentally undermining London’s wider appeal, the market will take time to absorb these additional costs.

The third and most significant driver of underlying demand has been global wealth generation. This will continue to be a function of economic growth at a regional level globally, evidenced by the increasing profile of buyers from Asia in the prime new homes market in particular.

Though expected to continue over the medium term, short term pressures on the global economy may lead to a weakening of emerging market demand, particularly at lower price levels.

Outer Prime London

Such new world wealth has been less evident in London’s other prime markets where domestic demand is still dominant, and where prices have risen to a lesser degree.

This said, in prime South West London, for example, they are on average 11.7% above their level five years ago. Without any significant injection of City bonus money in the past five years, price growth here has been driven by a recycling of domestic wealth and a displacement of wealth out of central London.

these markets will become more dependent on the spill out effect from central London

In an environment where banking profits are reduced and City pay is increasingly scrutinised, these markets will become more dependent on the spill out effect from central London, particularly when greater amounts of existing housing wealth begins to be exported out of the prime domestic markets of London, as owners start to look again at moving out of London into the commuter zone and beyond.

Prime Regional

Generally, the prime regional markets have had neither a substantial injection of equity from overseas buyers nor a consistent flow of equity from London to spark a sustained recovery in prices.

These markets have been much more exposed to weak consumer sentiment among largely domestic buyers.

There have been exceptions. The market for mansion houses on private estates, such as St George’s Hill and Wentworth, has parallels with central London, both in terms of buyer profile and the nature of product offered.

This sub market has substantially outperformed the rest of prime regional and is likely to continue to do so over the medium term.

In areas that benefit from a flow of housing wealth generated in London, the market has been stronger, but this equity flow has not reached far beyond the prime ubertowns of the South East, such as Beaconsfield and Sevenoaks.

This has created divisions between inner commuter zones, outer commuter zones and the rest of the UK, creating an urban-rural price gap within the commuter zone.

The next five years

Over the next five years, we expect to see a more widespread recovery as London-generated equity flows out. During this phase, we expect the ripple effect to follow the geographical distinctions already in evidence.

The uber towns are expected to be the greatest beneficiary of this ripple.

We expect improved market conditions to feed first into the prime markets of the South East and other core prime markets beyond.

This improvement will filter across Britain, a process that is likely to be quicker in prime than in the mainstream market, given a lesser reliance on mortgage finance. As a result, prime markets will respond more quickly to economic improvements.

The key questions are what will trigger the flow of equity through the market and when. The current value differentials across the market suggest the platform is there; it is an improvement in sentiment that is now needed.

We’ve just covered the prime sales market stuff, but there’s an awful lot more jolly useful insights in the Savills report, so you should probably get a cup of tea, download the full PDF here and have a read.