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  1. Property
May 21, 2012

UK Prime Property Market Will Survive a Eurozone Collapse

By Spear's

While the rest of the country’s residential markets continue to languish in the doldrums (although Chesterton Humberts’ country offices have all seen increased transaction activity this year), the prime London residential property market has again demonstrated its resilience in the first quarter of 2012 despite the economy having slipped back into recession and the Chancellor’s tax offensive on the high-end residential sector.

Land Registry data reveals that average prices in London in Q1 2012 were 1.9% higher than in the corresponding period in 2011. This compares with an increase of 8.4% seen by Chesterton Humberts’ offices in prime London locations over the same period. It is interesting to note that the relatively strong growth seen in the prime locations occurred in spite of the weakness of two of its traditional drivers: the stock market and the City jobs market.

The prime market remains characterised by an ongoing shortage of available stock which is largely responsible for the relatively impressive price growth along with sustained buyer interest. Buyer demand in Q1 was dominated by overseas purchasers who accounted for just under 54% of all London sales transacted by Chesterton Humberts. However, in some locations the figure was much higher – e.g. over 70% in Mayfair and over 80% in Docklands, Hyde Park and Kensington & Chelsea.

Flight capital – either driven by economic or political factors – has again been a feature of the market and accounts for much of the recent interest seen from overseas buyers. Further interest is likely to be triggered by recent developments in France and Greece. Cash buyers are prominent in the prime segment, accounting for 58% of purchases in the first three months of 2012 according to survey evidence from Lonres.

Figure 1: 12 month annualised nominal total returns (ungeared) as at end December 2011

I am cautiously optimistic about market prospects for the remainder of 2012. Whilst I do not foresee any reduction in buyer demand, transaction activity in the prime locations is likely to remain at below trend levels due mainly to continuing stock shortages. Given the likely continued supply/demand imbalance, I believe that price growth in the prime locations in the order of 6%-8% is comfortably achievable for 2012 as a whole.

As is usually the case, there is downside risk. Clearly, any significant worsening of the situation within the Eurozone would have serious ramifications for the UK, including London. However, in the unlikely event of a worst case scenario whereby the Eurozone is dismantled, the UK may well represent a good bet in terms of stability and a functioning currency and property is unlikely to lose its long held attraction for investors, especially as stock markets are likely to experience extreme turbulence in the immediate aftermath of such an event.

Lettings Market
The prime London residential lettings sector has experienced a healthy start to 2012 with average rents in the locations covered by Chesterton Humberts increasing by 9.7% in Q1 compared to the corresponding period last year. However, the market has slowed compared to the final half of last year and prime rents were marginally lower compared to the final quarter of 2011. This is a reflection of weaker corporate tenant demand and smaller corporate relocation budgets rather than any increase in supply as has been seen in the wider market.

The Olympics continue to have an effect on the market although it is not all positive. Indeed, we are aware of some landlords seeking to take advantage of inflated rents on short lets by removing existing long term tenants. Olympics rental fever is also causing some localised oversupply of stock, as noted above, much of which is anecdotally proving difficult to let. Many tenants are delaying moving until after the Olympics when rent negotiations should settle back into a more normal pattern based on longer term sustainability rather than short term gain.

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I believe rental growth in the prime locations this year will be minimal. The potential for a higher rate of growth when the economy picks up remains, however, as the mismatch between supply and demand for prime space is unlikely to be balanced for some time to come.

The Buy-to-Let (BTL) sector remains popular, however, finance conditions remain tight and have arguably become more difficult this year. Most lenders are placing a limit either on what they will lend to a BTL landlord or on the number of mortgages they will provide per client. Interest rates on mortgage loans have also risen this year while LTVs of more than 75% are hard to find. The Council for Mortgage Lenders (CML) also reports that the average minimum rental cover in Q1 was 125% – up from 123% in the previous quarter.

Residential property meanwhile has again demonstrated strong performance in times of economic downturn, delivering higher total returns (11.3%) in 2011 than all of the other mainstream asset classes apart from gilts. Gross yields in the prime central London locations moved in marginally during the first quarter and as at March 2012 stood at 3.7% as measured by Chesterton Humberts prime London yield monitor.

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