Prime London homes sparkle in 2011, but higher stamp duty dampens enthusiasm

Prime residential property in London defied the gloomy British economy and achieved sharp gains in 2011.

The price jump and mild rental increases caused yields to slide to such low levels that top notch London residential real estate may well have entered bubble territory. The budget could prick the bubble as  the new stamp duty of 7% for individuals and 15% for corporations has affected demand, according to agents.

Moreover the eurozone crisis and Middle Eastern revolutions turned out to be bullish for prime properties priced anywhere between £500,000 ($1.6 million) and £20 million or more. Money flowed from Italy, Greece and Egypt, according to agents, while Russian and other billionaires and multi-millionaires continued to favour the city. Such money, which has so far tapered off in 2012, tended to head for Knightsbridge, Kensington, Mayfair, Chelsea, Regents Park, St John’s Wood, Hampstead and other prime London boroughs. Price changes of other London boroughs, on the other hand, were mainly mixed with small increases and declines.

Prime properties boom since 2009, but rental yields indicate bubble

John D Wood & Co’s price and yield indices – based on sales data from all leading agents and compiled independently by Nuffield College (Oxford) and the London School of Economics – illustrate the extent of the London prime residential real estate boom. The price index for houses over 3,500 sq ft rose by 10.7 per cent in 2011 and is up by 21.5 per cent from the low point in 2009.

The index is below the August 2011 peak, which was a new record, but it fell back and in December was 4.6 per cent below the 2008 pre-recession peak. The performance of large prime area flats over 1,500 sq ft has been staggering. In 2011, the apartment price index jumped by 24.9 per cent and was up by 64.5 per cent from the 2009 nadir.

Indeed, the appreciation matched the revival of the FTSE 100 from its 2009 depths. The difference, however, was that the real estate rise took place on very low volumes.

Following such a run, gross yields on rentals have tumbled to around 3.3 per cent on apartments and 2.9 per cent for houses. James Wyatt, head of valuation at John D Wood, estimates that after deducting agent and management fees, maintenance, other charges and tenant voids, net rental yields can be estimated at only 2.3 per cent for flats and 2 per cent for houses.

The low returns indicate that the prime market has become over-blown for investors, although foreign super-rich buyers and others sought London homes for a variety of other reasons.

Wide price differentials between prime and other London properties

Some of the money reportedly entered the market to evade taxation, though this could not be confirmed. Regardless of the reasons for purchase, London prime real estate has become far more pricey than depressed US city properties.

‘The cardinal rule is to be highly selective,’ says Michael Ross, head of Stockton Estates, a London-based commercial and residential property company. He is wary of ultra low rental yields, but notes that since property is a non-homogeneous market, careful buyers can find opportunities to refurbish units and boost valuations.

In the great recession of 2008/2009, John D Wood prime house price indices fell by 21 per cent from the peak of the preceding boom, and apartments by 23 per cent. Similar to the recent revival, sales volumes during the bear market were small, recalls Mr Ross.

The market stabilised and then recovered because the Bank of England slashed interest rates, thus reducing the pressure on mortgaged home owners. Once again the market improved as London is in the centre of the global time zone and has cultural and higher educational advantages for both UK and international buyers.

The UK Land Registry’s sales data shows the wide price differential between London areas. Average prices in Kensington and Chelsea of around £950,000 compare with outer areas, such as Sutton and Croydon of around £240,000. Gross yields on properties of lower priced London boroughs range between 4 per cent and 6 per cent, but high maintenance and wide tenant voids can slash the net yield below 3 per cent, caution agents.

Despite Olympics uncertainty prevails

The London property market faces a year of considerable uncertainty in a nation which is experiencing recession and high unemployment. Despite the stock market rally in the first quarter of this year, trading, initial public offering and merger and acquisition volumes have shrunk. Widespread layoffs have occurred in the City of London and bonus payments have fallen.

‘The raft of City job losses announced in recent weeks is a reminder that London will not escape the recession unscathed,’ says Ed Stansfield, head of property research at Capital Economics. On the face of it both prices and rentals could slip although demand from overseas buyers could support prices in the short run. London, however, is likely to underperform on a medium-term view because valuations are stretched, he maintains.

Savills, which estimates that international buyers accounted for around 55 per cent of prime London real estate demand last year, has predicted that average central London prices will rise by 3 per cent in 2012. The firm contends that supply is constrained.

Crane survey, similarly to China, an indicator 

Drivers Jonas Deloitte’s latest London Residential Crane Survey found, however, that large numbers of developments will be completed this year. The more buoyant market raised construction levels to 39,300 units within 247 development schemes.

Drivers Jonas Deloitte’s unconventional research, which counts the number of cranes on residential schemes with 50 units or more, concludes that new build real estate in the pipeline is heavily dominated by flats, which account for 95 per cent of all units.

Liam Bailey, head of residential research at Knight Frank, has forecast that London prices will fall by 3.7 per cent in 2012, but that prime area prices will still manage to increase by 5 per cent.

The firm believes there is a 75 per cent chance that conditions in the UK mainstream market over the next few years ‘will resemble a slow correction under which the market will experience an extended period of low transaction numbers and price falls in real terms’.

It contends that there is a 20 per cent chance of a sharp fall, similar to the 2008/2009 property bear market, if there is a severe sovereign debt crisis, a collapse of the euro or an unexpected rise in interest rates.

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