London adjusts to higher taxes

THERE are clear indications that trading activity in the prime London residential property market has stabilised as prices have adjusted to a series of tax changes in recent years.

However, when anticipating what is likely to happen next, one needs to look beyond the fiscal landscape. Political uncertainty, primarily in the shape of Brexit, is keeping a lid on activity and a more meaningful recovery is expected to take place once this uncertainty lifts. For now, the market remains in somewhat of a holding pattern. So what is the evidence that the market has now adjusted to higher taxes?

By June this year, prime central London prices had fallen 9 per cent from their previous peak in mid-2015. Increased rates of stamp duty, which came into effect in December 2014 and April 2016, led to weaker pricing but a 9 per cent decline has more than compensated for any difference between old and new transaction costs.

An analysis of several hundred sales in the first six months of 2018 found that the average difference between old and new stamp duty rates as a percentage of the sale price was 1.97 per cent. That rises to 4.97 per cent, when a 3 per cent surcharge for second homes and landlords is added (the April 2016 change), which is well below the 9 per cent decline.

As prices rebase, there are signs demand is picking up. The number of new prospective buyers in prime central London was 31 per cent higher in June, than the same month last year. Furthermore, the number of properties withdrawn from sale in prime outer London declined 31 per cent in the year to June.

Properties are often withdrawn because buyers will not meet the asking price. The decline suggests asking prices now more fully reflect buyer expectations, as higher stamp duty is priced in. Meanwhile, in an indication that underlying demand remains strong, the total value of £10 million-plus (S$17.88 million-plus) sales in London in June 2018 was £407 million, the highest monthly total since December 2014.

Asian buyers

Demand is also strengthening from Asian buyers. Between January and July this year, Asian buyers accounted for 40 per cent of all overseas transactions in prime central London, while Singaporean buyers represented 2.2 per cent of the overseas total. These figures were up from 38 per cent and 1.3 per cent respectively, in 2017.

It is also worth putting the extent of the current price decline into perspective. The current period of month-on-month declines in prime central London has lasted for three years, which equals a run of price falls recorded in the early 1990s as the United Kingdom entered a recession. However, the current price decline from the peak is about 9 per cent, which is considerably lower than the 21 per cent decline recorded in the 1990s. In fact, the Knight Frank prime central London index has not moved more than 10 per cent up or down on an annual basis for almost six years, which is the longest such run since the mid-1970s.

There are clear signs the market is stabilising, but why is political uncertainty preventing a meaningful upswing? Brexit talks between the UK and the European Union are taking place against a relatively fluid political backdrop in London and ministerial departures in recent months mean questions have inevitably been raised about the durability of the government.

As political sentiment has become a more important driver of demand in the property market, so its near-term future direction has become less predictable. To anticipate what will happen next, one needs to take a close look at UK politics.

The concerns of Brexit-supporting lawmakers centre on the negotiating position of the UK government, which they believe cedes too much grounds to the EU. While it would take 48 of them to trigger a vote of no confidence in the Prime Minister, this has not happened yet. There are questions over whether they would win the vote or wish to put more acute pressure on the government. What happens next?

Tension will remain as those who wish to see an exit from the EU push the government into adopting a tougher negotiating stance. However, granting too many concessions on this front risks raising tensions with lawmakers who want to remain in the EU, who themselves could also block Brexit legislation.

In effect, Brexit has created a series of new cross-party alliances that has made predicting the outcome of legislative votes more difficult. However, as the UK moves closer to its exit from the EU in March 2019, we would expect some form of endgame to materialise in the second half of 2018 that is based on a pragmatic sense of self-interest.

Eleventh hour

That said, the EU's track record suggests any deal may be struck at the eleventh hour. Meanwhile, some have also proposed that a temporary arrangement such as the European Economic Area membership could be reached to avoid the UK leaving with no deal. A no-deal exit is something not in the economic interest of either side.

Meanwhile, a general election and a second EU referendum have both been cited as ways through any potential UK political deadlock. While the UK is not in that position yet, the first option would require two-thirds of lawmakers to support it, and the second has been ruled out by the government.

In other words, there is a multitude of competing interests that cut across traditional political lines, that makes anticipating the precise outcome difficult.

Back in the prime central London property market, there is positive news for landlords. Annual rental value growth (+0.8 per cent) returned in June this year, for the first time since February 2016. The reason is that supply has become more restricted. A series of tax changes affecting landlords means that more owners have attempted a sale in recent months and, as a result, there were 16 per cent fewer lettings listings in prime central London in the year to June 2018 than the previous 12-month period.

In a sign that tenant demand remains strong, Knight Frank agreed 7 per cent more lettings deals in London in the year to June 2018 than the previous 12-month period.

Financial services remains an important driver of demand for both the residential lettings and sales markets, but there has been little evidence that London's dominance as a global financial centre will be materially affected by Brexit.

A series of large-scale and high-profile commercial lettings deals since the Brexit vote, including those signed by banks and global tech companies, is both a positive sign for demand in the residential property market and underlines the enduring appeal of London.

Tom Bill is head of London residential research at Knight Frank.

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