Interesting times - Market Comment Autumn 2018

‘Our promises... were a series of possibilities,’ said Iain Duncan-Smith after the Brexit vote, as the complexities of leaving Europe were just starting to unfold and it was becoming clear that Brexit was far from the stroll in the park the Brexiteers had assumed. It’s now crunch time and the political tension, as tangible as the advent of autumn, is going to infect every facet of national life through the tight Brexit timetable now upon us.

The property market won’t be immune especially when the going gets tough on City passporting, the Conservatives look like collapsing under the weight of their own European contradictions, or if there is the faintest whiff of a Corbyn government. But, as Balzac said, “Our worst misfortunes never happen, and most miseries lie in anticipation.”

Recent examples bear this out. In 1998, the market seized up over the Russian default and the Asian financial crisis. When it recovered its nerve, we did almost a year’s worth of business in the last two months of the year. A decade later, who anticipated the prime market could nearly double in the aftermath of the 2008 global crash? Those who did almost certainly wished they were out of the market when Lehmans collapsed.

The point is not to prophesy sunlit uplands but to caution against an apocalyptic mindset that gives political strife more weight than it deserves. Life went on, bills got paid and Wimbledon still happened, even during the lowest points of our peacetime history – like the 1970s. It was just more fun in the 1980s.

Unintended consequences

A bad moment is when it isn’t anticipation but the real thing. Take George Osborne’s other legacy, the stamp duty hike, which has resulted in an average price fall in Prime London of 15 percent, and a 40 percent collapse in turnover since 2014. The latest figures from the Treasury show a downward trend in overall stamp duty receipts at the top end of the market - and an increase at the bottom of the market - which almost certainly had something to do with the cut in stamp duty rates below £925,000. A conservative Chancellor shouldn’t have to learn this lesson again. The damage has reached across the whole property ecosystem with estate agents, builders and decorators slimming down, and a corresponding loss of VAT, corporation and income tax as well as National Insurance. It has a name, and it’s called an own goal.

If his aim was to put off overseas investors he succeeded - up to a point. If he was trying to check the rash of towers covering the South Bank in particular, he seems to have failed. We commissioned some independent research in 2016 to find out just how many new-build units would be coming onto the market in Central London, which we defined as roughly from Tower Bridge to Wandsworth and from the South Bank to Regent’s Park. We found that 53,000 units were under construction, with planning permission or in the planning system. To put this into perspective, the second hand market in the same area, in that same year, was about 6,500 units.

You would think the unrelenting bad news on almost anything to do with property taxation over the last two years, alongside the Brexit cliff-edge, would have put the brakes on all this activity - but you would be wrong. We ran the same research over the same area this year and the figure is nearly 57,000. How can this be? Developers are not lemmings after all. The answer is that while there is still plenty of construction going on, most of the pipeline in, or just out of, the planning process probably won’t get built - at least during this cycle.

A perfect example is the Earls Court site, owned by Capital and Counties (Capco), which also own most of Covent Garden. The site is a huge 77 acres, with nearly 7,500 residential units. But they have only been selling one per week, implying that it would take 140 years to sell the lot. Unsurprisingly, the whole scheme is now on hold and there is a huge hole in West London where the Exhibition Halls once stood. Similar stories are even trickling in from developments like the Chelsea Barracks, which originally appeared to have been granted immunity from the downturn by virtue of its prime (properly prime) location. Like all developers, the Qataris have been hit by double digit build-cost inflation. Given the nearly £1 billion they paid for the site, it’s proving extremely difficult to make a profit on the last stage.

Search for the silver lining

If this is making you feel that all is lost, don’t despair. While the developers of these schemes have difficult decisions to make, the traditional prime markets are firming up in price even if turnover is down: the two are actually linked, as reduced supply has met strong demand. This applies to both London and the country house market where prices have been left behind but are now catching up.

Until around 2004, we had a rule of thumb that you could trade a medium-sized house in Kensington for a rectory in the Home Counties. By 2014, you got two rectories. Now, it’s about one-and-half. But this is not across the board. In London, wide, slick flats go at a premium while tired, skinny houses languish at a discount. Quality is - and always was - everything.

The investment market has seen the biggest change of all. The buy-to-let residential market has been cut off at the knees by taxation changes. The yield was always disappointing compared with commercial, but the capital gain more than made up for it. Not anymore. Yields are sky high at the very top of the market, where rents of £20,000 per week are not exactly common but no longer remarkable. If you are rich and want to be in London for less than four years, it’s cheaper, and much less hassle, to rent than pay stamp duty. Investors are increasingly focusing on commercial, where we have been putting together portfolios with good covenants and yields of over five percent. There’s the added attraction that interest is still deductible, the rental period is normally over 10 years, and the rent reviews upwards only, with the tenant, in most cases, paying for the upkeep. What’s not to like?

What we see emerging is a property market that is not a homogenous thing that moves like the tide across the ocean taking everything with it. Indeed, it is much more nuanced than the doleful headlines about Brexit, taxation or market downturns can convey. It’s clear that the market’s multiple sub-sectors are behaving in different ways depending on location, size, condition and type. The secret is to know the difference. Also, that politics come and go and that we have clients who see Brexit as an opportunity not a threat. Interesting times? Certainly. But life will go on.