Investment Returns Improve
The sales market in Central London is poised for a further period of stalemate with cautious buyers and owners unwilling to reduce prices. The supply-side shortage will persist for the foreseeable future, exacerbated by extended conveyancing periods, fire safety requirements and the lack of new construction in Central London. This will continue to support the recent trend of a low volume market.
On the demand side, confidence will continue to improve as interest rates settle and inflation falls back to more manageable levels, both of which we expect to happen this year. Prices fell by an average of 2% in the first half of 2023 across Midtown, City and East London which is in line with expectations that we published in December 2022.
Banks which have already tightened lending criteria this year will continue to favour low loan-to-value lending in the current economic climate. Cash-rich buyers, including first-time buyers who have saved large deposits in recent years will continue to take advantage of the opportunity to buy with less competition.
Fire safety legislation will however continue to dog our markets for the next decade. Six years on from Grenfell, progress on remedial works is slow and many landlords are prevented from selling until works are completed and paid for. Even then, compliance with the Building Safety Act, causes long delays in conveyancing. Buyers and sellers should allow 4 to 6 months for sales to be concluded from the point that a sale is agreed.
New construction activity will continue to be severely impeded by high construction and borrowing costs and the impact on viability of new requirements such a mandatory second staircase in any building over 30 metres high – which both reduces saleable floorspace and increases building costs.
Most data now points to a hybrid working model where people are in the office three days a week. That looks like the new norm. The rise of AI, which burst into the headlines this year, will undoubtedly threaten white collar jobs in the decade to come and the prospect of that should encourage a greater return to the physical office for those keen to prove the benefits of human contact.
London prices remain attractive for overseas buyers – particularly those with dollar denominated currencies – and housebuilders with stock to sell will continue to promote schemes overseas while the domestic market is slow.
We expect rents to increase in Q3 and then settle back to their current levels by the end of the year. Demand will be driven by students including overseas students who are often prepared to pay 6-9 months’ rent in advance to secure long term accommodation.
Renters who have renewed tenancies for 2 or even 3 years at discounts to the market rent, will find their landlords now expecting to raise rents closer to market values given the punishing service charges and higher mortgage rates many landlords are facing. While some renters will be willing or able to absorb market rents, some of those who moved into these areas when rents were low during Covid, will return to lower value areas, others will make a move onto the housing ladder.
However, the supply of rental accommodation will remain tight as some landlords sold properties, reoccupied them, or reverted to short term rentals.
The gross yield for an average one bed apartment now at 5.8% is still proving insufficient to attract buy to let investors back to the market. The Renters Reform Bill is unlikely to encourage more landlords to enter the market.
The vicious circle of cost of living inflation leading to wage inflation leading to interest rate rises seems to be becoming entrenched in the economy, which means we must wait until 2024 for interest rates to fall. Many employers are struggling to recruit and so further wage inflation looks inevitable. Wage inflation will underpin rental growth and ensure that for rental markets at least, our markets are on pretty solid foundations.
Development has been curtailed by the increase in construction and borrowing costs and we do not expect to see much new construction for the rest of this year or next. The most likely source of new supply will be vacant office space but there are planning hurdles and we do not expect any change of use to materialise in the next 12 months.
The biggest cause of concern in our markets remains the fire safety regulations which have unintended consequences that create new supply for the rental market as owners are prevented from selling and choose to become landlords instead.
Given the turmoil in current politics, an early election in May 2024, while unlikely, is still a possibility. Looking further ahead, we expect the traditional post-election wave of confidence to trigger a bounce-back in sales numbers in the city with the potential to deliver price growth after 10 years of no growth.
The property market has for now to weather the headwinds of higher interest rates but enters the second half of the year in much better shape than economists had predicted at the end of last year. This picture is supported by a shortage of homes for sales or rental.