MAKING THE GRADE - BEST GRADES OF PROPERTY WILL OUTPERFORM THE MARKET

Savills Research has today published its annual house price forecasts. The company is sticking to its prognosis, first published over a year ago, that average, mainstream UK property prices will experience a “second slip”. But, they say, never have there been bigger differences in the outlook for the best properties versus the rest and for London and the South of England versus the North.

Mainstream values are now expected to fall by a total of -7.3% between mid 2010 and end of 2011 (and some of these falls have already occurred, with -3% expected to occur in 2011). This compares to total falls of just 3.5% expected in prime central London over the same eighteen month period (with just -1.0% in 2011).

“Unlike the doomsters, we are not forecasting a deep double dip and there will be tiers of the market – like grade A prime London properties - that may well escape the downturn virtually unscathed,” says Yolande Barnes, head of residential research at Savills.

“It is the detailed forecast that counts. We have not only varied our prognosis for different regions and for prime versus mainstream, but we have also varied them for the most desirable, owner-occupied properties (grade A) versus poorer quality, tenanted stock (grade C), compared to the average (grade B). These distinctions will make a big difference to longer-term performance and we expect markets rich in equity to operate very differently to those historically heavily reliant on mortgage finance.”

As a result, the Savills forecasts for the prime locations and high quality residential property are that values will significantly outperform the UK mainstream housing market over the next five years, both in the pace and scale of growth.

The Grade A factor

“London is a market driven by a totally different set of factors to the rest of UK housing, not least its position as a global financial centre and appeal as a safe deposit for international investors,” says Lucian Cook, director of Savills research. “It will continue to lead the recovery, financed by overseas wealth inflows and a strong private sector economy, particularly in the financial and business services sectors. In turn, this will have a knock on effect to other parts of the South East which will also be driven by the stronger Southern economies.”

According to Savills Research, prime central London house prices are forecast to fall by just -1% in 2011 and, more importantly for those looking to buy now, to rise by 33% by the end of 2015 (compared to a UK average of 12%).

“Outside of London, there are also reasons why prime, grade A stock in the regional markets will avoid some of the falls,” Cook says. “Owned by equity-rich occupiers, its value is not so heavily underpinned by the availability of mortgage finance.

The equity divide in the mainstream

“We expect to see a growing division between the equity rich, owner occupied grade A stock at one end of the mainstream market and grade C stock at the other, the latter dominated by low levels of owner occupation and equity and high levels of renting,” says Barnes.

The growing gap between outright ownership, mortgaged ownership and first time buyers (or aspiring second movers) able to access neither mortgage credit nor cash lump sum cash deposits, is driving new demand for renting and shared ownership. Whether this demand is met by supply will depend greatly on whether significant investors can be attracted into the market.

“While the market waits for new investors, there will be a shortage of rental stock coupled with minimal demand from owner-occupiers on the bottom rungs of the housing ladder,” claims Barnes. This combination, she thinks, is likely to suppress capital growth for grade C stock over the medium term but could, simultaneously, lead to an increase in rents.

“Only when this combination raises yields to a level that attracts large-scale investors will we see grade C values rise again. This marks a significant and permanent structural change in the UK residential property market as the value of these properties will be driven in future by the size of incomes that they produce and investor sentiment rather than by owner occupiers and mortgage lending”.

In the shorter term, the mainstream UK market has, on average, outperformed expectations over 2010, by growing in the first 6 months. However, falling prices have been widely reported in the third and fourth quarters and Savills anticipates that it will end the year down by -0.5%. The forecast falls have therefore been delayed and are now expected in 2011 as declining buyer sentiment impacts on prices, though Savills believes that the falls next year will be contained to an average of a few percentage points across the UK.

THE FORECAST IN DETAIL - PRIME MARKETS

“We are currently seeing a lull in prime markets that often occurs in the recovery cycle particularly when activity is dependent on the confidence of equity rich buyers that can itself often be volatile,” says Cook. “Sentiment has been affected by reports of falls in the mainstream and evidence suggests that values will be suppressed for a while.

“But we continue to expect renewed growth to be fuelled both by the continued introduction of overseas equity into prime London, coupled with wealth generated in the financial and business services sector.”

Those benefits are expected to ripple out to the London hinterland initially, the effect of improved sentiment at a regional and local level reflecting the depth of the prime markets. For the reasons outlined above, Savills forecasts that the prime markets will significantly outperform the mainstream both in the speed and scale of its recovery.

THE FORECAST IN DETAIL - MAINSTREAM MARKETS

As 2011 approaches, the mainstream market is beginning to respond to an uncertain economic outlook, the expectation of increased pressure on household incomes and in some cases, the fear of redundancy.

As a result, Savills forecasts that the average UK house price will end 2010 -0.5% down, with further falls forecast in 2011. However, the company believes that low interest rates and mortgage affordability will put a floor under falls, meaning that this will be a second slip rather than a double dip, but with an expectation that the recovery will be significantly delayed in some locations and tiers of the market.

Wider regional differences in both the scale and timing of the recovery are now forecast. Such differences will be compounded by the comprehensive spending review and the uneven distribution of public sector employment.

“A recovery dependent on the confidence of equity rich buyers was always going to be volatile but the fear of job losses in the public sector and associated industries in the wake of the austerity budget and CSR is compounding this to create a second slip,” says Cook.

However, the best properties in locations with high owner-occupier demand will continue to outperform the average, an effect that is expected to become more pronounced over the mid to long term.

SUMMARY

“It is now clear that the divisions we have seen emerging in the market, particularly over the past two years, have become permanent,” says Barnes. “Going forward, the market will be characterised by subdivisions defined by location, property type and the nature of occupier demand, and it is these divisions that will dictate the scale, timing and sustainability of future price growth.

“There will be a very clear distinction between prime and mainstream markets over the coming five years, distinctions that will be further compounded by the very divergent performance of Grade A and Grade C properties. Grade A will outperform the average by 5% over the next five years, while Grade C will underperform by the same margin – a difference of 10 percentage points between the different types of property in the same location.”