The prime markets in London and the rest of the UK have historically always been driven by the availability of equity rather than borrowing. This has made them particularly resistant to the recent downturn in mainstream markets but there is a question over whether this can continue.

Strong buyer sentiment and the availability of equity to prime buyers has meant that prime country house prices rose significantly after March 2009. In London, the impact of equity purchasers, particularly from overseas, has been even more pronounced.

We estimate that, in the 18 months to June this year, a net £6 billion flowed into the secondhand and new build markets of prime London from overseas sources. This contributed to a 12.7% increase in Prime Central London values during the first three quarters of 2011.

Town and country

Prime London has been largely immune to the malaise that has hit mainstream property markets over the last year or so. Prime regional markets have been less protected though and changes in local economies have suppressed sentiment outside London so that prime regional values have fallen in line with mainstream markets, by -2.4% over the nine months to September 2011 (see Table 'Outlook for London has weakened').

Despite the widening price gap between town and country, there seems to be an increasing reluctance among Londoners to move out of the capital, and so we have seen a 24% drop in this type of relocation activity. If the equity doesn’t migrate from London, prime country markets will remain suppressed.

Personality divide

Meanwhile, the prime London market itself is also experiencing a personality divide. On the one hand, the more ‘domestic’ prime markets of south west London and locations such as Islington are more reliant upon earnings and employment in the capital’s financial and business services sector.

On the other hand, there is an enormous amount of overseas wealth coming to the capital. High commodity prices and growth in emerging economies are creating international billionaires and multi-millionaires at an unprecedented rate. Many of these ultra-high net worth individuals are attracted to the prime London markets. Some come because they are based here but others see a London property as part of a portfolio of must-have real estate.

They are attracted by the UK’s political, financial and legal stability and see the City as a ‘safe haven’ store of wealth. They are also attracted at present by low rates of exchange and some may see a sterling denominated asset as a longer-term currency play. This state of affairs is not uncommon in a market which has seen regular influxes of global wealth in past decades but it does mean that PCL markets have been more volatile as this activity has ebbed and flowed.

What is different today is the relative lack, and little immediate prospect, of large amounts of wealth being created in the City of London and finding its way into the residential real estate markets as the result of a strong domestic economy. In the absence of the influx of overseas equity, prime London would probably be undergoing a similar fate to prime property in the rest of the country.

International influences

Further growth in the central London market is dependent on it continuing to defy – or even benefit from – the pressures on the global economy. On the one hand, greater uncertainty encourages the search for a safe haven for wealth while on the other, there comes a point where a slowdown, prevents new wealth being generated and shrinks the pool of potential buyers.

While the eurozone may be teetering on the brink of a double-dip recession, the outlook in other parts of the world is more favourable. Economic forecasts for the Middle East, Asia and Eastern Europe have been ‘trimmed’ but they are more positive than for the US and eurozone, so we anticipate that buyers from these regions will drive demand in the medium-term (see Table 'Prime Markets').

The health of the eurozone affects the more family-oriented London prime markets such as south west London, where many households are employed in the financial and business services sector (see Table 3.2 in the gallery for the London outlook). So far, these markets remain unsupported by large-scale city bonuses. The latest estimates from the Centre for Economic and Business Research suggest that the 2011/12 bonus pool will shrink to about 62% of what it was in 2007 and be paid out over several years.

Global city fundamentals

We have already highlighted the volatile nature of Prime Central London and a lull in this market is to be expected at some point. On balance, we believe the influx of global wealth in uncertain times still has some time to run and may even be boosted by the international attention that London will receive in the run-up to the 2012 Olympics.

We have therefore forecast continued, but lower, Prime Central London growth next year with a short-lived downward blip in the final quarter before growth resumes later in 2013, driven by strong global city fundamentals and an improving domestic economy.

The prospect of a lull in London will do little to improve sentiment in the prime markets beyond London, but the gap between London and country prices is wide and makes prime property outside the M25 look comparatively good value. To date, the markets which are completely divorced from London (the Midlands, the North and Scotland) have been the slowest to recover. That is set to continue (see Table 'Rental Markets').

Taken from
Residential Property Focus, Q4 2011