In the 18 months between September 2007 and March 2009, all sectors of the prime residential market – whether prime or ultra prime, London or country – experienced sharp price falls of between 20% and 25%. Since that date, there has been a significant divergence in performance.

In the prime markets of London, a very strong recovery means prices have more than made up lost ground, standing at 14.6% on average above their level five years ago. By contrast, in the country house market prices are on average 10.1% below their pre crunch level. These averages hide variation between different locations and property types in both markets.

Understanding the reasons for these differences, and considering how they will affect the market in the next phase of the housing market cycle, is key to formulating a view for the next five years.

Prime Central London

Central London has seen the strongest recovery. Prices are averaging 22% above their third quarter 2007 levels. The ultra prime market, which has become increasingly international, has risen even further.

One of the key catalysts for the recovery was an exchange rate play as the weakness of sterling made London look inexpensive in a global context despite correspondingly strong investment prospects. This advantage has now largely been extinguished by the resulting price growth and a stronger pound.

The second key driver of international demand has been the ‘safe haven’ play. Economic uncertainty in the eurozone and political uncertainty in other world regions, such as the former Soviet Union and the Middle East, mean ultra-wealthy individuals have looked to invest in an accessible market with a strong, long-term track record for capital growth. Many well-rehearsed factors have combined to put London in this enviable position.

There is little doubt that the UK tax environment has historically been one factor conducive to such investment, but in the past two years this competitive advantage has been put under pressure.

Property specific taxes, such as stamp duty, have increased as has the exposure of UK property to other taxes following the recent introduction of anti avoidance measures. Though not fundamentally undermining London’s wider appeal, the market will take time to absorb these additional costs.

The third and most significant driver of underlying demand has been global wealth generation. This will continue to be a function of economic growth at a regional level globally, evidenced by the increasing profile of buyers from Asia in the prime new homes market in particular.

Though expected to continue over the medium-term, short-term pressures on the global economy may lead to a weakening of emerging market demand, particularly at lower price levels.

Outer Prime London

Such new world wealth has been less evident in London’s other prime markets where domestic demand is still dominant, and where prices have risen to a lesser degree. This said, in prime South West London, for example, they are on average 11.7% above their level five years ago. Without any significant injection of City bonus money in the past five years, price growth here has been driven by a recycling of domestic wealth and a displacement of wealth out of central London.

In an environment where banking profits are reduced and City pay is increasingly scrutinised, these markets will become more dependent on the spill out effect from central London, particularly when greater amounts of existing housing wealth begins to be exported out of the prime domestic markets of London, as owners start to look again at moving out of London into the commuter zone and beyond.

Prime Regional

Generally, the prime regional markets have had neither a substantial injection of equity from overseas buyers nor a consistent flow of equity from London to spark a sustained recovery in prices. These markets have been much more exposed to weak consumer sentiment among largely domestic buyers.

There have been exceptions. The market for mansion houses on private estates, such as St George’s Hill and Wentworth, has parallels with central London, both in terms of buyer profile and the nature of product offered. This sub market has substantially outperformed the rest of prime regional and is likely to continue to do so over the medium-term.

In areas that benefit from a flow of housing wealth generated in London, the market has been stronger, but this equity flow has not reached far beyond the prime ubertowns of the South East, such as Beaconsfield and Sevenoaks.

This has created divisions between inner commuter zones, outer commuter zones and the rest of the UK, creating an urban-rural price gap within the commuter zone.

The next five years

Over the next five years, we expect to see a more widespread recovery as London-generated equity flows out. During this phase, we expect the ripple effect to follow the geographical distinctions already in evidence (see our 'timeline of recovery' graph).

The uber towns are expected to be the greatest beneficiary of this ripple. We expect improved market conditions to feed first into the prime markets of the South East and other core prime markets beyond.

This improvement will filter across Britain, a process that is likely to be quicker in prime than in the mainstream market, given a lesser reliance on mortgage finance. As a result, prime markets will respond more quickly to economic improvements.

The key questions are what will trigger the flow of equity through the market and when. The current value differentials across the market suggest the platform is there; it is an improvement in sentiment that is now needed.