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The performance of the prime London residential markets shows strong parallels with commercial property in the West End, albeit characterised by much greater capital than rental growth.

As a consequence, both residential and commercial sectors have seen yields fall in an environment where investors have been prepared to accept lower income returns for ‘safe haven’ property investments in the prime areas of London and where they consider that the fundamentals are strong and bode well for the long-term.

In the residential markets of PCL, the average gross income yield has fallen from 6.3% in 2005 to 3.1% in 2013. Though investor demand is a much smaller proportion of total demand for prime London residential than for retail property, it nonetheless stands at something of a high. Over 20% of purchases in PCL residential are for letting purposes, a figure that rises to 25% in the prime east of City markets.

Though not the primary driver, yield is not entirely irrelevant to these buyers. Typically they buy stock which is 25% smaller and 31% less expensive than the average to tap into slightly higher yields, with the higher income attributes of east of City stock being particularly attractive to Asian buyers.

Underlying asset value

But in central London in particular, residential investment remains much more about the underlying asset value, its potential for growth and the security which it offers as a store Investor demand for rental property is on the increase, with one in eight purchases across prime London earmarked for lettings of wealth. Against this context, location is critical, particularly to overseas investors from Europe and the Middle East.

For residential tenants, location is more interchangeable, which is one reason why recent rental growth has been lacklustre.

Of course, the same cannot be said for office and retail tenants of the West End where stock constraints, particularly Grade A in the case of offices, is more pronounced – perhaps explaining why since 2011 indices for rents across the commercial and residential asset classes have diverged.

In the prime residential rental markets, family tenants with lower corporate budgets have been moving to less expensive parts of prime London or to new build units in emerging areas. This has suppressed residential rental growth particularly in core PCL.

As we look forward, the bedrock of residential demand from those employed in the financial and insurance services sector is likely to be constrained by the employment growth prospects in this sector. Growing numbers of employees from technological, media, communications and professional services are likely to take a greater share of the rental market. This will require landlords to be competitive both in terms of the stock that they offer to the market and the rental levels they seek in the short-term.

Taken from
Spotlight: Prime London Residential Market - Autumn 2013

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