An analysis of Land Registry data shows that of all the local housing markets of England and Wales, house price movements in the most expensive boroughs of London are the least correlated with the national average. Their performance is even less aligned to the country as a whole than the lowest value markets, such as Merthyr Tydfil, Hartlepool and Blackburn.

While the latter group substantially lags behind the rest, prime London is the ultimate market leader, being the first to show signs of recovery and showing the most price growth in the first half of a housing market cycle.

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Early rapid ascent

This has certainly been the case in the period since the housing market bottomed out just over five years ago. Since that date prices in prime London have risen by 75.1% to the point where they are 37.9% above their pre-crunch levels. In contrast, across the UK as a whole, prices are on average -5% below where they were pre-downturn.

This is because prime London markets are driven by a different set of factors to the mainstream, with much more emphasis on the generation of wealth and the way it is spent than on the affordability and accessibility of mortgage debt.

Furthermore, there are earlier catalysts for recovery, not least among international buyers who respond to a currency play. While heavily concentrated in central London, this activity can quickly affect buyer sentiment in more domestic prime markets such as South West London.

Yet even in comparison to the recovery following the downturn of 
the early 1990s, prime central 
London (PCL) was particularly quick 
out of the blocks this time around. 
In the three years after the market hit its nadir in March 2009, prices rose 59%, much higher than the 38% seen in the equivalent period from the end of 1992. This reflected the intense flight to safety of global wealth against the backdrop of uncertainty in the Eurozone in particular.

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Applying the brakes

Subsequently, in the part of the cycle when the currency play takes 
a back seat and the market becomes more dependent on the underlying fundamentals of supply and demand, price growth has been much less than in the equivalent period of the 1990s.

In the past two years, prices across the PCL market have risen by 13%, compared to 23% across the Greater London market as a whole. Perhaps more pertinently, in the second quarter of 2014, prices in both PCL and prime South West London rose by just 0.4%.

This indicates that the market is, 
at present, looking fully valued. 
While this partly reflects the rapid rise of prime London prices in the two years prior to the downturn, it also reflects the fact that the market over £2m has had to contend with an increased tax burden and the threat of further taxation.

Sizing up the market

Both factors have had implications 
for the pattern of price movements in the past two years. Smaller properties that are least likely to be affected by increased taxation and more likely to be bought as an investment than a luxury home, have performed much more strongly than large properties where price growth has been heavily curtailed.

At the extreme, properties under 1,000 sq ft have risen in value by 22% since mid-2012, while at the other end of the scale, those over 7,000 sq ft, where the tax burden is greatest, have grown in value by just 3.3%. Whereas those between 1,000 and 2,000 sq ft have seen a two year price growth of 18% on average, those between 5,000 and 7,000 sq ft have risen in value by under 7%.

What next?

The key question is whether this is 
a temporary slowdown in the market, common at this point in the cycle, 
or the beginning of a more prolonged period of lower growth, more akin to 
that seen in the period 2001-05.

This depends on the extent to which underlying demand is supported by global and domestic wealth generation and the fiscal, regulatory and political backdrop.

Taxation has already contributed to the recent muted performance and is likely to remain in focus given an impending general election and opposition proposals for a mansion tax. If implemented in a draconian way, it is probably the biggest threat to the market. However, it is far from certain whether such a tax will be introduced and, if so, the extent to which original proposals would be watered down.

Mortgage regulation also has the potential to moderate growth in the domestic markets and lower tiers of the prime market, as does the regulation of bank bonuses higher 
up in the market.

Therefore, price growth in the next five years seems unlikely to replicate that seen in the corresponding period in the last market cycle, even though market fundamentals point to the potential for further price growth, assuming there are no further changes to the taxation of high value property.

Taken from
Spotlight: Prime London Residential Market - Autumn 2014