The 2015 General Election was widely expected to mark a turning point for London’s prime housing markets when either the market would re-price if the threat of a mansion tax materialised, or bounce back if not, after a period of pre election caution.

In reality, despite the certainty of the election outcome, the market continues to adjust to the stamp duty reform of December 2014 and, in some cases, the Mortgage Market Review of April 2014.

Across the prime London market prices rose by just 2.3% in the six months to the end of September 2015, leaving them effectively the same as a year previous, largely as a result of the falls triggered immediately after the new stamp duty rates were announced. The slowing price growth also reflects a market that had seen five and a half years of sustained growth prior to the announcement of these tax changes.

This raises the question of whether prime London pricing can resume a strong upward trajectory or is a much more sedate market to be expected in the new tax environment? Early signs are that the fundamentals of demand remain sound, but it will take time for buyer and seller expectations to realign, pointing to a period of lower growth.

The role of tax

Though the tax environment has become less favourable for buyers, international wealth continues to grow and there are still many nonfiscal reasons why London remains an attractive location for the ultra high net worth individuals (UHNWI) to invest.

The effective stamp duty rate is now over 7% for any property worth over £1.725 million and over 10% for any property purchased for more than £4.3 million. This compares to a previous flat 7% rate for all properties over £2m.

The tax on a £5m property now stands at £513,750. Ten years ago the stamp duty on the same property, then worth £2.2m, would have been just £88,000.

For non doms, such properties have become more difficult to shield from inheritance tax following the first budget of the new parliament, with corporate ownership viewed with suspicion by the current government.

While the new rates of stamp duty undoubtedly look onerous, there seems little chance of a policy reversal in the immediate future, unless the change results in a net loss to the exchequer. Though transaction levels at the top end of the market have undoubtedly slipped, it does not appear that stamp duty revenues from this part of the market have fallen to any significant degree so far.

Mortgage regulation

Equity has always played an important role in the prime London markets, but the prime markets are not immune from the effects of the Mortgage Market Review.

Cash buyers are most dominant in the highest value housing markets, with 75% of purchasers in prime central London buying without borrowing. Nonetheless, we estimate those buying homes worth over £1m borrow a total of around £6.1bn a year across the UK, with London accounting for under 70% of this sum.

This means that outside the most expensive central London locations, some 51% of prime London buyers rely on a mortgage to cover at least half the purchase price of their property. As such, the availability and cost of a mortgage still has an important part to play in more domestic parts of the prime market.

For those moving up the housing ladder, higher levels of stamp duty will erode the equity built up in a previous home. This will make them more reliant on mortgage borrowing for their next purchase, at a time when mortgage regulation reduces high loan to value and income lending, as well as borrowing against bonuses.

Looking forward

Examples such as the one outlined in the case study panel suggest buyer caution will remain a feature of the prime London market. We therefore expect this market to remain price sensitive over the next 12 to 18 months as it adjusts to a changed tax and mortgage environment. However, the underlying drivers of demand, explored in more detail on 'Prospects For Wealth Generation', suggest that following this adjustment, we can expect a return to trend rates of price growth in due course.

Case Study: South West London

Upsizing to a £2.5m property

A buyer in south west London looking to trade up from a home worth £1.875m to a property worth £2.5m will have built up £518,000 in equity after five years of ownership. The stamp duty on their new home will be £213,750, equivalent to 41% of that equity. Even after 10 years of ownership, the stamp duty would account for 22% of the accumulated equity.

Given lending constraints and the inevitability of interest rate rises, we would expect more upsizers to look beyond established prime locations, or outside London, to lower value markets, where their money will stretch to a larger property. This may lead to a ripple out of London, also reducing the amount of existing housing wealth being recycled in the capital.

Source: Savills Research