House price growth in London slowed down to 2.6% y/y in August, from a recent peak of 14.8% y/y recorded in March last year, according to figures from the Land Registry.
The London housing market has been hit by a combination of policy and economic developments that call into question the sustainability of current relatively high valuations in the capital. House price growth in London slowed down to 2.6% y/y in August, from a recent peak of 14.8% y/y recorded in March last year, according to figures from the Land Registry .
Momentum in the housing market has been dampened by changes to stamp duty, which included an extra 3% for those buying a second property from April 2016 and an earlier introduction of a new progressive Stamp Duty system, which increased the duty paid on properties valued above £937,000 – hitting London properties disproportionally hard. Transaction numbers in the capital have been particularly affected since April 2016, down by 12% in the 15 months since April 2016 compared to 15 months earlier.
Uncertainty surrounding the outcome of Brexit negotiations has probably reduced the appetite of some international investors, an important driver of the London property market – albeit many continue to see London as a “safe-haven” store of wealth alongside its attractions as a global city. Around a third of sales of new built units handled by international estate agents in London are to overseas buyers, rising to over 50% in central London. That uncertainty, in particular coupled with the increased cost of purchasing an additional property, may well be undermining the strength of potential interest from international buyers, which would have normally been sparked by the weaker pound.
The general economic environment in the UK has also become less supportive of the housing market. As the inflation rate has crept up, nominal earnings have failed to keep pace – leaving households squeezed amidst falling real wages.
Prices in inner London have so far been affected to a relatively greater extent than suburban boroughs. Since July 2016, following the change in the stamp duty legislation in April and the Brexit vote in June, house price growth rate in central London averaged 3.5% compared to 6.8% in outer London and 4.9% in London as a whole. Boroughs such as City of London, Kensington and Chelsea, and Westminster have all seen price contractions since the start of this year.
The UK’s vote to leave the EU is expected to alter migration patterns between the EU and the UK. Indeed, net migration to Britain fell to its lowest level in three years in the 12 months to the end of last March, with more than half of that decline caused by European Union citizens leaving and fewer arriving since the Brexit vote.
London boroughs with high levels of EU-born residents might be vulnerable to sharper house price corrections in the aftermath of Brexit, as demand softens due to lower inward migration, while housing supply increases thanks to stronger outward migration. Residence trends up to March 2017 show stronger net outflows from the EU8 countries and Romania and Bulgaria than from the EU14, although this could change as the Brexit process evolves.
The Royal Borough of Kensington and Chelsea, which has the highest valuation in London as measured by house price-to-earnings ratio, also had the highest proportion of EU-born residents in 2016 (see Figure 1 below). French and Italian nationals make up a large share of the borough’s 53% of residents born abroad. Given its attractiveness to non-EU migrants – Americans are the largest migrant population by country of birth – it is possible that a departure of EU citizens from the borough would be compensated to some degree by stronger demand from other nationals. However, this would be contingent on the British government not imposing tighter overall migration restrictions post-Brexit.
Other London boroughs that may be particularly vulnerable include Waltham Forest (with 18% of EU-born residents), Hammersmith and Fulham, Newham and Brent (17% of EU-born residents). Meanwhile, Newham and Ealing have the highest share of residents born in EU8 countries (8% compared to the London average of 3%), which may impact short term price movements in these boroughs more severely.
With the Brexit negotiations still underway, it is too early to estimate the future trend in EU net migration to the UK. However, it is worth taking into account that possible reversal of recent migration trends leaves certain London boroughs more exposed to sharper price corrections.
Looking ahead, our base case scenario is for the UK economy to remain relatively lacklustre, weighing on local demand in the London housing market in the medium term. Moreover, elevated inflation and a tight labour market could see the Bank of England start to raise rates as early as next month. This will translate into a gradual increase in mortgage costs and tighter credit conditions.
On the supply side, projections by Savills suggest that the number of new dwellings coming on the market will peak this year and then slow down thereafter. That means that more limited new supply should provide some support for London house prices over the forecast period.
On the whole, our projections for the London housing market see a continued cooling in the short term, followed by a gradual rebound in the medium term, which will allow the cumulative price growth to remain positive over the forecast horizon overall. However, annual growth rates are not expected to revert to the above-5% figures seen before 2017 in most boroughs during the period (see Figure 2 below).
Hackney is expected to experience the highest growth on average over the 2017-2020 period, while Richmond could see the slowest pace on average among the different boroughs. While changes in local infrastructure and connectivity inevitably impact on the attractiveness of particular boroughs we see a particularly strong link with earnings growth momentum in the short term, and hence that is the main driver for house price variability in our forecasts.
Hackney recorded an average growth rate in real income per capita of 2.9% between 2005 and 2015, compared to only 0.5% in Richmond over the same period. At the same time, Greater London Authorities’ measures of deprivation improved sharply in Hackney over that period. However, large areas of Hackney still fall within the 10% of most deprived areas in England, and our forecasts expect continued strong real income growth in Hackney relative to other boroughs such as Richmond, driven by continued influx of higher earners, which will support house price growth in the borough.
Young “gentrifiers”, aged 20-30, can be seen as “early adopters” as they usually start off in boroughs where rents are relatively lower as they are moving in. However, young professionals and creative classes tend to change the make-up of their neighbourhoods, attracting diverse businesses and services. These ultimately make the area appealing for young families and middle class professionals, raising the average income and house prices in the borough.
Areas ripe for this process of gentrification may be identified using leading indicators such as the inflow of young population. The number of residents between the ages 20 and 30 has been falling in London since 2012 (with the exception of a marginal increase in 2015). However, there are areas which have been bucking the general trend and which we see as having more potential for faster gentrification. These include boroughs in South London such as Southwark, Lambeth and Lewisham, which are also amongst those we project to have higher increases in house prices over our forecast horizon, compared to London as a whole.
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