Prime central London, a review

To note

• London’s economy is expected to recover to 2019 levels in 2022 and grow by a further 17% by 2030
• Average prices in PCL have fallen by 18% since the peak in mid-2015, which underlines the extent of the buying opportunity.
• Post-election 2019 saw this coming to fruition, January 2020 marked the highest number of new applicants in PCL in the twenty years of data we have, then the pandemic hit.
• Overall sales volumes in PCL were down 10% in 2020, which reflected the international travel restrictions and ‘flight to the country’ trend. However, between £5 million and £10 million, the market performed more strongly, rising 7% year on year
• Over the past 25 years PCL prices have risen by 404%, outperformed only by the Dow Jones with 464%
• Knight Frank’s latest forecasts are for PCL to see 2% growth in 2021 and outperform over the next five years with cumulative growth of 25%, compared to 23% in prime outer London (POL) and 18% across Greater London
• The drop in new permissions, down 66% last year, and starts across prime central London will be a big factor influencing supply in coming years
• In The Wealth Report’s annual City Wealth Index, which measures where the wealthy spend time and invest, London was joint top with New York. London is home to 6,611 UHNWIs and 874,354 millionaires which is the most HNWIs of any city globally
• Despite Brexit London is cementing itself among competitors as a financial centre had a record quarter for IPOs in Q1 2021 and is the leading technology hub in Europe, accounting for a quarter of Europe’s total venture capital investment in the sector in 2020
• London was top in Knight Frank’s Active Capital innovation-led city ranking. In addition, London has been positioned in second place, behind New York, in the World Economic Forum’s 2020 Global Talent Competitiveness Index for cities

Economic context

Prior to the pandemic London’s economy was expanding having grown 27% between 2010 and 2019, before falling 10% in 2020.

London’s economy is expected to recover to 2019 levels in 2022 and grow by a further 17% by 2030.

Whilst population growth has been steady, 10% over the past 10 years, the level of household wealth has risen. According to Oxford Economics, the number of households earning $100,000, or more, increased by almost a third between 2010 and 2019 before dipping 3% in 2020. This cohort is expected to grow by a further 19% over the next 10 years.

Employment growth has outpaced that of the population, rising 22% since 2010. Employment in sectors key to the prime residential market, notably financial and business services, has been almost 30% over the same period and a further 11% is forecast by 2030. Even with Brexit woes London still ranks as the second-best financial centre according to the latest Z/Yen Global Financial Centres Index released in March 2021.

London’s residential market

Prices of prime central London (PCL) property have been put under pressure since the changes to stamp duty in 2014 and 2016, coupled with Brexit uncertainty and an ever-shifting tax landscape that saw rules change for non-doms and people buying through a company. At the outset of 2020 the tide seemed to be turning following the decisive general election result of December 2019. Pent-up demand started to be released, but the Covid-19 pandemic put a temporary halt on the market.

Average prices in PCL have fallen by 18% since the peak in mid-2015, which underlines the extent of the buying opportunity. A period of house price inflation in PCL is overdue. Indeed, January 2020 marked the highest number of new applicants in PCL in the twenty years of data we have, then the pandemic hit.

Overall sales volumes in PCL were down 10% in 2020, which reflected the international travel restrictions and ‘flight to the country’ trend. However, between £5m and £10m, the market performed more strongly, with volumes rising 7% year on year.

There are several reasons for that. First, it is a price bracket that had been particularly affected by stamp duty hikes in recent years, which had kept a lid on prices, helping to sustain demand. It also slowed decision-making and left owners in properties that no longer suited them, and they are now beginning to transact.

Second, there are generally more houses than flats at this price point. Third, they tend to be owner-occupied properties and in 2020 the market was more propelled by emotionally driven requirements, typically with a higher proportion of British buyers who were not hampered by travel restrictions.

The chart below lays bare the impact of travel restrictions – showing how price growth has diverged between the mainstream London market and PCL over the course of 2020. Prices are currently broadly flat in PCL while they are growing by around 5% in Greater London.

With Heathrow passenger data down by at least 80% the lack of overseas buyers has played a big part in that. Questions have been asked regarding the impact of the 2% overseas surcharge from April. The answer is that we are in a unique situation where it has been effectively priced in before its introduction. While overseas buyers will seek to use the 2% surcharge to negotiate on price when travel restrictions are lifted, there will also need to be a recognition that prices have been flat in their absence.

The pandemic has also shifted the buyer demographic. UK buyers accounted for 59% of sales last year versus 47% in 2019. The French were the most active nationality in PCL in 2020 for the simple reason they were able to get to the UK more easily.

Not only have opportunistic European buyers been taking advantage of less competition from Asian and Middle Eastern buyers, they have also been capitalising on the weak pound and the fact a 2% stamp duty surcharge for overseas buyers comes into effect in April. Once travel restrictions are eased it is likely that Middle East and Asian buyers will return as the nationality breakdown of buyers reverts to historical patterns.

Pent-up demand is building among overseas buyers and that will kick in once travel restrictions are relaxed. The £10 million-plus market provides a useful barometer of international demand, with overseas buyers typically accounting for between two-thirds and three-quarters of sales in recent years.

The number of new prospective buyers registering in this segment increased by 109% in the year to January 2021 compared to the previous 12-month period. It was the highest such rise in more than 10 years and demonstrates, among other things, the impact of a weaker pound and the general election result in December 2019.

Meanwhile, the number of viewings fell by 36% over the same period due to the pandemic, the steepest such decline in a decade. For international buyers, there is a huge disparity between the desire to buy and the ability to view. Anecdotally, many have positioned themselves to act quickly once rules are relaxed and they are encouraged by the success of the UK’s vaccine roll-out.

Overseas buyers have enjoyed relatively larger discounts in recent years due to a weaker pound post-referendum. At the end of 2020 the five-year discount for PCL in euros was 32% and in dollars 23%. With the Brexit deal agreed in December the pound has strengthened, albeit not as much as many had expected. Whilst continuing to oscillate around $1.38 it could conceivably hit $1.50 by the end of the year. So, the frustration of limited air travel is compounded by a ticking clock of a strengthening pound for those overseas buyers looking to strike at the right time.

When we look at the track record of prime central London prices over the past 25 years to February 2021, only the US Dow Jones index outperforms. This underlines the credentials of prime central London property as a long-term store of value. Over this time period PCL prices have risen by 404% compared to Dow Jones’s 464% although much of the stock market’s performance was driven by rally in the second half of 2020 – it is up 22% over February 2020 alone. PCL has outperformed gold’s 334% and the FTSE 100’s growth of 74% over the same time period.

Forecasts

Knight Frank’s latest forecasts point to prime central London (PCL) outperforming over the next five years with cumulative growth of 25%, compared to 23% in prime outer London (POL) and 18% across Greater London.

Knight Frank revised its 2021 forecasts down to 2% from 3% for PCL due to continued uncertainty around the relaxation of international travel restrictions. Average prices in PCL have been flat over the last six months as international demand has fallen. By contrast, prices have risen by 1.3% in POL and 4% in Greater London.

Furthermore, when international buyers return, possibly late in Q2 this year, there are two further considerations.

The second consideration is that demand from international buyers may initially be more skewed towards properties with outdoor space than it was before the pandemic.

This could make any recovery in PCL prices more inconsistent across different property types. Demand for lateral living will be stronger among those with other properties in their portfolio with outdoor space. Furthermore, it should be noted that demand for new-build developments with best-in-class facilities has remained strong through the pandemic.

Knight Frank’s forecast for PCL in 2022 has been revised upwards to 7% from 6% as more of the pent-up demand currently building is displaced into next year. A sense of finality will be of overriding importance for the property market this year, in relation to the stamp duty holiday, lockdown measures and international travel restrictions.

Once buyers stop anticipating further lockdowns, demand patterns will revert towards their historical norms.

Underpinning our forecasts is the story of supply. According to Molior the number of new permissionsfor the boroughs of Kensington & Chelsea and Westminster fell by 66% from 2019 to 2020, and by 95% from the peak in 2016. Whilst the number of new starts rose slightly in 2020, they are over 50% below their peak in 2017. The drop in these will be a big factor influencing supply in coming years – the level of completions is clearly correlated below.

London’s continuing global appeal

London is continuing to attract global attention and investment as demonstrated by the strength of its financial and technology sectors. In addition, the city continues to appeal to ultra-high-net-worth individuals (UHNWIs – those with US$30 or more in net assets) and draw in commercial real estate investment.

In the annual City Wealth Index, which forms part of The Wealth Report, London was top with New York. London is home to 6,611 UHNWIs and 874,354 high-net-worth individuals (HNWIs – those with US$1 or more in net assets) the most HNWIs of any city globally. The index looks not only at the wealthy population but investment in the city’s commercial real estate and lifestyle factors such as connectivity and top universities.

London’s commercial real estate appeals to a broad range of investor types globally. The city saw the highest levels of cross-border private capital from the widest range of different countries invested in over the 12 months to September 2020. Looking at all investor types and central London was the highest ranked city for cross-border office investment during 2020, ahead of Paris and Manhattan.

This level of interest and investment in London is set to continue. The Knight Frank 2021 Global Capital Tracker Survey, which tracks capital that has an interest in deploying into London, was close to £46 billion. Whilst this is 5% lower than it was during 2020, this change will have negligible impact, particularly considering the double-digit declines in cross-border investment recorded globally. It should be noted that this figure is still 15% up on 2019.

The first quarter of 2021 was the biggest ever for initial public offerings (IPOs) for London. IPOs have raised in excess of £13 billion in 2021 so far more than double the previous record of £6.4 billion in 2006. This is before the introduction of any possible new rules which could boost the UK’s attractiveness.

The focus on Brexit has moved from the, as yet undetermined, Memorandum of Understanding or financial services equivalence to what the government will do to boost the city’s competitiveness. Much of this will be set out in a consultation expected in Summer 2021.

Huw Jones, the European regulations correspondent at Reuters, notes that he believes ‘the UK will do what it can to roll out the regulatory red carpet for wholesale professional investors to trade here’ potentially through making it easier for institutional investors and banks to trade with each other via what some call dark trading. In addition, competitiveness could be boosted by fast-tracking of visas for fintech workers and easing of listing rules. Although Jones points out that some rules are global, and the UK won’t want to upset Wall Street banks ahead of trade talks with the US.

Aside from the dominance in financial services, London is poised to remain dominant in the ever-growing tech sector, any changes may too reinforce this. The entire British tech sector has more than doubled since 2017 and London is at the heart of this. Tech firms in the capital raised $10.5 billion in venture capital investment in 2020 helping to boost Europe to a record year . In fact, London cemented itself as the leading European hub, accounting for a quarter of Europe’s total and more than three times the amount of investment than its nearest rival Paris.

The momentum is continuing in 2021. The UK’s tech sector has attracted record investment of close to $8 billion in the first three months of 2021, with five companies valued at over $1 billion, which almost equals the whole of 2020.

This will continue due to the underlying fundamentals of the city. London ranked first in Knight Frank’s Active Capital innovation-led city ranking. The ranking includes four factors i) quality of innovation, ii) innovation infrastructure, such as the number of different research organisations in a city, iii) funding and iv) drive to innovate, all of which are key drivers of growth and are fundamental to attracting and retaining the wealth and population needed for well-functioning real estate markets.

Indeed, London has been positioned in second place, behind New York, in the World Economic Forum’s 2020 Global Talent Competitiveness Index for cities, a measure of a city’s ability to grow, attract and retain talent. London is likely to remain a hub for businesses, with employers continuing to seek out office space in the capital, examples from the latter half of 2020 include Baker & McKenzie LLP (144,500 sqft.), American Express (131,300 sqft.) and Netflix which has expanded their footprint to 100,000 sqft.

This builds on the longer trend of large companies, especially Tech companies, committing to London despite Brexit. For example, behemoths Apple, Google and Spotify have committed and even expanded their presence since 2016. Apple’s new HQ at Battersea Power Station with approximately 500,000 sqft, Google’s King Cross HQ was supplemented by an additional 115,128 sqft. in 2020.

And today, with the booming life sciences sector, and plans to make London the world centre for green financing as part of the government’s vision for a ‘Green Revolution’, we are already seeing a continuing evolution of the sources of office space demand. The life sciences sector already supports 250,000 jobs nationally and there was a 45% increase in the number of life sciences companies incorporated in the UK last year.

In conjunction and as another significant post-Brexit vote of confidence, the United Arab Emirates has agreed a multibillion-pound investment partnership with the UK to invest in British health, technology, clean energy and infrastructure. As part of the deal, Mubadala, one of Abu Dhabi’s state funds, will pump £800m into the life sciences sector over five years alongside £200m from a British government fund.

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