Political uncertainty dampens the UK's property market
September 04, 2017
In London prices decelerated sharply, with price rises of only 1.2% (-1.5% inflation-adjusted) during the year to Q2 2017. London is the second weakest region in the country after the North, according to Nationwide.
"There has been a shift in regional house price trends. Price growth in the South of England has moderated, converging with the rates prevailing in the rest of the country," said Nationwide´s Chief Economist Robert Gardner. "Nevertheless...the price gap between regions remains extremely wide."
Supply of houses to the UK's market has hit a record low. Newly agreed sales have also fallen, as buyers have taken a more cautious stance in recent months.
The highest price rise was in East Anglia, with house prices increasing by 5.04% during the year to Q2 2017. It was followed by South West (4.43%), North West (4.13%), East Midlands (4.11%), and Northern Ireland (3.80%). A net balance of 7% of respondents in RICS's Chartered Surveyors' survey believed that house prices are rising, down from last month's 17%.
The North had the weakest growth of 1% y-o-y in Q2 2017. House price growth was also weak in Wales (1.40%), and Scotland (1.72%).
Nevertheless June was a strong month, though the reasons are unclear. “At this point it is unclear whether the increase in house price growth in June reflects strengthening demand conditions on the back of healthy gains in employment and continued low mortgage rates, or whether the lack of homes on the market is the more important factor. While survey data suggests that new buyer enquiries have softened, it also indicates that this has been matched by a decline in new instructions. Indeed, the number of properties on estate agents’ books remains close to all-time lows," said Gardner.
The weakness in the government following the election is "stifling" the country's housing market, respondents to the RICS´s UK Residential Market Survey suggested in June 2017. Around 44% of RICS respondents felt that the weakened activity in the housing market was due to the country's uncertain political climate. Only 27% of them identified Brexit as the biggest factor for the market slowdown.
RICS's survey respondents saw London prices softening, especially in the most expensive areas. Aside from political uncertainty, respondents in London also equally cited Brexit and changes in Stamp Duty as factors contributing to the housing market's flat activity.
"London is slowing more dramatically than the rest of the country, as it is more exposed to changes in sentiment due to house price growth over the last 10 years and what that did for affordability," says Savills' head of residential research, Lucian Cook.
The UK's and particularly London's previous dramatic house price rises were fuelled by four factors:
- Immigration and population growth have been strong, especially in London.
- Interest rates have been at record lows, with a large expansion of the money supply through “quantitative easing”.
- The City of London (London’s financial centre) continues to boom.
- Construction activity remains weak (though this is less true of London). Dwelling starts rose 0.5% y-o-y to 172,740 units in 2016. Dwelling completions increased 10.4% y-o-y to 168,370 units, according to UK’s Development for Communities and Local Government.
House prices in the UK are likely to rise by about 2% in 2017, according to Gardner. Slower household spending amid rising inflation, as well as housing affordability pressures in key areas are predicted to drag house price growth and housing activity in the following quarters. In contrast, the ongoing housing shortage in the market and subdued building activity are expected to provide support for house prices.
There are no restrictions on foreign ownership of properties in the UK.
London's yields are low
London´s residential prices have stopped rising in the higher-end districts. But London remains by any measure extraordinarily expensive.
That impacts rental returns, since rents have not risen as much as prices. Gross rental yields, i.e., the gross annual rental return on an investment in an apartment if fully rented out, are now quite low in London.
A 50 square metre (sq. m.) apartment in prime central London is likely to cost you £750,000. If rented out, it will give you a gross rental return of around 3.2%
A 120 sq. m. apartment in prime central London is likely to cost you £2,200,000. If rented out, it will give you a gross rental return of around 2.6%
Yet surprisingly, larger apartments sometimes have higher yields - particularly in the more expensive districts of London. This defies the almost universal rule in other cities that smaller flats have higher rental returns. Why is it now different in London? Because of the UK's amazingly high stamp duties on super-expensive property purchases, which are dissuading high-flyers from buying. People prefer to rent if they are staying just a few years, because the total costs of renting high-end properties are lower than the total costs of buying and then selling them. High capital gains taxes on sale, and worries about Brexit, reinforce the message that in London, renting now makes sense for the rich.
To get the picture, look at our table and at the high-end districts. In Knightsbridge and Kensington, rental returns on 1 bedroom apartments are 2.7%, but returns on 3 bedroom apartments are 3.2%. However before you leap in, to buy your 3 bedroom Kensington apartment will cost you a cool £4.2 million!
The highest yielding 3 bedroom apartments appear to be in W1 (Mayfair, Marylebone and Soho). These areas have traditionally been popular with the Arab market, and a 3 bedroom apartment can earn 5.3%.
Foreign residential property investors in Britain have long faced a rising rumble of discontent from the British public about exorbitant housing prices in London, which rightly or wrongly is partly blamed on the large numbers of foreign buyers, as well as the continuous flow of immigrants into London. Both are hot-button issues.
One result is that foreign buyers are now liable to capital gains taxes when they sell their UK properties (previously they were exempt). Another is that stamp duty has been ramped up on higher-end properties. There is talk of further measures - it is widely agreed that Council Tax is too low on high-end properties, and the Liberal Democrats have been agitating for a mansion tax.
Round trip transaction costs are higher in the UK now than they were in the past, especially in London given higher stamp duties on expensive properties. See our UK residential property transaction costs analysis and our Residential property transaction costs in UK compared to other countries.
Effective tax rates are moderate in the UK
Rental Income: Unless nonresidents take specific steps, they will be taxed on net rental income ssourced from the UK at a flat rate of 20%, which must be withheld by the tenant or letting agent. However, effective tax rates can be brought down to around 9% with all the allowable deductions.
Capital Gains: Capital gains are taxed are taxed at progressive rates, from 18% to 28%.
Inheritance: Estates or assets exceeding the current tax threshold of £325,000 (€433,333) are subject to inheritance tax at 40%. In calculating the amount of the estate, the value of any gifts made by the deceased within 7 years of death must be added (some small gifts are exempt).
Residents: UK residents are taxed on their worldwide income and on capital gains from disposal of their UK assets, and most likely on their overseas properties too.
Roundtrip transaction costs moderate in Britain, can be high on high-end properties
Total roundtrip transaction costs range from 3.90% to 12.16%. Almost all buyers, UK-based or not, employ lawyers as well as real estate agents. Legal fees are around 0.5% to 1% while agent's fees are around 2% to 3.5%, plus 17.5% VAT.
UK law is pro-landlord
Rents: Landlords and tenants can freely agree on rent levels. They can freely agree any mechanism of increasing rent levels. Deposits are lawful.
Tenant Security: Contracts naturally revert to a standard monthly contract which, after an initial six month's period of security of tenure, allows the tenant to be evicted at two months' notice. However in practice the eviction process can disadvantage the landlord.
Uncertainty still looms around Brexit negotiations, undermining UK's economic outlookThe UK showed its resilience amid the Brexit vote, as it ended 2016 with a strong growth of 1.8% from the previous year, based on the figures from the Office for National Statistics (ONS). While last year's economic growth is slower than 2.2% in 2015 and 3.1% in 2014, the recent GDP growth was actually a better outcome than earlier forecasts of a possible recession right after the Brexit vote.
Before the UK referendum in June 2016, the economy was still recovering from the downturn brought by the global financial crisis in 2008. Although the economy showed improved numbers in 2014 and 2015, GDP growth per capita figures are less impressive. In 2016, GDP growth per capita was 1.1%, following per capita GDP growths of 1.4% in 2015, 2.3% in 2014, 1.3% in 2013, 0.7% in 2012, and 0.7% in 2011, according to the International Monetary Fund (IMF).
In general, the UK´s recovery since the recession has been anaemic, at best. In previous recessions, there was above average growth. For instance in 1983 GDP grew by 4.2%, and in 1994 by 3%. Despite that, the UK remains one of the developed nations´ fastest growing economies. Its growth mostly relies on the services sector, according to Office for National Statistics (ONS).
In the first quarter of 2017, GDP decelerated and was up by only 0.2% from the previous quarter, a decline from 0.7% in Q4 2016 and the weakest in the past four quarters. On an annual basis, the economy rose by 2%. The recent slowdown was attributed to the lower consumer spending, which was dampened by slower wage growth and higher inflation. The Bank of England (BoE) expects a 1.9% economic growth in 2017, a slight downgrade from its earlier 2% forecast.
The UK is still shrouded in uncertainty regarding the outcome of the Brexit negotiations and the recent general elections. "Although the UK’s growth prospects over the long-term remain highly uncertain, the risks are shifting to the downside. Increased uncertainty in the aftermath of the General Election and around the Brexit negotiations could result in more muted growth," according to British Chambers of Commerce's (BCC) Head of Economics Suren Thiru.
The BCC, albeit upgrading UK's GDP growth forecast for 2017 from 1.4% to 1.5%, also expect growth to be lower than "historical trend levels". "Higher inflation is likely weigh significantly on the UK’s near-term growth prospects. We expect inflation to rise further over the course of this year as the rising cost of imported raw materials continues to filter through supply chains. Consumer spending, a key driver of UK economic growth, is expected to slow considerably as inflation erodes real wages," said Thiru.
In May 2017, the UK´s overall unemployment rate was 4.5%, down from 4.9% a year earlier, according to the ONS.
UK's annual inflation rate rose by 2.6% y-o-y in June 2017, slightly down from 2.9% in May, but a sharp increase from a 0.5% annual inflation rate in June 2016. The sharp rise in inflation was partly attributed to the higher costs of imported goods due to the pound's depreciation, shortly after the referendum.
The UK held a general election in June 2017, heeding the call for a snap elections by Prime Minister Theresa May last April that was eventually ratified by the House of Commons during the same month. The recent elections, which came three years earlier than the supposed May 2020 elections, was an attempt by Prime Minister May in raising the majority to ensure political stability in the Brexit negotiations. However, the election resulted in a hung parliament as the ruling Conservative Party loses its overall majority, with a net loss of 13 seats.
In contrast, the Labour Party, headed by Jeremy Corbyn, got a net gain of 30 seats. To obtain the support in key votes, the Conservatives made a "confidence and supply deal" with the Northern Ireland's Democratic Unionist Party (DUP), combining the Conservatives' 318 seats and the DUP's 10 seats to reach the 326 seats needed for a majority.
The result of the elections, with Prime Minister May ending up with fewer MPs, is what makes the Brexit negotiations now more uncertain. "One year after their referendum, we still don't know the British position in the negotiations on Brexit and it seems difficult to predict when we will, because democracy often requires time," according to the EU's foreign policy chief Federica Mogherini.