LCPq: London Central Portfolio Quarterly ReviewPrime Central London (PCL) Market Outlook

London Central Portfolio (LCP) specialises in Prime Central London (PCL) residential investment with a specific focus on the Private Rented Sector (PRS). This report has been compiled following the release of HM Land Registry Quarterly Statistics on September 19th. PCL is defined as the Royal Borough of Kensington & Chelsea and the City of Westminster.

An Increasingly Fragmented Property Market

The UK’s property market is becoming increasingly fragmented as it is variously impacted by the many headwinds it is encountering. This has resulted in different growth dynamics driving the core sectors which we have defined as PCL’s mainstream Private Rented Sector (PRS), PCL’s luxury property market, Greater London’s new build sector and the domestic market, outside PCL.

An analysis of just released Land Registry data for Q2 2016, the most comprehensive data set available, shows a roller coaster year to date. Vividly demonstrating the distorting effect of changes in tax legislation, sales volumes have fallen dramatically in all sectors in Q2, following a rush of activity during the previous quarter, as buyers sought to be beat April’s 3% Additional Rate Stamp Duty deadline.

PCL’s discretionary luxury property market has been particularly hard hit in Q2, resulting in a painful quarter for the ‘Houses’ sector, where average prices have fallen 21%. Price growth, however, in Q2 has been strong in PCL’s PRS: a consequence of it being less impacted by the majority of the new residential property taxes introduced over the last 4 years, as well as traditionally being a consistent performer.

Meanwhile, Greater London’s new build sector saw a 43% reduction in sales compared with last year as international interest for these units, often selling at a 25% premium over older stock, begins to wane.

For the rest of the domestic market, encompassing most of Greater London and England and Wales, Q2 has seen large falls in price and sale volumes. Whilst uncertainty pre-Brexit resulted in a ‘wait and see’ attitude, harsher salary caps on mortgage lending may have also begun to impede buyers.

Due to the lag in Land Registry reporting, the data for Q3 is not available. However, empirical information indicates that the roller coaster has continued. The devaluation of sterling has encouraged more proactive investors to enter the market and buy opportunistically, particularly in the new build sector, albeit seeking heavily discounted prices.

PCL’s Mainstream PRS

PCL’s Luxury

Property Market

GreaterLondon’sNew Build Sector

TheDomestic

Market(Outside PCL)

Source: HM Land Registry Quarterly Standard Reports

PCL Flats

Quarterly Sales Volumes

% Quarterly Change

Q2 2016 Average Price

% Quarterly Change

England & Wales

Greater London

£1,319,654 £558,082 £268,713

6.6% -7% -4.5%

436 15,412

-44.5% -30%-66%

PCL Houses

£3,437,497

-20.9%

62

-70.1%

155,895

Volatile performance of other investment classes:

Over the last 16 years, PCL’s PRS has significantly outperformed the major financial markets. During this period, the sector has almost quadrupled in value whilst the FTSE 100 has seen just a 10% increase. Although the FTSE 100 has seen a positive run since the low of February 2016, the general economic outlook is at best uncertain, encouraging a retrenchment into blue-chip tangible assets.

PUSH FACTORS: Weak Sterling & Low Interest Rates:

PCL’s PRS is expected to respond, post-Brexit, in a broadly similar way as it did during the Global Financial Crisis. After a year of very constrained activity in 2009, investors aggressively re-entered the market which subsequently outperformed almost all other asset classes. This rally was underpinned by the weakness of sterling and rock bottom interest rates. The current disconnect between vendor and buyer price expectations is creating a similar hiatus in the short term. However, prices are likely to harden when buyers come back to the table.

PULL FACTORS: Go-To Destination:

The attractions of PCL as a centre of culture, finance & education with absolute rule of law & unequivocal title to property remains compelling. The PRS is increasingly important with 50% of properties now rented to global tenants.

Limited Supply and Global Demand:

Home to some of the world’s most exclusive real estate, PCL property remains highly demanded. However, limited stock means that only just over 2,500 sales took place under £1m over the last year. Demand, therefore, significantly outweighs supply, driving continued price growth

1,319,654Average Price

6.6%

Flats & Maisonettes quarterly Price Growth

Q2 2016

Sales Volumes

436

66%

Flats & Maisonettes quarterly transactions

Q2 2016

Source: HM Land Registry Quarterly Standard Reports

Representing 88% of PCL sales in Q2, the mainstream ‘Flats and Maisonettes’ sector, where average prices stand at £1.32m, has shown positive growth despite pre-EU referendum pressures and changes in tax legislation. In Q2, prices increased a robust 6.6% over the previous quarter.

This market predominantly comprises one and two bedroom flats making up PCL’s Private Rented Sector, where pricing traditionally shows a far more consistent performance than the discretionary upper end of the market. This is a function of the fact that, as an entry-price market, it is generally more accessible and being primarily a rental market, there is a commercial yield-based means of valuation. The price point is also close enough to the ‘domestic’ Greater London market not to get captured by the onerous taxes specifically targeted at the higher end of the market.

Next quarter (Q3), the market may see little price movement, however, as there is a disconnect between vendors who are not distressed seeking increased prices and buyers who are seeking bargains. As a result, transactions levels may not increase significantly despite the devaluation of sterling post-Brexit, which has increased overseas appetite.

PCL’s Mainstream Private Rented Sector(PRS)

The Factors for Continued Investment into PCL’s PRS

0

50

100

150

200

250

300

350

400

450

FTSE  100 S&P  500 ESTX50 NIKKEI  225SSE  (China) Hang  Seng STI  (Singapore) PCL

Source: HM Land Registry Quarterly Standard Reports, yahoo

Prime Central London vsGlobal Financial Indices

January 2000 - date

As LCP predicted, a discernible price correction has taken place for PCL’s luxury ‘Houses’ sector, following an influx of discretionary capital in Q1 as buyers sought to beat the 3% Additional Rate Stamp Duty deadline. Average prices for houses fell 20.9% and only 62 sales were registered, representing a 70% fall over Q1 2016.

Unlike PCL’s ‘Flats and Maisonettes’ sector, the high end ‘Houses’ sector, where the average price now stands at £3.4m, has been hit hard by the introduction of new taxes. It has seen three rises in Stamp Duty between 2012 and 2016, a rise for some purchases from 5% to 15%. In addition, the introduction of the Annual Tax for Enveloped Dwellings in 2013 has particularly impacted top-end property.

A further price correction was inevitable and is reflected in the anecdotal evidence of severe price discounting. New units are likely to be particularly affected, as these tend to be at the higher price points where development costs can be justified and where vendors often need to dispose of their assets quickly.

In addition, historically, the high value ‘Houses’ sector witnesses far more volatility than the lower value ‘Flats and Maisonettes’ sector in periods of economic and political turmoil. While the long term outlook remains compelling as a global destination with limited stock, this market is likely to experience continued instability especially in the face of the forthcoming non-dom inheritance tax (more detail below). It may take some years to correct, with prices rebasing themselves before growth returns.

There may well be similarities to the period from 2000 - 2005. Over that time, the top end sector was affected by a variety of external factors: the aftermath of the dot com bubble, the threat of a US recession, a weak stock market and political events such as 9/11 and the onset of the Iraq war. It took 5 years for prices to recover. In comparison, the Flats and Maisonettes market saw price growth of 41.5%. In the three years to Q2 2016, the houses sector has seen just 3.6% growth compared with 18.4% for Flats and Maisonettes.

PCL’s Luxury Property Market

Published proposals from the UK Treasury have confirmed that from April 2017, the scope of existing Inheritance Tax (IHT) legislation will be widened to look through offshore structures and capture underlying UK residential property assets. Typically charged at 40% of one’s estate (before allowances and exemptions), the measure will apply to UK residential property of any value, irrespective of whether a property is rented or retained for own use. This will apply to any chargeable event taking place after 5th April 2017 with no grandfathering for existing structures.

For investors targeting the mainstream PRS, where the average value of units is often less than £1m, they will remain broadly unaffected by the new measures. The use of offshore structures which come with high establishment and running costs has increasingly not been considered as an option and other steps have been taken to maximise tax efficiency, such as the prudent use of leverage. However, for those already holding higher value property in corporate structures, this will be another tax burden and will require careful consideration.

Residential property funds, such as those advised by LCP which provide genuine diversity of ownership, offer an alternative and tax efficient solution to holding UK residential directly. As with the recent introduction of non-resident CGT, where an exclusion has been made for diversely held vehicles, there will be a similar exemption from the new IHT rules. For LCP’s full report on the new IHT measures, click here.

New iht for non-doms holding uk resi

3,437,497Average Price

Housesquarterly Price Growth

Q2 2016

Sales Volumes

62

70%

Housesquarterly transactions

Q2 2016

21%

Price Growth in PCL ‘Flats’ versus ‘Houses’

5 Year Price Growth

PCL Flats

PCL Houses

Total % Growth

Q4 2000 - Q4 2005

100

100

141.5

100.2

41.5%

0.2%

Q2 2013 - Q2 2016

100

100

118.4

103.5

Total % Growth

18.4%

3.6%

3 Year Price Growth

Source: HM Land Registry Quarterly Standard Reports

Prime Central London vsGlobal Financial Indices

January 2000 - date

5

Properties within new developments typically sell at a significant premium, averaging 25%, over older stock. History demonstrates that a saturation of over-priced, over-supplied commodity-style property leads to softening prices, particularly during times of economic uncertainty. In Tower Hamlets, for example, which undertook an extensive building program before the Global Financial Crisis, prices took six years to reach parity with their pre-recession level. In contrast, in PCL, where there is very limited new build due to the conservation of its architectural heritage and lack of land availability for development, prices had returned to par by 2010.

The issues being confronted by the Battersea-Nine Elms development are, therefore, not new but the media interest coupled with the extent of the new stock pipeline has led to greater public awareness. Together with the increased tax burden on buyers, this is leading to the significant price discounting being reported. New research has shown that the appeal of new properties in the current pipeline is beginning to wane. In the first six months of 2016, only 1,491 new units were sold, a substantial 43% decrease on the same period in 2015. Developers are responding by pulling back, with new build ‘starts’ down 65% in Q2 2016 vs Q4 2015 and the number of new units applied for down 48% on Q1 2016, according to JLL.

The Inner London* market, outside the central core of PCL, is particularly impacted by the proliferation of high value new build schemes. New analysis has shown that this is causing a deepening new build crisis.

According to new research from LOREMA, the number of new developments in Inner London approved for construction surged in 2015, with a substantial 20% increase in the planning pipeline since 2013, representing 106,208 new units. This is largely made up of projects in the ‘mega cluster’ areas around Tower Hamlets and Battersea-Nine Elms where 33,239 and 18,665 units respectively were scheduled to be built. Applications for 17,494 new units including 111 towers (buildings over 20 storeys) were also submitted, a 27% increase on 2013. However, this level of activity now appears unsustainable.

Inner London’s* planning pipeline rose 20% since 2013 with 106,208 new units approved for development

New applications increased 27% with 17,494 submitted, including 111 high rise towers

These are centred around tower hamlets & battersea-nine elms with 33,239 & 18,665 new units planned respectively

New build sales are also significantly down, decreasing 43% on the same 6 month period last year

Greater London’s New Build Sector

The Growing Crisis

Source: Estates Gazette: LOREMA, Land Registry Price Paid Data*Inner London comprises Camden, The City, Hackney, Hammersmith and Fulham, Islington, Lambeth, Southwark, Tower Hamlets and Wandsworth

5

PCL is a global asset class whose performance is more aligned to international factors than to the domestic factors which impact the market in England and Wales.

It also demonstrates different dynamics from the rest of Greater London and indeed from the other nine boroughs that make up Inner London. Greater London is essentially a domestic market where about 8 million people live, representing 12.5% of the UK’s population.

In this quarter, despite record low mortgage rates, reductions in basic rate Stamp Duty and Government schemes to augment first time buyer numbers, England and Wales has suffered once again, registering the lowest number of sales since Land Registry records began in 1996. Only 155,895 sales took place in Q2, a 30% decrease over Q1 and down from a pre-credit crunch average of 246,876. Average prices in England and Wales also fell 4.5% over Q1 to £268,713.

Whilst overall there has been a recovery since 2007, this has been slow, amounting to 17%, equivalent to an annual increase of 1.77%. In real terms, this represents a fall of almost 9% in prices over the period.

The surge in prices experienced in Greater London over the last few years has also stuttered in Q2. Average prices fell 7% over Q1 to £558,082, alongside a 44.5% decrease in sales.

Following a very strong rally since 2014, Greater London prices may well be reaching a ceiling of affordability, exacerbated by the 2014 Mortgage Market Review, leading to a slowing of growth. This is likely to be magnified by the new additional 3% Stamp Duty and Inner London’s brewing new build crisis which has seen a 43% fall in sales compared with last year, according to Land Registry.

UK wide, with harsher salary caps on mortgage lending impeding buyers and potentially difficult times ahead for the economy affecting sentiment, significant growth in the areas outside PCL is unlikely as buyers come to terms with the ‘new normal’.

% Price Growth Q2 2016 - Q3 2007 (Pre-GFC)PCL vs Greater London

and England & Wales

The Domestic Market, Outside PCL

Stock levels have increased dramatically over the last 3 months as many landlords opt to rent their properties rather than sell them in the current market. The number of properties to let has increased nearly 3 times, from 8,834 in the previous 3 months to 24,761, according to industry website Lonres. This increased level of competition has meant that tenants are increasingly attracted to good value newly refurbished properties as they continue to seek a complete ‘lifestyle’ experience from the moment they walk in the door. This has meant that weekly rents for small refurbished flats have performed best this quarter with new lets achieving a 3.6% uplift over anticipated rents.

One bedroom properties continue to put in the strongest performance with weekly rents now averaging £460 - up 5.3% over expected returns. 2 bedroom properties, however, are becoming more popular again as they now show particularly good value. Weekly rents now average £700 - up 1.5%.

However, with the current high levels of supply, rents for re-lets of older properties have remained largely static this quarter. This has been compensated by continued positive renewal increases from tenants in-situ with average rental growth of 3.1%. Landlords, therefore, should look to retain existing tenants if possible rather than remarketing in the hope of achieving higher rents. They may also need to be open to carrying out remedial and upgrade works between tenancies to remain competitive at re-let stage.

PCL Quarterly Change in Rents

New Lets

3.6%

Source: LCP In-House Research

Renewals3.1%

- 0.7%Re-Lets

PCL’s Rental Market

0%

10%

20%

30%

40%

50%

60%

70%

80%

England  and  Wales Greater  London Prime  Central  London

17%

48%

75%

Source: HM Land Registry Quarterly Standard Reports

Long recognising the importance of Prime Central London residential (PCL) as an alternative asset class, LCP was established in 1990 to offer an integrated service

exclusively representing the interests of investors looking to maximise their returns.

LCP focuses on the “bullseye” around Hyde Park, where scarcity of stock coupled with international demand underpins long term price growth. It is the only company to specifically target the increasingly important mainstream Private Rented Sector (PRS), offering all the relevant market expertise and property services in-house to provide a one-stop solution.

LCP accesses whole-of-market for the best opportunities and uses proprietary financial modelling to evaluate each investment. It manages the development & design of the assets and provides a letting and management service, optimising capital & rental returns. It acts for private clients to individual mandate.

LCP has also advised on a series of successful closed-end property investment companies, targeting the Private Rented Sector in PCL. LCP is the first company to have advised on Shariah compliant structures targeting this market in the UK.

LCP has advised clients on USD 1bn of investment in PCL. Since 2000, LCP’s clients have seen the value of their investments exceed average market growth by over 31.5%1

on divestment.

1Market growth refers to the performance of the Flats and Maisonettes sector as measured by HM Land Registry from January 2000 to March 2016. The measure is Gross Capital Return before transaction costs & SDLT: LCP In-House Research. It includes any uplift in value following refurbishment. Past performance is not a guide to the future. The value of any direct or indirect investment in property may fall as well as rise. Approved as a financial promotion by F2 Capital Ventures LLP (authorised and regulated by the Financial Conduct Authority). All statistics have been collated with care but no warranty is given as to their accuracy. The figures contained within this document should not be relied upon.

www.londoncentralportfolio.com+44 (0) 207 723 1733

Naomi Heaton Chief Executivenaomi@londoncentralportfolio.com

Hugh BestInvestment Directorhugh@londoncentralportfolio.com

Rick DentonDirector (LCP Corp)rick@londoncentralportfolio.com

Lauren KempPR & Market Researchlauren@londoncentralportfolio.com

Robert GuestDirectorrobert@londoncentralportfolio.com

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