REAL ESTATE PERSPECTIVE OCTOBER 214 Stephen Rees Head of Real Estate Advisory Inside this issue: What s slowing down the London residential market Why tighter Mortgage Market Review regulations haven t reduced private banks appetite to lend Why investors are looking beyond London for higher returns from commercial property How markets are returning to business as usual following the Scottish referendum Why election uncertainty might dampen sales momentum Market insight on Cambridge, Aberdeen and Edinburgh Welcome to the October edition of the Coutts Real Estate Perspective. The last 12 to 18 months have seen rapid price growth in both UK commercial and residential property, especially in central London. The significant improvement in the economy and buoyant housing market caused frenzied media speculation about whether a property bubble was forming. More recently, however, several factors have helped slow growth in London, including the prospect of an interest rate rise, pre-election uncertainties, global geopolitical issues and a tightening of lending regulations. In our previous issue in May we considered the potential for a housing bubble and concluded that while we expected nearterm transaction activity to remain strong, we anticipated it to return to a more normal level of activity thereafter. Many speakers at the property seminar we recently held for clients at our London offices echoed this sentiment. Tightening the regulations over lending is one of the main ways policymakers hope to dampen the fervour in UK house prices. Later in this issue, we discuss the impact of the Mortgage Market Review, a comprehensive evaluation of the mortgage market by the Financial Conduct Authority (FCA), and explain why these latest regulations haven t reduced private banks appetite to lend, albeit the approvals process may take longer. With rising prices rippling out from London, we highlight some regional markets, in particular where Coutts has offices, to see how those markets are reacting. As with commercial property, the recent lack of quality stock at sensible prices in London has forced us to look elsewhere when helping clients looking to buy. Cambridge, for example, has seen a 1.3% increase in prices over the last year (43.1% increase since 29), according to Savills Research. Given we remain cautiously confident about the state of the UK economy, the potential for rental growth in commercial property may present some interesting opportunities, particularly in London. As long as consumers continue to spend, businesses continue to grow and investor confidence remains stable, there will be demand for retail units, office space and rentable commercial property. The relationship between the strength of the economy and rents is an interesting one. Residential rents rose strongly in 212 whereas wages lagged, which contributed to a clear deceleration in rental growth in 213. With signs that wage growth was starting to pick up in 214, rents started strengthening. However, recent data on wage growth has been less strong, which may dampen the sustainability of the improvement. Nevertheless, we expect the improving economy to drive wage growth, affordability and, ultimately, rental growth. In numbers 9.4% UK house price growth in the year to September 214 Source: Nationwide
MORTGAGE MARKET REVIEW The Mortgage Market Review (MMR) a comprehensive evaluation of the mortgage market began in 29 and culminated in new rules in October 212, most of which came into effect on 26 April 214. As such, it should not be seen as a knee-jerk reaction to recent fears of an emergent housing bubble. The MMR reforms aim to ensure continued access to mortgages for the vast majority of customers who can afford them, while preventing the poor practices and over-lending seen in the past. A key outcome of the review is that lenders are now fully responsible for assessing whether customers can afford their loans, and have to verify their customers income. This has a dual impact: more rigorous criteria for lending and a longer approval timeframe to allow the additional required information to be processed. Lenders have also been asked to stress test borrowers ability to afford repayments should UK interest rates rise, which we expect them to do gradually from next year. Most banks private and retail already apply such tests in assessing affordability. The MMR has provided clearer rules around how the appropriate stress test should be calculated. This should mean greater consistency across lenders. In some circumstances, this has meant lower stress-tested rates than before the MMR. In such cases, the new rules increase affordability for clients and inject additional confidence into lenders credit stress models. Kumar Jethwa, a Director in Coutts Private Office, recently commented: Against the backdrop of tightening lending regulations, clients may be surprised to learn that the recent reform of the mortgage market hasn t reduced private banks appetite to lend. While the market in interest-only mortgages has shrunk dramatically in recent years (especially where high street lenders are concerned), the flexibility offered by such borrowing remains very popular with high-net-worth clients. The MMR stipulates that borrowers seeking interest-only mortgages must be able to demonstrate a credible repayment strategy that cannot be based solely on expected property price rises. Many earn high incomes, but not necessarily through a high salary, with less regular sources of income received, for example, from partnership distributions, bonuses, investment income, etc. This demands a more flexible approach to repayment. In addition, many borrowers may have lower incomes that are sufficient to service interest, and plan to repay capital from the future sale of assets such as second homes or buy-to-let properties, etc. Longer term social and market trends will continue to shape how society views home ownership; its finance and regulation will need to support emerging demographics. Andrew Haigh, Head of Client Propositions comments: We can expect to hear a lot more about the need to give access to the property market to younger generations (a public debate that s already started) but also how parents are supported in appropriate living conditions. At the current pace of medical advances a life expectancy of 12 years will no longer be ridiculous in a generation or so. The implications of this include that inter-generational support will become a key element of financial planning. In discussing wealth transfer we already see clients debating what would be a fair level of support for their adult children s housing. Increasingly, the debate also includes what might be a necessary contribution to much longer term support for parents who fall outside the regulated affordability criteria. Mortgage approvals will take longer as a result of the stricter assessments and lengthier advisory process, although Bank of England data shows that the disruptive impact of the MMR on mortgage approvals is already lessening. After rising strongly in June, mortgage approvals for house purchases declined marginally by 516 in July, to 66,569. That still left approvals up around 8% compared to the same period last year, and 7.5% higher than the trough in May that immediately followed the introduction of new MMR rules. At the time of going to press, the figures for August were released. The number of mortgage approvals had dropped again but we believe this is attributable to the seasonal characteristics of the property market which generally slows over the summer and the slow down in the market overall. Most lenders certainly private banks have already been applying the new guidelines without any appreciable impact on lending. For more information on interest-only borrowing or any of our mortgage products please speak to your Private Banker. If you are new to Coutts please speak to the business development team on 2 7753 1365
MARKET INSIGHT CAMBRIDGE The rise in house prices in London commuter towns 213-214 12 13.1% Our last two editions of Real Estate Perspective have commented on the ripple effect of demand and prices spreading from London. Cambridge has witnessed an influx of buyers moving out of the capital, with the market also attracting affluent buyers from around the UK and abroad. The city offers convenient links for London commuters, who can reach London King s Cross in 45 minutes by train with Stansted Airport 3 minutes away by car via the M11 motorway. With its ancient, world-class university and prestigious science park, Cambridge has attracted leading research and development businesses and is home to the research divisions of Microsoft and AstraZeneca. 9 1.3% 9.3% 8.1% All these factors contribute to demand for property in Cambridge, and the appeal of the area means that demand often outweighs supply. According to Rightmove, the UK s largest property portal, the average time to sell a home in Cambridge is just 27 days compared with 41 in London. Buyers need to act quickly if they wish to secure a property, and the sales momentum is also seen in new residential schemes where new-build programmes struggle to reduce the supply deficit. The ripple effect is also evident in other commuter towns and cities, as highlighted in the graph. 6 3 CAMBRIDGE GUILDFORD 4.3% TUNBRIDGE WELLS CHELMSFORD 6.4% WINDSOR OXFORD Source: Savills research COMMERCIAL As the price of London commercial property increases, investor appetite for opportunities in regional metropolitan markets strengthens. Commercial property funds are an alternative way for private investors to gain exposure to the sector. Coutts offers clients access to a number of such funds. Performance of these funds can be seen to the right, plotted against the IPD index. Performance history shows similar trends to the IPD index, but will always lag due to fees, uninvested capital and valuation timing. Better economic prospects over the last two years and higher yields relative to other investments have encouraged investors to move into more cyclical assets classes, such <.8.7.6.5.4.3.2.2.1.1 Sep-9 Property fund performance* Nov-9 UK IPD Legal & General UK Property M&G Property Portfolio Scottish Widows Property Fund Jan-1 Mar-1 May-1 Jul-1 Nov-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 UK IPD Legal & General UK Property M&G Property Portfolio Scottish Widows Property Fund To learn more about our offering in commercial property funds, please speak to Mar-12 May-12 Jul-12 Sep-12 Nov-12 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 My-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 Jul-14 Sep-14 your Wealth Manager or Heidi Jones, Head of UK Fund Selection: heidi.jones@coutts.com. Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Source: Thomson Reuters Datastream *Past performance should not be taken as a guide to future performance
Source: Thomson Reuters Datastream as property. This has proved a challenge in itself for retail property funds, which are forced to remain open-ended due to the nature of their regulated status. As a result, these institutional investors became forced buyers of commercial property, which further drove up prices and squeezed yields. While commercial property prices may seem expensive, capital values remain 3% below their 27 peak. London offices have performed better, but are still 15% below their peak. London s status as a safe haven, competition from buyers (particularly overseas buyers) and real rental growth (i.e. after inflation) have continued to fuel demand and compress yields, with prime Bond Street values now at around 2%. Many investors in the London market are looking at the prospect of rental growth. For example, 26 Albemarle Street in Mayfair, let to luxury Japanese restaurant Sumosan, was marketed this summer at a yield of 1.2%. This is thought to be the lowest ever net initial yield recorded in the Bond Street area, albeit at the time of going to press the property remained on the market. In line with the stable economic outlook, rental values are expected to continue to grow in prime retail and office markets for the next three to five years. The chart below compares the returns available from commercial property, equities and fixed-income securities (bonds). This shows that the average yield of 6% available on UK commercial property appears attractive measured against the 2.5% yield on 1-year gilts (government bonds) and 3.5% yield on UK equities. We are seeing investors considering opportunities in regional cities around the UK, in particular Manchester, Leeds, Edinburgh and Aberdeen. In these cities, our clients are competing against institutional investors, particularly insurance companies and pension funds, all of which are chasing higher yields than are available in London. 1 9 8 7 6 5 4 3 2 1 Yields - commercial, gilts and equities IPD UK property rental yields UK 1-year benchmark gilt redemption yield FTSE 1 dividend yield Name 31/12/1996 3/6/1999 31/12/21 3/6/24 29/12/26 3/6/29 3/12/211 3/6/214 31/12/1996 3/6/1999 31/12/21 3/6/24 29/12/26 3/6/29 3/12/211 IPD UK property rental yields UK 1-year benchmark gilt redemption yield FTSE 1 dividend yield 3/6/214 MARKET INSIGHT ABERDEEN AND EDINBURGH The commercial real estate sector in Scotland has many opportunities to exploit. Although activity has slowed in recent months as vendors held back on sales pending the result of the Scottish independence referendum, we expect to see more opportunities coming to the market over the coming weeks. The economic uncertainty, in particular around currency risk, has lifted and markets are returning to business as usual. Aberdeen s dominant oil and gas industry underpins a thriving local economy. Knight Frank expects prime headline rents for Aberdeen office space to reach a new high of 33 per sq ft by the end of 214. Aberdeen is unique within the UK s main office markets in terms of its incentive packages, which are generally extremely limited. In some cases, prime space carries zero rent free packages, which is good news for investors. The economic uncertainty, in particular around currency risk, has lifted Edinburgh, Scotland s elegant capital, is a city where we have found many interesting opportunities for clients. As a cultural, political and educational hub, Edinburgh is a bustling centre of tourism and commerce, and its Old and New Towns are UNESCO World Heritage Sites. Knight Frank reported that it expects prime headline rents in Edinburgh to increase to 29 per sq ft by year end. We believe this may increase further over the next year or so especially with the affects of devolution max and the resulting increase in demand for government office space. London continues to present interesting opportunities. A high level of ongoing development will transform London s boroughs and communities as well as its skyline. This is already taking hold around Battersea Power Station and the development around Nine Elms in the west of the city. Chinese developer ABP and development manager Stanhope have secured planning permission for their 1bn, 4.7m sq ft scheme at Royal Albert Dock in the east of the city. Earlier this year, New London Architecture (NLA), an independent organisation, conducted a study of local authorities and found that over 23 new tall buildings (more than 2 stories) are currently proposed, approved or under construction in the capital. Although London embraces its architectural past very well, London s landscape is set to evolve rapidly over the next decade.
TAX INSIGHT Dominic O Connell Head of Tax, Trust & Estate Planning With the Scottish referendum behind us and the party conference season coming to an end, some might have hoped for greater clarity over how UK taxation policy might evolve in the coming months and years. Unfortunately, this was never likely to happen. Regardless of the referendum result, Scotland was always going to be granted some powers over taxation, and, with a general election next year, there remains significant uncertainty over the trajectory of UK taxation, particularly for individuals. Party manifestos could be interesting when published next year but of greatest importance of course is which party will actually form a government after 7 May. Adam Smith s principles of good taxation over 2 years ago stressed concepts such as certainty and simplicity. Acknowledging that having much certainty is necessarily difficult at present, one hope from a perspective is that there is a genuine drive for simplicity in the tax system, including in relation to property taxes. Although the current complexity is partly a result of the tax system having sometimes been viewed as a political football, the tax profession needs to shoulder some of the blame. Some aggressive avoidance schemes have necessitated ever more voluminous and complex counter legislation, which has created what has been described as mutually assured complexity. I also hope that in the run-up to the election, consultations aimed at making better legislation will not be sacrificed for political expediency. Looking specifically at UK property, taxation uncertainty may dampen sales momentum over the next few months as homeowners and investors go into wait and see mode. For instance, the more mooted annual mansion tax on highvalue properties could impact some investment decisions and the property market more generally. Conversely, the proposed capital gains tax charge for non-residents may result in more high-end central London residences coming onto the market as some overseas investors try to sell before April 215. Regardless of any specific implementation complexities, some experts believe that in certain respects UK property is still a relatively untapped source of taxation revenue. Perhaps the only certainty is that more tax will be levied on property in one guise or other over the coming years. SAVE THE DATE 7 May 215 UK General Election If you require further advice regarding the residential and commercial real estate services we offer, please contact: Stephen Rees: stephen.rees@coutts.com Katherine O Shea: katherine.o shea@coutts.com If you would like to know more about our Tax, Trust & Estate Planning Services please contact your Private Banker or Wealth Manager.
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