Buyers and sellers in London's luxury residential market are digesting a series of tax changes affecting the investment case for this asset. Property advisor Huntly Hooper explores the evolving landscape and the opportunities it presents.

The market for luxury homes in Central London has seen some significant changes of late and the April date for a further increase in stamp duty for buy-to-let properties and second homes is fast approaching. With the deadline of midnight 31 March 2016 for the tax hike to kick in, there has been a notable rush to buy in the mainstream market. Figures for the higher end of the market, however, tell a different story. In this article, Oliver Hooper, founder and director of Huntly Hooper, discusses the supply and demand dynamics at play. The views expressed are those of the author, but WealthBriefing is pleased to share them and invites readers to respond.

The market for expensive homes in Central London, a favoured asset in the portfolios of the world’s wealthy, has reached a tipping point with falling asking prices and transaction levels that will present attractive investment opportunities this year.

Owners put up the for-sale sign on more than 600 homes in prime Central London, which is concentrated mainly in the boroughs of Westminster and Kensington & Chelsea, in the first month of 2016 with an average asking price of £1,722 ($2,463) per square foot. It was the third consecutive month of declining asking prices for properties newly placed on the market, marking a 4.8 per cent drop from October 2015.

This is encouraging because it shows the newest sellers are becoming realistic on pricing. It will take time, though, to feed through to the rest of the market, since the average asking price still hovers defiantly near to the all-time high reached in December 2015, of £1,816 per square foot. How long it will take for asking values to soften further is much harder to predict. Average annual sales prices slipped 1.2 per cent last year after doubling from 2006 to 2014. 

January’s data highlight the gulf that separates vendors’ expectations and what buyers are actually prepared to pay. Asking prices were on average 18.9 per cent higher than actual sales prices. Historically, a sale mainly occurs within 3 per cent of the asking price and so it is no coincidence that the number of homes sold in prime Central London last month was the lowest since January 2009 – shortly after the collapse of Lehman Brothers and when the global financial crisis was gathering momentum. 

The message from this is clear: sellers need to lower their pricing expectations to reflect the new supply and demand dynamics in the market.

There were almost 3,750 homes for sale at the end of January in the prime Central London market, an inventory that has risen 69 per cent over the past two years. The demand side has also been weakened following three waves of tax increases and changes in the past 15 months as well as the knock-on effects of volatility in global financial markets.

In December 2014, a graduated rate of stamp duty on property purchases was introduced, affecting homes sold for more than £937,000, with higher tax rates of 10 per cent and 12 per cent. This replaced the “single slab” tax, which had a 7 per cent top rate levy on properties bought for more than £2 million. 

Two months after the Conservative Party’s unexpected general election victory in May, Chancellor of the Exchequer George Osborne announced that from 2017 he would phase out relief for higher and additional rate UK income taxpayers on mortgage interest payments for rental properties. He also ended the automatic 10 per cent “wear and tear” allowance that is deductible from rental profits for UK taxpayers, requiring proof of capital expenditure instead. Another blow came with the announcement in November of a 3-percentage point increase in stamp duty for second homes or rental properties, effective in April. The rush to beat the hike may be apparent in the mainstream UK housing market, but I find no evidence of it in January’s data for prime Central London. 

The higher cost of purchasing a residential property in Central London’s most desirable neighbourhoods and Osborne’s other measures have fundamentally altered the investment case for many landlords by making it much harder to make profits. This matters because some areas of Central London – Mayfair, South Kensington, Fitzrovia and Marylebone – are predominantly rental markets. The added complexity and new incentives, such as using corporate structures, establishing portfolios of scale and the treatment of capital expenditure, are a lot to digest and probably explain why transaction activity has slowed. 

As with all investments, the best returns from the prime Central London market stem from buying and selling well: by seizing seasonal patterns or pricing imbalances, such as the one that we have at the moment. The necessary correction in pricing will present investment opportunities, particularly for properties that require renovation or refurbishment. This is also an attractive time for investors with dollars to spend as the sterling weakens on the uncertain outcome of a “Brexit” referendum on the UK’s future within the European Union and as the Bank of England pushes back the timing of any interest rate increase. 

The long-term fundamentals of investing in a prime Central London property remain attractive, which is why it serves as a store of value over time and a safe haven asset in the portfolios of high net worth individuals from across the globe. Oversupply is certainly not an issue in certain neighbourhoods, which are reaching, or are already at, the limit permitted by strict planning rules. In Chelsea, for instance, overall housing stock is contracting, our research shows. This cap on new supply creates high barriers to entry that are supportive for pricing in the long run. Meanwhile, London’s population growth and its multicultural identity underscore why it is one of Europe’s pre-eminent cities and a magnet for global talent; it is reasonable to conclude that demand for homes in the most desirable locations will not diminish any time soon. 

The pricing stand-off between buyers and sellers is unsustainable. That is why this tipping point will open up an opportunity for active long-term investors to find and create tremendous value through selective purchases.