Dramatic surge in UK's housing market caused by stamp duty increase - but central London may be at tipping point
The average house price in the UK rose by 5.3% (5% inflation-adjusted) to £198,564 (US$ 286,806) during the year to Q1 2016, according to Nationwide. This followed y-o-y price increases of 4.26% and 3.67% in Q4 and Q3 2015, respectively.
The highest price rises took place in the Outer Metropolitan Area around London, with house prices increasing by 11.9% y-o-y in Q1 2016, followed by London (11.2%), Outer South East (8%), South West (5.5%), and East Anglia (5.4%).
The North West barely increased at 0.2%, while both North (-1.4%) and Scotland (-0.5%) experienced annual price declines.
"There has been a pickup in housing market activity in recent months, with the number of housing transactions and mortgage approvals rising strongly," said Nationwide's Chief Economist Robert Gardner. "This is likely to have been driven, at least in part, by upcoming changes to stamp duty on second homes, where buyers have brought forward purchases in order to avoid the additional tax liabilities."
"The pace of house price growth may moderate again once the stamp duty changes take effect in April."
Dangers ahead for the UK property market
The 3% increase in stamp duty came into effect in April 2016. This applies to all Buy-to-Let purchases, and is on top of already-high existing Stamp Duty rates. It means that a landlord considering spending £1,000,000 for a normal-sized house to convert it into 5 flats now has to pay Stamp Duty of £73,750, or 7.4% of the purchase price, in addition to other transaction costs.
A further hit to the London property market may result from anti-money laundering steps likely to be taken against foreign property owners in the wake of the Panama Papers revelations, which highlighted the role of the London property market as a destination for dirty money. These steps are a worry for the market, as large swathes of top-end central London property are now owned by foreign investors buying through companies, many of whose owners will not be happy to be under scrutiny.
Finally a large-scale extension of the right-to-buy at highly discounted prices is planned for 1.5 million Housing Association tenants. This is likely to have a significant impact on the lower end of the housing market.
House prices are already declining in some central parts of the capital, and the trend is expected to continue over the next three months, according to the RICS's UK Residential Market Survey report in March 2016.
Despite that, price expectations for the next twelve months remained positive in the RICS survey, and strong price growth is also predicted across all other parts of the UK in 2016.
Despite very high price to income ratios in London and cities in the South East and South West, UK house prices are boosted 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. Dwelling starts rose 3.8% y-o-y to 166,900 units in 2015. Dwelling completions increased 10.2% y-o-y to 152,440 units, according to UK’s Development for Communities and Local Government.
To relieve pressure on the housing stock, earlier this year (January 2016), Prime Minister David Cameron announced the government's intention to remove around 100 most run-down housing estates in the country and replace them with high quality homes.
The government also stated that it will commission thousands of new affordable homes in 2016. Out of the 13,000 homes included in the first wave, 40% will be 'starter' homes, and will be located in four sites outside London. Also, a £1.2 billion (US$ 1.73 billion) starter home fund has been activated, which will be used for the preparation of brownfield sites for new homes. This aims the creation of 30,000 starter homes and around 30,000 market homes by 2020.
There are no restrictions on foreign ownership of properties in the UK.
Analysis of United Kingdom Residential Property Market »
Prices per square metre (sq.m.) of apartments in Prime Central London (PCL) range from GBP 16,800 to GBP 25,000, with bigger apartments tending to cost more.
A 120-sq.m. apartment costs on average GBP 2,500,000
A 250-sq.m. apartment in Prime Central London costs around GBP 6,200,000.
Monthly rents per sq. m. range from around GBP 51 to GBP 64. This means that a 120-sq.m. apartment lets for around GBP 6,600 per month, while a 250-sq.m. apartment rents out for around GBP 16,000 per month. As a reminder, these are not typical London rents - this is Prime Central London.
Average square metre prices in the other luxurious areas of London range from around GBP 14,700 to GBP 19,000. A 120-sq.m. apartment here costs on average, GBP 18,800 per sq. m. or about GBP 2,250,000 to buy. Monthly rents per sq. m. range from around GBP 41 to GBP 44. Even so, a 120-sq.m. apartment in these areas can typical rent for around GBP 5,000 per month.
In Prime Central London, rental yields range 3.08% to 3.65%, whereas in the other luxurious areas of London, rental yields range from 2.72% to 3.20%.
However these figures may be somewhat misleading. because of London's size and its position as a global centre, its flavour-of-the-month quality with Russian, Middle Eastern and Chinese buyers, neither of these two central London zones that we cover are truly representative.
If you look the sources of the data in our table, you will see that some of these 'other luxurious areas' are very luxurious indeed. South Kensington for example is placed here.
A possibly more realistic impression is given by the figures from Association of Registered Letting Agents (ARLA), which suggest that gross rental yields in Prime Central London are 4.37%. Arla's estimated yields in the rest of London are 4.74%. These estimates are taken from a database of active buy-to-let landlords, and are likely to represent a good assessment of the real situation.
Foreign residential property investors in Britain face a rising rumble of dicontent 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 will soon be 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.
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 (€439,982) 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.
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.
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).
During the first quarter of 2016, GDP rose by 2.1% y-o-y, and by 0.4% from the previous quarter. The IMF expects the UK's economy to slow to 1.9% growth during the full year 2016.
"Uncertainty over ‘Brexit’, weak overseas growth and financial market volatility are all creating an unsettling business environment and point to downside risks to the economy in 2016," according to data company Markit's chief economist Chris Williamson.
"It definitely increases uncertainty," said Ricardo Reis of London School of Economics. "There are few other political events that would have such a direct and immediate effect on the economy, and especially on international capital and trade flows. I would further expect that investment of firms based in the UK with significant international relations is delayed until the outcome of the referendum is clear."
In February 2016, the UK's overall unemployment rate was 5.1%, down from 5.6% a year earlier, according to the ONS.
The country's annual inflation rose by 0.5% y-o-y in March 2016, up from 0.3% in February. Although still relatively low in the historical context, inflation was observed to have been gradually rising since October 2015, according to the ONS.
After the UK's local election on May 5, 2016, London named Sadiq Khan, an actively affiliated Muslim, as the city's newest mayor. Khan, a member of the Labour Party, succeeded Conservative Party Mayor Boris Johnson.