Updated: Feb 20, 2020
(LUDGROVE DECEMBER 2019 YEAR END NEWSLETTER)
Jim Morrison aka "Mr Mojo Risin"
Dear Clients and Friends
Over the last 5 years the Prime London property market has endured a battering. Multiple tax changes, a seemingly perennial threat of a hard-left Government, political uncertainty in the face of three General Elections as well as the possibility of the UK exiting the EU without a transition agreement have all taken its toll.
With a vastly improved political backdrop, the threat of a hard-left Government removed and Britain's transition out of the EU settled, we expect 2020 will be the year the Prime London property finally regains its mojo.
Strong pent-up demand, limited stock availability and the backdrop of a record 5 year-long property bear market is likely to provide upward momentum and we forecast Prime London prices and volumes to grow around +10% and +20% respectively in 2020. Although our views are an outlier we have high conviction and outline the key reasons for our optimism below:
1. Adjusting for inflation, Prime Central London (PCL) prices have fallen -28% from peak to trough. Historically very similar real-terms declines have been recorded at the point of previous troughs in the market:
2 .In the last 5 years we have witnessed the longest Prime London Bear Market on record. If history is any guide then a bounce is overdue:
3. PCL rental yields are trading near the high of their 10 year range and this compares favourably with rental yields in England and Wales, the MSCI World Equities Dividend Yield and UK Government Bonds that are all trading at or near 10 year lows. PCL therefore offers relatively good value compared to other assets:
4. Commonly used as an indicator by professional real estate investors, the spread between the average PCL rental yield and risk-free UK Bonds (Gilts) is showing extreme value trading at a 19 year high. Separately, Ludgrove analysis has also shown that historically when the spread between PCL rents and Gilts has been positive, the average PCL capital return has been +8% p/a:
5. PCL property is cheap relative to the mainstream London market, trading near the low of its 10 year trading range:
6. Rental values are rising as supply diminishes in response to Government changes to Stamp Duty and Buy to Let tax policies. We also expect rents to harden further in 2020 as the full impact of BTL taxes take effect.
7: Future housing supply in Zone 1 is set to decline significantly. Construction starts in H1 2019 declined -66% compared to H1 2015. (Source: Molior). This is likely to underpin prices in the next real estate cycle.
8. There are extreme levels of pent-up demand and a limited availability of stock. Indeed according to Knight Frank, the combined budget of Buyers on their books has risen +15% over the last 12 months to £55bn, representing the largest combined budget in 10 years. In comparison the supply of new listings has declined around -22% in Prime Central and Prime Outer London. Ordinarily we would expect this to foreshadow a material uptick in values:
Knight Frank PCL & POL New Listings vs Total Potential Spend/Budget
Source: Knight Frank Research
Note: PCL (Prime Central London) & POL (Prime Outer London).
9. Despite the recent rally following the General Election, Sterling still trades near a 40 year low against the Dollar making UK assets attractive to Overseas Buyers. Of course, we are not suggesting Sterling will return to the top of its long-term range, but a return to Purchasing Power Parity (PPP) around 1.43 and possibly towards 1.50 over the next 18 months is within reason. It is also worth remembering that it is not just US Buyers who are well placed to benefit from Sterling weakness but also the large number of Dollar-pegged regions that favour London property such as Hong Kong, Malaysia, Singapore, Qatar, Bahrain, The UAE and Saudi Arabia:
10: Finance is cheap with mortgage costs having fallen 39% since the peak of the market:
11. Stamp Duty remains a millstone but with the Prime Minister, Deputy Prime Minister and Chancellor all having spoken about cutting Stamp Duty in their leadership campaigns, we think there is a reasonable chance Stamp Duty may be reduced for Domestic Buyers in the March Budget. It should also be remembered that Boris Johnson has previously described the current Stamp Duty rates as "absurd" and in the 2016 Referendum campaign he spoke about the benefit of an independent UK having the ability to set separate Stamp Duty rates for Domestic and Overseas Buyers - something that is illegal under EU tax law.
There are also sound economic reasons for a cut. Ludgrove research has shown a -36% across the board reduction in Stamp Duty would create an additional £1.4 bn in tax revenue and £8.36 bn in business revenue as a result of higher property transactions and property-related business activity. Taken together this represents a £9.8bn tax and growth opportunity for the Economy.
Furthermore our analysis shows that for each 1% tax cut there would be a 20% increase in property transactions. By way of an example a £2m property buyer currently pays 7.7% Stamp Duty and reducing the tax rate by -36% (to 4.9%) would increase transactions in this price bracket by +55%.
12. With a pro-capitalist, Conservative party restored to Government and enjoying an 80 seat majority, the political environment has vastly improved for high value property owners. Indeed, ordinarily parties with such a large majority tend to serve at least two terms in office so if history is any guide the possibility of a hard-left Government is unlikely in the next 10 years. Furthermore, it is almost inconceivable that the Government will not update the woefully out-of-date constitutional boundaries. Indeed as Electoral Calculus has shown, the Conservatives would have a 104 seat majority under the proposed new boundaries. Again if history is any guide, this suggest a hard-left Government is unlikely in the next 10 years:
A 104 Seat Majority for the Conservatives Under the New Boundaries
Source: Electoral Calculus
Note: the proposed reduction in total seats from 650 to 600 would give the Conservatives 59% of total seats (vs 56% in the 2019 General Election) and a 104 seat majority over Opposition Parties.
The last 5 years has seen an almost perfect storm of negative news flow affecting Prime London property and it is very difficult to imagine how things could get much worse. For instance, picture for a moment a recession. This would in all likelihood lead to a significant reduction in Stamp Duty, a 0.75% cut in interest rates and a relaxation of certain mortgage lending standards (such as mortgage interest coverage ratios). Similar action was taken during the Global Financial Crisis and this led to a significant recovery in the Prime London market.
Moreover, having studied Bear Markets and market bottoms as a former Fund Manager they are without fail characterised by extreme negative sentiment, despondency and despair with the recovery in price typically being a function of an amelioration of negative news flow and fundamentals. Indeed, it was the great investor Sir John Templeton who put it so eloquently:
"Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria".
And it is in this context we are confident we will look back on the dark days of 2014-2019 as a time when a bull market was "born in pessimism".
We wish you all a happy, healthy and prosperous 2020.
Ludgrove Property Ltd
Tel: +44 (0)207 889 2860
Biography: Fraser Slater is the CEO and Founder of Ludgrove Property. Prior to Ludgrove Fraser spent 20 years in The City. In the course of his career he was a Real Estate Analyst, the Fund Manager of a £6bn Equity portfolio for USS Ltd and the Founder and CEO of WDB Capital, a London based Fund Management business. In 2008 WDB Capital outperformed its peer group by +52% making Fraser's portfolio one of Europe's best performing Funds during the Financial Crisis. In the same year his Fund was nominated New Fund of the Year by EuroHedge. After leaving The City, Fraser started Ludgrove with an ambition to be Prime London's leading Property Buying agency with an emphasis on original research and delivering a highly value-added service to clients.
Disclaimer: Ludgrove Property Limited is not authorised or regulated by the Financial Conduct Authority (FCA) and we do not provide any financial or investment advice. We recommend that any property investor seeks appropriate professional advice before entering into any contract, and we would also advise that the value of any investment can go down as well as up and that you might not get back what you put in. You may have difficulty selling a property investment at a reasonable price and in some circumstances it might be difficult to sell at any price. We would urge you not to invest unless you have carefully thought about whether you can afford it and whether it is right for you, and if necessary to consult with a professional advisor in accordance with the Financial Services and Markets Act 2000. All information is provided strictly as a guide only, is subject to change without prior notice and does not constitute an offer of investment. The Ludgrove website should not be regarded as an offer or solicitation to conduct investment business, as defined by the Financial Services and Markets Act 2000. Investors who are resident in or citizens of countries other than the United Kingdom may be subject to local restrictions. In particular, no offer or invitation is made to any US persons (being residents of the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof), who are excluded from the services offered in this site. The information on this website and our publications has been obtained from sources which we believe to be reliable and accurate, but without further investigation this cannot be warranted.