LUDGROVE NEWSLETTER (SEPTEMBER 2019)
In the second half of 2019 Ludgrove has seen a +55% increase in demand from Investors looking to bulk-purchase residential apartments in Central London. In this note we take a look at some of the key factors driving Investor demand.
The Market is Good Value
Our December 2018 Newsletter outlined 10 reasons why we anticipated Q1 2019 would mark the low-point of the Prime London real estate cycle and whilst it is too early to say the market has definitely bottomed, it is noteworthy the Prime London market rose +3.1% in the first half of 2019; its first positive start to a calendar year in 5 years (Source: LonRes).
Below we briefly update our thoughts on why the market is good value and why it is likely the bottom has been reached - a view shared by a number of Investors:
i) Adjusting for inflation, Prime Central London (PCL) prices have fallen -28% from peak. Historically very similar real-terms declines were recorded at the point of previous troughs in the market:
ii) Sterling is trading near a 40 year low against the Dollar. When combined with the -28% real-terms price decline (above), US Buyer can now acquire PCL property c55% below the 2014 peak. In comparison to previous cycles, this is the largest real-terms price decline for a USD Buyer on record. Furthermore, it is not just US Buyers who are well placed to benefit but also the large number of Dollar-pegged regions that favour London property (eg Hong Kong, Malaysia, Singapore, Qatar, Bahrain, The UAE and Saudi Arabia).
iii) The duration of this downturn is excessive and has far surpassed previous Prime London Bear Markets. A bounce is therefore long overdue:
iv) PCL rental yields are trading near the high of their 10 year range and this compares favourably with other assets such MSCI World Equities, UK Government Bonds and rental property in England and Wales which are all trading at or near 10 year lows. PCL therefore offers relatively good value:
v) Many Investors assess rental yields relative to risk-free UK Bonds (Gilts) and on this basis, PCL is offering good value with the spread between the two at a 19 year high. Our analysis also shows that historically when the spread between PCL rents and Gilts has been positive, the average PCL capital return has been +8% p/a.
vi) PCL property is cheap relative to the mainstream London market trading near a 10 year low. Historically when this has happened Buyers tend to trade-up to PCL property:
vii) 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 effect of BTL taxes come into effect.
viii) 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.
ix) There is likely to be strong pent-up demand as tax changes, political uncertainty and Brexit have held back transactions over the last 5 years. Taking 2014 as the last year of normalised transactions, we estimate there is c1.45 years of pent-up demand in PCL to year end 2018. Furthermore, if the trend in Q1 2019 continues throughout this year, then we expect there will be over 2 years of pent-up demand by year-end 2019:
x) Once Brexit is resolved, it is likely political stability will be restored and Stamp Duty may be slashed if Boris Johnson is returned as Prime Minister. There are also strong economic and fiscal arguments for a significant reduction. Our research indicates a 36% cut in Stamp Duty could generate an extra £1.44bn in tax revenue and £8.6bn in business revenue for the British economy.
xi) Finance Costs are cheap and have fallen 39% since the peak of the market:
Bulk Buyers Achieve Deeper Discounts
For obvious reasons, wholesale buyers with their significant buying power are better placed to achieve deeper discounts. Depending on the Vendor’s financial situation, the proportion of the total units acquired and the desirability of the scheme itself, discounts of 20-30% are not uncommon. By way of comparison the average discount to the initial asking price in PCL is -12% and -5.5% to the final asking price. (Source: LonRes). When these sorts of discounts are combined with a favourable exchange rate, we can understand why there is heightened appetite amongst some Overseas Investors for London property.
Higher Rental Yields & Less Maintenance Capex
From a yield perspective, buying at a large discount also means rental yields can be significantly above the market average. In context the average PCL rental property (which is typically a tired, relatively under-invested, period property) is showing a yield of 3.5%. By contrast Bulk Buyers are achieving yields in excess of 4% on new-build product with a high specification and often with the benefit of access to amenities such as a gym, swimming pool & in-house cinema. Given their new build or recently refurbished nature, these apartments are also likely to require limited capital expenditure over the next 5-10 years and many come with the benefit of a new build guarantee.
Lower Transaction Costs (Stamp Duty)
Property transaction costs are lower for Bulk Buyers compared to Individuals. Whereas an Individual Investor buying property in their own name can face a marginal Stamp Duty rate of 15%, a Bulk Buyer qualifies for either Multiple Dwelling Relief (MDR) or Non-Residential Stamp Duty.
By way of an example, an Individual Buyer of a single Buy to Let (BTL) residential unit for £10m would pay £1.41m in Stamp Duty (14.1% tax). This compares to £1.07m Stamp (10.7% tax) on the acquisition of 5 BTL units at £10m (Multiple Dwelling Relief is applied to the acquisition of 2-5 linked units) and £0.49m or 4.9% tax if 6 or more units are acquired in a single transaction (6 or more is classed as a non-residential transaction):
Bulk Deals Enhance Liquidity
Whilst Prime London residential property has historically been an attractive investment due to its tendency for relatively consistent, low volatility returns throughout the economic cycle its Achilles Heel is its poor liquidity. By bulk-purchasing apartment blocks however, liquidity is substantially improved as individual apartments can be sold piecemeal as and when liquidity is required. This can be especially appealing to Fund Managers and Service Apartment operators who may require access to capital to meet Fund redemptions or strategically as more attractive opportunities arise. Achieved exit prices are also likely to be substantially improved in comparison to a bulk sale which would tend to achieve substantially discounted prices.
UK Corporation Taxes are Highly Competitive
Lastly, UK Corporate taxes are amongst the most competitive in the Western world at 19% and are set to fall to 17% in 2020. This is encouraging International Real Estate Investors to invest in the UK Private Rented Sector (as well as other sectors of the economy). The chart below compares the UK Corporation tax rate to the G7 and the EU 15:
Source: Institute for Fiscal Studies
After 5 years of price declines as well as the longest Bear Market in over 30 years the market is fundamentally offering good value to Investors. New supply is drying up, rents are hardening and there is a significant amount of pent-up demand. With the depreciation of Sterling, foreign buyers are particularly well placed and although far from clear, a resolution of Brexit should restore political stability. There is also a strong likelihood Stamp Duty will be reduced if Boris Johnson returns as Prime Minister in a General Election.
Clearly the bargaining power of a large Investors enables greater discounts and in turn superior rental yields. Acquiring brand new stock also means lower capital expenditure on a 5 to 10 year horizon and the ability to sell units piecemeal in the future provides greater liquidity and optionality for Investors. Transaction taxes are also lower for Bulk Buyers and UK Corporation tax rates are some of the most competitive in the Western world.
If you have any questions on this article or would like to find out more about how we can help you bulk-buy in Central London market, feel free to get in touch. We have access to a number of bulk purchase deals.
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.