Commentaries

Now raising intellectual capital

Should I be short London property?

August 19, 2009

Has London’s residential property market bottomed out?

This question has a particular resonance for my husband and me. We are in the middle of selling our London flat. So, unless we buy again immediately, we will be short London property.

Over the longer term, British, and especially London, residential property has been a spectacular investment. We can thank strict planning laws, tax advantages to home ownership and the wealth of the City.

However, in the short term, renting appeals. First, we can try out a neighbourhood that makes my daily schlep to Reuters’ office in Canary Wharf more bearable.

Moreover, this is–for now at least–a renters’ market. If we bought a house, it would be to live there, but it is always instructive to work out the rental yield to see whether it offers good value.

We looked at what appeared to be a great buy – a reasonably-sized house in central London that we could actually afford.  I ran the numbers. I knew the rent, but I had to make assumptions about how much the house would cost. First – would the seller accept a low-ball offer from newly chain-free buyers? Second, how much would we have to shell out for a lease extension (one of the banes of the London market). And how little could we get away with to update its tired decor?

Depending on the answers to those questions, the yield ranges between 2.75 percent and 3.75 percent gross. Once you make reasonable assumptions about voids (say, 4 weeks a year) and an agent’s letting costs (say 11 percent plus value-added tax at 17.5 percent), you are looking at yields of 2.2 percent to 3 percent. And that is before considering the other costs of ownership–the insurance, the ongoing maintenance, the surprise roof leak, or whatever.

Now, you could say that those returns look OK in a world where the base rate is 0.5 percent. But the base rate and the rate at which you and I can borrow, dear reader, are two different things. Our mortgage broker told me that, even with a fat deposit, one of the best 2-year fixed rates we could get would be 4.69 percent, or almost 10 times base rate. Were we buying to let, the rate would doubtless be higher. (Admittedly, I have heard that you can get better-than-advertised deals by negotiating directly with your bank).

So, we could end up paying someone 2.5 percent to live in our home. That gap could increase as base rates rise, as they inevitably will.

Of course, in the past people have funded ongoing property costs because they expected house prices to rise. However, previous property cycles show that they can take several years to play out.

Moreover, the tax advantages of home ownership are no longer what they were. The stamp duty on properties costing more than 500,000 pounds is 4 percent. True, there is no capital gains tax (CGT) on “principal private residences”, ie the home you live in. However, CGT has also been slashed, from 40 percent to 18 percent. And stamp duty is paid on the way in, while capital gains tax is paid only on gains made.

Let’s say you buy a property for 500,000 pounds. That costs 20,000 pounds in stamp duty. However, you could make a gain of 111,000 pounds, (of which 20,000 pounds is 18 percent) or around 130,000 after allowances, on that 500,000 invested elsewhere and pay the equivalent amount in CGT. That equates to a 22 percent return. And, if you buy bonds or equities you can take small gains every year to minimise the tax bill.

There are two good financial arguments for buying. The first, right now, is that while the banks might charge us 4.69 percent to borrow, we will struggle to find anyone to pay us more than 2 percent net of tax on our savings, and we would probably have to lock it up to get even that. This would take away some of the advantage of being a chain-free buyer in this market.

Second, if inflation returns, property tends to be a good hedge.

Helpful comments from other observers of the London market are very welcome.

Comments

The bigger question is where is the London property market heading. It has only fallen about 20% from the peak. For most new buyers even a small flat is out of reach. Jobs are still being slashed, people are hurting.
The transaction volumes are still a tiny share of what they used to be so it is hard to read the real market. But look out below.

 

londons demographics arent very good even with recent mass immegration to the capital, net population has dropped this people say is “White flight” maybe, but also relocation of major industries is a factor. I dont think the mid end london market for families is rosy however slum landlords will do alot better

 

Stamp duty at a purchase of £500,000 is 3% =£15000

Posted by Paul | Report as abusive
 

We may be coming out of recession, but the REAL world is still very much IN recession.

House prices in general are based on the following factors: interest rates (for mortgages) and job security (to pay the mortgages)

Interest rates will not be increased in a hurry, for 2 main reasons: 1) that was a mistake made in the 1930′s with disastrous consequences 2) Already the BoE (and Fed & ECB & BOJ) understands that classical economics of using interest rates to control inflation & growth is simply NOT working now.

Job security will also not return in a hurry: (see Boe & IMF & World Bank) they stop short of calling it a depression, so as not to panis the markets – but that’s what they mean.

So house prices will not jump, without the loose money & available credit as we enjoyed before it will take some time. Remember, a house is somewhere for you & your family to live NOT an investment

Posted by Alex | Report as abusive
 

Time: Property investment is a long term game. Take a short term view and you will loose.
Economy: More deflation to come with continuing rising unemployment into 2011 / 12. Property does well with inflation but badly with deflation.
Finance: Banks not interested in lending at an acceptable level so no point in borrowing to invest in property.
Tax: Stamp Duty much to high at present. CGT also too high at 18% considering the risks and now that Tapered Relief the long term incentive has been removed.
Conclusion: Wait until property is cheaper and until the banks have recovered and wish to lend at acceptable levels once again. Suggest 2017 being 10 yrs after the credit crunch started.

Posted by Tim Worlock | Report as abusive
 

Hmmmm London buy to let market, tought one, you do need to know the areas very well both for purchase and then the rental market in the same area, that’s quite an ask, even for an agent…with a single apartment you also have to look at void periods, on top of no income you are paying the mortgage and all other costs for the void period.

An alternative is Berlin in Germany, for the same money you could by an entire block with say 10 apartments, all apartments already rented to long term tenants, typical NET yield of around 8%pa, fully managed, with 10 apartments even if one is vacant is only a small drop in income, rents on the whole are on the way up in Berlin so buying now at 8% net yield in a few years if you buy in the right area (Central East)could hit 10% net yield.

Google some Berlin property agent sites, ours is Berlinpropertyforsale.com our London site is HomeSearchLondon.com

Good luck..John

 

http://www.strategic-uk-land.com recommends UK investment land with a potential to be designated for residential development in the medium- to long term. Historically, UK residential land values rose at almost double the rate of UK residential property prices. In addition to organic growth, land increases in value up to 20 times when it is designated for residential development.

 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •