Should I be short London property?
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.