Prime Market

Rents in the prime housing markets of London fell by -5.1% over the course of 2016 in the face of high levels of stock available to rent and relatively weak corporate demand for larger properties in particular.

By contrast, rents in the prime markets of the commuter zone fell by just -0.9% on average. Across both markets, demand has remained most robust for smaller properties.

In the prime markets beyond London, rents rose for one, two and three-bedroom properties in 2016, while they remained broadly static for four–bedroom homes. The average price falls seen in these markets were driven by properties of five or more beds where rents fell by -2.2% on average.

In the prime London markets, rents softened across the board, though these falls were contained to -1.5% and -3.3% for one and two-bedroom properties respectively. In comparison, rents for larger family homes of five or more bedrooms fell by -7.0%, with the most expensive homes renting for over £3,000 per week falling by -8.9% over the course of the year.

^{Source: Savills Research}

High supply in London

Here, the overriding reason for these rental falls has been the unprecedented amount of stock available to let on the market. This has come from three sources – investment buyers of new build property that has now reached completion, a one-off increase in supply from those who bought rental property prior to the stamp duty deadline in April and, accidental landlords caught by the weak sales market in the aftermath of the EU referendum.

On the demand side, the referendum has tempered demand from those employed in the banking industry and made large corporations more cautious about recruitment, particularly at a senior level.

This has had a particular impact on demand for family housing. With tenants increasingly budget conscious, they have also continued to be more flexible around location.

But despite being much more price sensitive, the market has remained relatively active – especially in areas such as Shoreditch, where growth in the tech industry has supported demand.

Parallels in the country

There are some parallels in the prime lettings markets of the London commuter zone. Here, there has been evidence of accidental landlords adding to available rental stock as well as weak demand from corporate tenants. Likewise, tenants not wishing to stretch themselves financially have generally focused on smaller properties.

This has resulted in a fragmented market where very large properties have struggled to let and that is beginning to feed through into more substantial cuts in asking rents.

By contrast, family and smaller country houses, which are primarily let to those commuting into London, have seen much more consistent demand. But by far the strongest demand has been for smaller houses and flats let to young professionals, where there remains a shortage of supply.

Outlook

Whereas we expect there to be continued rental growth in the mainstream markets (because demand from those unable to access homeownership is expected to outstrip supply from private landlords facing tax and mortgage constraints), we believe the growth prospects in the prime rental markets are weaker.

Stamp duty is likely to increase rental demand and curb investor buying activity to a degree at least. But in London, high levels of competing supply are likely to continue to come from the new build stock which is expected to be completed over the next two to five years.

More widely, supply from accidental landlords is likely to continue to be a feature of the market in the short term, though not as pronounced as in the immediate aftermath of the EU referendum.

Demand for prime rentals and the spending power potential will be largely dictated by the impact of Brexit on employment and earnings in key industries such as finance, technology and professional services. Whilst ultimately we expect London to continue to hold its position as a global financial centre, ongoing uncertainty and the prospect of some functions being relocated are likely to have an impact on demand in London markets.

Therefore, it is difficult to see drivers for rental growth over the medium term across most sections of the prime market. More than that, there remains a risk of continued falls in prime rental values in London over the short term. This will mean landlords, particularly those who own larger properties, will need to continue to be flexible in their rental expectations and ensure the property meets prospective tenants hopes in terms of condition and amenities.

^{NB: These forecasts apply to average rents in the second hand market. New build values may not move at the same rate.}

^{Source: Savills Research}

TAXATION IN THE PRIME MARKET

Increasing levels of stamp duty, together with a series of other capital tax measures primarily targeted at non-domestic buyers, have played a significant part in the sales market over the past few years. Whilst the additional 3% for buyers of second homes and investment property undoubtedly distorted the market in 2016, the tipping point in London was the changes introduced in the Autumn Statement of 2014. Since that date, values of prime central London property have fallen by -12.5%.

These taxes have also contributed to a lower transaction market, where renting looks comparatively more attractive for occupiers and where investors will take longer to recover their costs of acquisition. For example, our analysis shows that the buyer of a property worth £1 million would pay stamp duty equivalent to 456 days of rent while an investor would need to set aside 769 days rental income to fund the SDLT burden. For the buyer of a £2.5 million property these figures rise to 1,040 and 1,405 days rental income.

^{Source: Savills Research}