The importance of sales to housing supply in London

Sales activity in London is weak, and this has implications for developers and future housing supply. For every home buyer with a mortgage, affordability has been severely impacted by heightened interest rates. Cash buyers are the only group of buyers who have seen increased activity over the past year, whilst first time buyers and home movers alike are struggling to make the finances stack up. Overall this has led to lower levels of activity in the market and price falls.

Pressures facing London developers

The average size of a new housing scheme started in London in 2023 was 176 homes. Developers selling those homes have multiple pressures around pricing and sales rates, as well as the increased cost of their development finance. While all developers are funded differently, each has investors or stakeholders who set them milestones to hit throughout the development and sales programme.

If target sales rates aren’t achieved, there are a number of levers which developers can pull to increase demand. Their appetite to use each of them will vary depending on the level and type of pressure coming from their funders:

• Lower prices (either individual units or consider bulk discounts)
• Offer buyer incentives (assistance with stamp duty, deposit assistance schemes)
• Hold the units and rent out
• Hold the price and accept a slower sales rate
• Switch private sale to another tenure (typically affordable, or in the case of large multi-phase schemes, can be Build to Rent, student or senior living).

New build homes sales benefited from Help to Buy for the last ten years, and in London the equity loan scheme (40%) was much more favourable than outside London (20%).

The end of Help to Buy (in October 2022) plus the higher interest rate environment led to a significant drop off in new build sales in the mainstream market (below £1,000psf) in the last 12 months. Using Molior sales data, excluding BTR ‘sales’, we estimate volumes in this market have fallen 41% compared to Q3 2022. This is compared to just a 3% fall in the sales numbers above £1,000psf.

This demand pressure is not the only challenge developers have faced in the last two years. Build costs have substantially increased, squeezing development appraisals further at a time when the sales market is weakening. Stricter building safety standards such as second stair cores (on buildings more than 18 metres, or seven storeys), environmental regulation and affordable housing requirements are further adding to development costs and challenging viability on sites in London.

The result of these challenges is a slowdown in delivery; private starts on site are falling and are currently 60% below their peak in 2015. Earlier stages of delivery are also affected. New planning permissions on private sites over 20 units are down 60% from their 2015 peak, while new applications are down 70%. This does not bode well for the Mayor, since even current delivery levels of 34,985 new homes (new annual EPCs to Q3 2023), are just 67% of the London Plan target, and only 41% of housing need (as identified by the Government in the standard method). These forward-looking figures suggest the worst is yet to come. 

 Only for the bold

The structure of the development market has changed in the face of mounting challenges. In 2023 there has been less land traded, due to the lower land values (so vendors are less motivated to sell for residential), and fewer players in the market who can make residential development work with the higher cost of debt, build cost volatility and policy environment. And that’s before you consider the confidence needed to buy a site with the intention to deliver new homes when sales rates and house prices are falling.

Build to Rent, especially in the absence of Help to Buy, looks here to stay. Housebuilders and developers are incorporating this into their business plans and appraisals for new sites, rather than just using it as a contingency exit route. There also continues to be appetite for alternative residential uses, including student housing and co-living, with developers looking to capitalise on more liquid occupier markets.

Things can only get better

The lack of buyers is stark, and the land market needs a better functioning sales market. It looks like this might happen when interest rates come down. Oxford Economics are currently predicting that the base rate has peaked at 5.25% and will start to come down in the middle of 2024. This should be beneficial to the developer in two ways; offer a lower cost of development finance, and also boost demand as purchasers’ affordability is improved.

The areas of demand in 2024 (compared to 2023)

First time buyers; anyone using a mortgage should see an improvement in their ability to purchase throughout the course of next year, plus a ‘push factor’ from rising rents, so there should be an increase in demand from this group of buyers (albeit off a low base in 2023 where volumes were constrained). We have already started to see developers entice first time buyers with their own versions of deposit assistance schemes, and more are planning on launching these in the new year.

Investment from overseas should follow, once the domestic market shows signs of improvement. This group of buyers will not commit to off-plan sales while house prices are falling, and coupled with political and economic uncertainty, volumes will remain similar to 2023 levels.

Although investor demand from overseas will take time to build, we have seen a pickup in international buyers intending to relocate. International owner occupiers continue to be lured by education, as well as push factors such as geopolitical events or security of wealth. We expect this to continue into 2024.

Build to Rent forward funding activity is expected to pick up throughout 2024 and into 2025 as interest rates fall, and debt pricing improves, unlocking liquidity in the market. However this will be reliant upon the right opportunities getting through the planning system.

Overall, we are likely to see a small increase in new build sales confidence by the end of next year, representing a gradual recovery from the slow market of 2023. From 2025 onwards, a stronger market will support new homes sales, in line with our wider market transaction forecasts.

It is clear buyers have adjusted their budgets as the hurdles to home ownership have increased over the past year. What does this mean for the new homes market and the displacement of buyers due to the shifts in their affordability? In our next article we look at how the improving economic picture will allow London to become more affordable for some buyers.