Average UK house prices are set to rise 5% in 2016, but the speed and timing of interest rate rises will dictate the pace and sustainability of price growth, according to the predictions from real estate advisors Savills.
In the commercial market, average total returns on UK property investments are likely to slow to approximately 7.5% while in the agricultural market Savills has downgraded its forecasts for the next five years given recent market evidence and the short to medium term expectations for commodity prices and therefore farm profitability.
The firm says that income and the ability to unlock the latent value of individual assets through active management are likely to be priorities, due to the current stage of the property cycle and the medium term prospect of interest rate rises, regulation and tax policy in the residential sector, and the outlook for commodity prices in the agricultural sector.
In the commercial and residential markets Savills expects a shift towards investment in regional markets, given where recent capital growth has left yields.
The referendum on membership of the European Union (EU) presents the greatest uncertainty for UK real estate in 2016/2017, according to Savills, as the outcome has potential implications for all three sectors. The prospects for a pre-referendum investment slowdown may well depend on how close polling companies believe the outcome will be, the report suggests.
The report explains that annual house price growth stood at just 3.9% at the end of October, with annual housing transactions appearing to have peaked at 1.2 million per year so the forecast for 2016 is 5% for average UK house prices.
It points out that stamp duty changes have left the top end of the London market looking both fully priced and fully taxed suggesting a further delay in the return to trend rates of house price growth.
Meanwhile, the mainstream market is more dependent on what happens to the cost of borrowing. ‘Capacity exists for short term price growth if rate rises are delayed further, but rising interest rates will squeeze affordability, making house price growth dependent on earnings and the pace of economic growth,’ the report says.
It adds that in some areas in London, for example Ealing, Acton, Greenwich, Lewisham and Waltham Forest, may buck this trend as they attract more affluent buyer groups. Attractive commuter towns will also continue to offer good medium term price growth, particularly where travel times are shortened by rail improvements.
Also demand for private rented accommodation will continue to rise. The restriction in tax relief and additional 3% stamp duty charge for buy to let landlords may result in rising private rents and shift investor focus towards higher yielding sectors of the market, particularly key regional cities, it suggests.
While Government policy continues to focus on house building, the firm points out that it is not yet clear if this will deliver a step change in housing delivery.
Existing pressure on farm incomes is unlikely to lead to a significant increase in the supply of farmland unless there is a threat to direct farm subsidies from a UK exit from the EU or a significant negative change to the capital tax treatment of farmland.
It explains that a UK exit from the EU could have a significant negative impact on farm incomes and land values but rural estates remain attractive to high net worth buyers as safe shelters for wealth that they can also enjoy and they are also partially protected from commodity price volatility having a diverse asset base and multiple sources of income generation.
In the short term, demand for farmland is expected to be more localised. Non-farmer demand, and the expected growth in prime country residential markets over the next five years, will continue to support prices especially on residential and amenity type farms, but investor demand may weaken as the performance of alternative assets improves, says Savills.
‘In the light of recent market evidence and the short to medium term expectations for commodity prices and therefore farm profitability, we have downgraded our forecasts for the next five years. We expect values to be much more varied than those of the past five years,’ the report says.
‘This market will last three to four years until commodity prices start to recover, following stronger global growth. However, the fundamental factors driving UK farmland value growth remain. Supply is historically low, the product is finite, and competing land uses and ownership motives will all support farmland value growth in the long term,’ it adds.
In the commercial market the forecast is that average total returns on UK commercial property investments are likely to slow to approximately 7.5% and investors will need to focus more on rental growth than capital growth.
Investment volumes are likely be ahead of the long term average, and there will be a rise in demand from institutional investors looking for longer income asset management and alternative asset classes, it suggests.
‘Smaller lots of between £5 million and £15 million will provide a rich opportunity for opportunistic buyers and private investors looking to create larger portfolios for eventual sale to institutions,’ the report says.
‘Good quality refurbished office space in the UK’s top seven major cities will experience stronger than average rental growth, reaching levels recently seen for similar assets in London,’ it adds.
It points out that the retail market in many of the UK’s regional towns and cities has now rebased to a level where retailers can trade profitably, and the outlook for retail rental growth in 2016 in these locations is stronger.
The outlook for the prime West End retail market is that rents will continue to rise at over 6% per year and the report suggests that there are still good opportunities in the core industrial distribution markets for investors if they can locate appropriate sites, with the best prospects in the under supplied middle of the country.
‘This year UK real estate will move into a new stage of the property cycle and will also face a number of known unknowns such as an in-out EU referendum within the next 18 months, new regulation coming into force, and a potential end to more than six years of record low interest rates, resulting in a very different year to 2015,’ said Mark Ridley, chief executive officer, Savills UK and Europe.
‘As we’re unlikely to see a repeat of the strong capital growth witnessed recently, we’re predicting that investors’ attention will turn to maximising rental growth and income returns. There are still numerous opportunities across all the sectors we’ve explored, however, particularly outside the capital, and we expect to see the shift towards investment in the regions that began this year to strengthen in 2016,’ he added.
