Prime central London lettings market set to see improvement in total returns

Average rents in the prime central London lettings market fell 2.2% year on year in December, the most modest decline for 21 months, the latest rental index shows.

Looking ahead a combination of rising rents in 2018 along with increasing capital values means that total returns will improve, according to the prime central London rental index from Knight Frank.

It points out that the average gross yield of 3.2% in prime central London is higher than a 10 year UK government bond yield of 1.2% and with activity improving the outlook for investors is positive.

The index shows that while the number of new lettings properties coming onto the market recorded a like for like fall of 1.2% between January and November compared with the same period in 2016, there was a 19% rise in viewings year on year and the number of tenancies agreed rose 14% in the first 11 months of 2017.

Tom Bill, head of London residential research at Knight Frank, explained that average rental values for existing homes have been falling year on year for more than two years due to rising supply but the pattern is now reversing.

‘A large spike in new lettings properties in the middle of last year, which followed the introduction of the additional rate of stamp duty in April 2016, was one of the factors behind the increase. The other key reason has been a growing number of so-called accidental landlords, a group of would-be vendors who are waiting for more pricing certainty before they return to the sales market,’ he said.

‘From an investor perspective, in a world of low returns, the prime central London lettings market became a comparatively more attractive asset class in 2017. Although extra taxes have given landlords pause for thought in recent years, this has come against the backdrop of rental values that are bottoming out,’ Bill pointed out.

‘The current average gross yield in prime central London is 3.2%. This is higher than the risk-free rate of a 10 year UK government bond, which was yielding approximately 1.2% in mid-December. Indeed the spread between the two is high by historic standards. This trend looks set to continue which, combined with bottoming out sales values, will boost total returns,’ Bill added.

He also pointed out that despite the fact that UK inflation rose to 3.1% in December, there is no immediate likelihood of a rate rise. ‘Indeed, subject to the usual caveats, the Bank of England expects the base rate to be 1% in 2020, which is still ultra-low by historical standards,’ said Bill.

He also explained that political uncertainty has not been the primary reason for the relative slowdown in sales volumes and price declines in the prime central London market. ‘Tax changes have been the fundamental cause of pricing tension between buyers and sellers,’ he said.

‘However, the political backdrop has altered the more intangible dynamic of sentiment. This, in turn, has prolonged the period over which asking prices have adjusted to higher transaction costs. Two general elections and a referendum since 2015 mean political uncertainty has played an important role. While there would be a material impact on prime central London property markets in the event of a large-scale exodus of financial services workers from London, there are few indications this would happen,’ he pointed out.

He believes that as a greater sense of pragmatism appears to take hold in Brexit talks, it is the stability of the UK Government rather than the contents of the deal that would arguably have a greater impact.

‘It is worth noting that a version of Brexit that has the backing of a majority in Parliament may lead to a more consensual outcome that is less subject to challenge. The indirect role played by politics perhaps explains the limited anecdotal evidence that the 08 December deal bolstered demand. Given the extended nature of Brexit talks, asking price reductions are likely to remain the key prerequisite for increasing market liquidity in 2018,’ Bill concluded