9.2% REAL ESTATE PERSPECTIVE MAY 2016

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1 REAL ESTATE PERSPECTIVE MAY 2016 Inside this issue: Fiscal and political headwinds cool the prime central London market while outer London boroughs and South East commuter towns grow steadily At a regional level, the East, South East and South West have had stronger annual growth than prime central London Higher yields draw investors to the North of England, but the Northern Powerhouse also has potential for stronger long-term capital growth Important projects on the National Infrastructure Delivery Plan could create capital growth Call to action for landlords on energy efficiency A TALE OF TWO HALVES Welcome to our May edition of Real Estate Perspective. As the year progresses, a tale of two halves is emerging, with prime central London remaining subdued and the rest of the market predominately tracking upwards. The London property market is often one to grab the headlines, but a series of headwinds (taxation, political and macro-economic uncertainty) have hampered activity over the last 18 months. The latest Land Registry data shows that the annual sales volumes across London are down 12%. More specifically, figures from LonRes show that transactions in prime central London were down by 22% in the final quarter of last year, while sales above 5m fell by more than a half. On 23 June the British public will vote on whether to stay in the European Union (EU) or leave ( Brexit ). Uncertainty about the EU referendum will naturally make investors cautious about the effects on the property market, forcing many into wait-and-see mode. Commercial bookmakers are currently giving 60 70% odds of the UK staying in the EU, but the result is by no means certain. This uncertainty has also been weighing on Sterling, which impacts foreign investors. However, a weak pound cuts both ways foreign owners might suffer a loss on paper, but cheaper purchases for foreign buyers could support demand. In our view, sterling is already undervalued on a long-term basis and is likely to strengthen in the long term regardless of the outcome on the EU vote. This is a factor mainly relevant to the London market, where foreign investors have historically poured into the market to access safe haven property investments. Fiscal changes, used to deliberately cool the market, have targeted multiple ownership and higher value properties. These include the additional 3% stamp duty on investment properties and second homes, as well as the hike in stamp duty charges, particularly for properties above 1.5m. These changes are having a bigger impact on the London property market, where there is a larger private rented sector and average house prices in the prime boroughs hit the top end of the stamp duty charges. The latest UK Budget verified the government s stance on property by announcing that Capital Gains Tax (CGT) rates will reduce for higher rate taxpayers, while excluding gains on residential property. Slower growth and localised price corrections in London do not, in our opinion, signal the start of a broader housing market crash. There is a fundamental lack of supply and there are pockets of London that are likely to see capital growth due to the infrastructure changes scheduled over the medium to long-term (see map on page 3 for details). The rest of the UK property market seems to be relatively unaffected by the fiscal changes and the EU referendum. The Halifax index of UK house prices is growing at a healthy annual pace of 9.2%. In numbers 9.2% UK Annual House Price Growth Source: Halifax

2 In the past decade the number of years olds living in the city has nearly doubled. The purchase price of one and two-bedroom apartments is still relatively low, but constant demand from young professionals and students ensures rental yields are strong. NORTHERN POWERHOUSE BUILDS MOMENTUM The concept of the Northern Powerhouse was first aired in June 2014, and has been revisited by Chancellor George Osborne many times since. The premise is that the North of England with its major cities of Manchester, Leeds, Liverpool, Newcastle, Sheffield and Hull and a population of 15 million is not fulfilling its potential. The region produces gross value added (GVA) of 287bn, compared with 338bn produced in London from a smaller population of 8.5 million. GVA per capita across the North ranges from 17,400 to 19,900, while in the capital it is 40,200. While the comparison with a global financial centre may be slightly unfair, the gap in productivity between London and the second largest city economy, Manchester, is wider than the equivalent in any other G7 country. The Chancellor s 2016 Budget focused on a number of significant infrastructure changes which we believe will support house prices in areas that benefit from these changes. There is continued commitment to growing Britain s Northern Powerhouse ; the green light has been given to the HS3 high-speed rail link between Manchester and Leeds, 230m was earmarked for road improvements including delivery of a fourlane M62, the west east trans-pennine motorway in Northern England, connecting Liverpool and Hull via Manchester and Leeds, and plans for a new tunnel road from Manchester to Sheffield. The establishment of an economic powerhouse in the North of England will require collaboration, innovation and investment in infrastructure, but there seems to be real commitment to its success. The real estate sector as a whole should benefit from a step change in economic growth and productivity in the North. Jonathan Hopper, managing director of Garrington Property Finders, one of the firms on our panel of buying agents, recently noted that London property has become a victim of its own success as property costs have outpaced rental values following successive years of double-digit price growth. This has eroded yields and prompted many astute investors to turn their attention northwards. Manchester s consistently buoyant rental market has attracted investors interest. Hopper cited compelling demographics with more affordable property prices, which are generally lower than the national average, as the main drivers. In the past decade the number of years olds living in the city has nearly doubled. The purchase price of one and two-bedroom apartments is still relatively low, but constant demand from young professionals and students ensures rental yields are strong. As the Northern Powerhouse builds momentum, there will be potential for strong capital growth too. Hopper noted that while many property investors who turn their gaze to Northern England do so initially in search of better yield, it could yet be the potential for stronger, long-term capital growth that keeps them there.

3 INFRASTRUCTURE INVESTMENTS AND THE POTENTIAL IMPACT ON CAPITAL VALUES MIDLANDS Boston Barrier Midland Metro extensions Lincoln Eastern Bypass Midland Mainline electrification A38 Derby junctions M6 junctions 13 to 15 Smart Motorway National College for High Speed Rail M42 junction 6 HS2 Phase 1 from London to Birmingham M1/M6 junction 19 improvements NORTHERN POWERHOUSE North of England rail enhancements Mersey Gateway Bridge Smart Motorway projects on M62, M1, M6 and in Manchester Heysham to M6 Link Road A5036 to Port of Liverpool A1 North improvements A160/A180 Immingham Sunderland New Wear Crossing Leeds New Generation Transport Carrington Gas CCGT Power Station Sir Henry Royce Institute for Advanced Materials Teesside and Lynemouth biomass plants Manchester Airport investment Leeds Flood Alleviation Scheme Siemens Green Port Hull EAST OF ENGLAND SOUTH WEST Hinkley Point C Great Western electrification A303/A30/A358 Corridor Bristol Temple Meads Station National College for Nuclear Infrastructure development has historically been one of the most powerful drivers of capital growth in property markets. Locations with good infrastructure such as schools, shops, transport, amenities and services, have generally tended to make for good investment. Infrastructure generates economic activity and jobs, which in turn creates demand for real estate. Recognising the role that infrastructure development can play in property investments, we highlight some of the key infrastructure projects on the government s National Infrastructure Delivery Plan LONDON Crossrail and Crossrail 2 Northern Line extension to Battersea Thames Tideway Tunnel Francis Crick Institute London Power Tunnels A14 Cambridge to Huntingdon Northstowe housing development Norwich Northern Distributor Road East Anglia 1 offshore wind project Luton Airport New river crossings at Ipswich and Lowestoft SOUTH EAST M20 Lorry Park (Operation Stack) Smart Motorways on M3 junctions 2 to 4A and M4 junctions 3 to 12 East-West Rail Phases 1 and 2 Thames Estuary 2100 Programme Ebbsfleet Garden City Source: National Infrastructure Delivery Plan 2016 to 2021

4 CALL TO ACTION FOR LANDLORDS ON ENERGY EFFICENCY Sustainability has become an increasingly important factor in property investment and management in recent years, and one of the driving forces behind this has been the introduction of Minimum Energy Efficiency Standards (MEES) in 2015 (an output of the Energy Act 2011). All leased buildings in England and Wales which legally require an Energy Performance Certificate (EPC) will be captured by MEES, with a minimum energy efficiency rating of E (on a scale of A to G, G being the least efficient). What you need to know for residential property: From 1 April 2016 tenants can request landlord consent for energy efficiency improvements From 1 April 2018 it will be an offence to let a substandard property (i.e. properties with an energy efficiency rating of F or G ) From 1 April 2020, it will be an offence to continue to let a sub-standard property Although MEES regulations could result in additional capital expenditure, financial penalties and loss of rental income, they also present owners with a catalyst to improve their properties and future proof them against potential obsolescence and reductions in market value. There are a few cases where property owners can apply for an exemption, but the Department of Energy and Climate Change (DECC) estimates that nearly one in five residential properties fall below an E EPC rating. Rhona Turnbull Associate Director, Sustainable Energy, RBS The residential sector was responsible for 16% of the UK s carbon emissions in (DECC 2015) The Department of Energy and Climate Change (DECC) estimates that nearly one in five residential properties fall below an E EPC rating.

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