23^rd June 2010

Reaction to Emergency Budget –

Impact on the UK Prime Residential Market

Highgrove International is a premier property service organisation that provides market advantage to clients in regard to the sourcing and sale of property, negotiating transactions, conveyance management, and post-acquisition services. Our expertise gives us a useful impression of the prime property market which may be of benefit to potential purchasers, vendors and other interested parties.

The coalition government’s Chancellor of the Exchequer, George Osborne, yesterday revealed his widely anticipated Emergency Budget. The government certainly spent a great deal of time prior to the announcement preparing the country and financial markets for an unprecedented tightening of economic policy. This PR campaign and the resultant announcement was not just a response to the recent hit the UK has taken from the recession. It was also directly linked to the ever unfolding story of a number of economies within Europe becoming seriously challenged by a deteriorating ability to relieve themselves of their economic burdens.

In typical fashion, it is our position that budgetary and macro-economic influences the confidence and manoeuvrings of the UK property market, particularly on the prime residential market. In this report we review the most pertinent headlines of the Emergency Budget and try to predict what the broad impact will be on this part of the market. Specifically, we look at the impact of the relevant changes in Capital Gains Tax, the Bank Levy, the view of the markets and the intended impact on interest rates, and the impact of consequential macro-economic changes on the prime residential market.

Capital Gains Tax

The Chancellor introduced an increase in Capital Gains Tax (“CGT”) from today for higher rate tax payers from 18% to 28%. He reviewed the possibility of a higher rate with accompanying reliefs and he also considered at what point would government total CGT revenues increase and decrease as a result of different levels of CGT tax increases. Instead of introducing the widely expected 40% or possibly 50% tax level, the rate was set much lower confounding those who expected the government to seriously clamp down on what they alleged was serial tax avoidance.

We believe that this announcement will beckon a number of sighs across the country. From savers to landlords who have spent the last number of weeks worrying.  Depending on their view of the future of values, those that sold too quickly might just be a little disappointed. Whilst the increase is still an increase, the impact on the residential property market will be a lot less harsh than first thought. Wise investors will ensure their most optimum positions are maintained by continuing their review of alternative forms of investment, but we believe that this change alone will not have as dramatic effect on the residential property investment market as first anticipated. Property will retain its top of the list investment-income yielding category status. Indeed a number of private wealth managers are currently anticipating that vehicles liable to CGT will still remain attractive against UK income tax rates.

The anticipated rush of new supply affecting prices will be less dramatic, and so households looking to sell their primary homes may fear a lot less that their values may be dragged down by competing demand from desperate landlords eager to switch investments. Also, the anticipated rush to sell second homes in country areas is likely to simply not happen. Good news for values, bad news for those less comfortable with the invasion of city types.

With most residential property investment values within the UK falling well below the £500,000.00 mark, the average price drag-down influence on the prime market will be a lot less significant as a result purely of this change alone, maybe even negligible to non-existent.  The fear prior to the announcement was that a flurry of landlord disposals would seriously tug at the sub-£500,000 market which would then have a direct impact on the properties whose values go right up to £2,500,000, in terms of ability of people to buy and the ability of purchase/sale chains to reach their intended completions. We simply do not see this CGT change as having this affect. From this, of course, we would argue that from £2,500,000 and above, to way above, there will be no impact whatsoever as a result purely of the CGT announcement. Our position may have been slightly different if the tax change had been up to 40%-50%.

The Bank Levy

Again, it is our opinion that the Chancellor’s announcement of a Bank Levy on the balance sheets of bigger banks will at the amount proposed both politically please those who wished to see the banks punished and those in the banks who are likely to think the amounts are not as disastrous as they could have been (compared also to the typical revenues this sector generates for the public coffers). Perhaps it remains to be seen, but the growing advantage of Corporate Tax reductions to these institutions may also soften the blow slightly. A question that does remain that few can answer with certainty, is whether by January 2011, when the levy is introduced, will other countries have followed (beyond France and Germany who are apparently joining Britain) to prevent a form of bank decision arbitrage that might influence matters. Whilst some foreign bank boardrooms may think a little harder about future investment in this country, we feel the government has effectively reached a compromise position when looked at from the position of the banking industry that has at least reduced an otherwise greater incidence of bank relocation.

Why this is significant to the prime residential property market is that those who are employed by or adjacent to this sector represent a very serious category of vendors and buyers within this market. Any policy that too disadvantageously influenced the pay packets of these individuals would almost certainly bring about the departure of a significant number of these people together with the liquidation of their prime property assets. Again, we do not feel this will be a serious influence on the market as a result of yesterday’s announcement.

Also, of course, in theory extra levies on the banking sector may result in a pressure to raise the price of high street mortgages. Depending on the view taken by the lending institutions as to the pinch the levy brings, an impact on the high street is possible.  This could further affect the ability of purchases and chains to buy up to the £2.5m level, if they feel any resultant increased rate offered is intolerable. However, for those buyers active in the more prime residential markets, not only might they be less considerate of any pinch, a pinch may not in fact be forthcoming.  Many lenders are likely to continue offering preferential rates to this affluent and lucrative customer segment.  

Sometimes we feel it is necessary at some stage in our reports to remind our readers that they should not think we are wearing Estate Agency, rose-tinted spectacles. Whilst the reaction to the announcements above has been quite positive/less fearful than expected, please read on before you judge us entirely!

Financial Markets & Interest Rates

Of course, the longer term reaction of the financial markets remains to be borne out and we don’t consider ourselves qualified to make reliable predictions. So feel free to skip this part. However, it is our view that the macro effect of these factors weighs heavily on the residential property market. The financial markets dictate the confidence of others in our economy as well as the important factor of this country’s exchange rates in relation to other currencies. Fluctuations in these factors will also influence changes to interest rates. The government has taken the view that pleasing the financial markets is a leading policy, and the immediate reaction from them has been quite warm but also undecided for the long term. But only time and policy success/failure will tell.

The prime residential market will undoubtedly be influenced by the fluctuations in the exchange rate. If the country feels more economically depressed by the impact of the Emergency Budget then a portion of the supply side of the prime residential market will dry up. This is what happened during the depths of the recent recession. Property owners locked up and waited for the bad news to go away. The exchange rate position, again as the last 18-24 months has proven, tends to determine the demand side not in terms of how many are buying but in relation to who is buying. A confident market with confident indices brings national buyers to the fore with impressive levels of demand being met by slightly more pleasing levels of supply. A less than confident market together with a weaker pound brings international buyers to the fore. Either way, demand remains high and prices tend not to head south.

Specifically, one of the Chancellor’s leading objectives is to keep interest rates low. If this does turn out to be the case, then the environment for buying in the prime market remains favourable in the short to medium when looking at resultant mortgage rates, but only in taking this factor in isolation. Also, low rates will reduce the incidence of a rising currency, which is likely to further incentivise foreign buyers.

It’s All About Macro

The main reason that as a property advisory business we have over-inflated pretensions of being highly qualified economists, is that it is naturally the combined components of macro-economic policy and reality that dictate the direction of the market. Now as much as any time this remains to be the case. Whilst the general residential market and the prime residential market do not always move in sync as a result of the same influences, there is no doubt that they are and will be both influenced by yesterday’s announcement.

The change in VAT and public sector cuts will undoubtedly influence the confidence of the general economy and both property markets (ie general and prime). It is this changing level of confidence and activity, both separate and combined, that will have a far greater impact than any CGT change or bank levy. The anticipated impact on consumer spending on the high street and the likely job cuts in the public sector, will at least affect confidence in the general economy including the private sector for the rest of this year. What happens after that is open to debate and beyond our competency.

In the general residential property market household costs per VAT’able item will increase and may result in lower total spending. If that affects the results in the high street, then job insecurity in the private sector will also increase. This may force many households to sit and wait at least. The level of confidence and the anticipation or reality of future unemployment will affect households’ interest and ability to buy and sell, or more unfortunately their ability to remain as owners.

The result of this likely eventuality will be to place a tug on the prime residential market up to the £2.5m or so level, at least in terms of activity. For those owners of properties from £1m to £2.5m, the appetite for these properties may reduce somewhat, particularly if these properties are not in central London.

For properties from £1m and upwards outside London, the usual follow-the-fortunes-of-the-London market scenario is quite possible, but any downgrading is likely to be felt more severely.

Above £2.5m in central London areas, the prime buyers are unlikely to stay away. As suggested above, the fortunes of this area seem to be covered with almost any non-apocalyptic scenario. A slight downgrading of confidence tantalises the foreign buyers (as we have seen continuously throughout the recession up to now), and with an upgrade the native buyers return. On the supply side, low confidence creates lock-up and better confidence brings more supply, neither satisfying demand nor downgrading prices a great deal. Even the worst scenario of the feared double-dip recession is more likely to put a pause on this part of the prime market rather than a complete crash. For those not in this area, this worst scenario is likely to create a more significant pull, of course.

It is also possible to argue, that for those private or corporate investors coming in from abroad and assessing the UK as a place to do business as their European hub, the government is trying to fight back. When one considers changing corporation taxes and other factors such as an arguably weak bank levy. perhaps the case for the UK has improved just a little? Should we change the colour of our spectacles??!!

And finally, we should not let this rather noticeable budget blind us to the impact of other previously announced macro changes, namely the highest rate of income tax to 50% and stamp duty to 5% on the total for purchases over £1m. Certainly deterring factors, but we do not believe they will alone reduce appetite.

Conclusion

If we are to believe the nation’s new independent Office for Budget Responsibility, bar a mild temporary glitch, the country is on a positive course as a result of yesterday’s announcement. We do not believe that changes to CGT or the bank levy will hit the residential prime market a great deal. It’s not all benign, as prime properties up to about £2.5m outside central London may fee a tug from the short-term impact (at least) of macro-economic changes. However, owners above these values, especially in London and the South East, are unlikely to feel too many dramatic changes that destroy their market or force them to do something they would rather not do.

If you would like to argue with any points we have made, we would love to hear from you.

Regards

Highgrove International

Tags: Property Budget Prime Residential Wealth