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LONDON PRIME RESIDENTIAL PIPELINE 2016

London Prime Residential Pipeline 2016

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Page 1: London Prime Residential Pipeline 2016

LONDON PRIME RESIDENTIAL PIPELINE 2016

Page 2: London Prime Residential Pipeline 2016

Prime housing has been instrumental in lifting London’s residential and construction markets out of recession. In recent years, investors from all over the world have taken a shine to the capital’s real estate market, taking it towards unprecedented levels of growth. Although London remains a magnet for developers and investors alike, the market has matured significantly, requiring development opportunities to be carefully selected.

In recent years the shortage of high quality, ‘fresh out of the box’ luxury homes in central locations, coupled with favourable exchange rates, made for a heady mix that investors simply could not resist. This resulted in huge price hikes right across the capital’s prime market. In some areas values have accelerated up to fifty percent.

However, while planning and development have continued to surge ahead in light of these trends, the market is evolving. Successive tax tinkering has had a big impact on the very top of the market and its effects are not just felt in prime but in every area of the market. Developers will now need to be more agile if they want to ensure the right margins.

One feature of the recent ‘boom’ years was sales values steadily outstripping construction price inflation. However, higher stamp duty charges – combined with other tax reforms and global economic uncertainty – have turned the thermostat down on buyer demand, while construction costs are now rising faster than before.

Significantly, the issues facing the London market are potentially playing into the hands of other cities across the country. Birmingham and Manchester, in particular, are coming up on the rails as developers and investors - boosted by the more affordable land values and the government’s long-term infrastructure commitments - are looking to alternative locations for prime residential investment.

The question we pose this year is – how can developers and investors turn a maximum profit in a market that keeps changing? What are the consequences of rising costs and easing demand? And, crucially, where next for the prime residential market?

Successive tax tinkering has had a big impact on every level of the market

Page 3: London Prime Residential Pipeline 2016

EXECUTIVE SUMMARY• The amount of ‘prime’ homes

due for construction in London over the next ten years is expected to hit over 35,000 with a total sales value of more than £77 billion

• Chelsea & Fulham is the most popular location, followed by the regeneration areas of the Southbank and the City and fringe

• The combined floor space of these properties would eclipse the entire City of London

• Despite initially encouraging investment to stimulate wider growth, the government has changed policies mid-cycle, stemming buyer demand and, consequentially, hurting affordable housing allocations

• Stamp duty, in particular, is becoming more of a tax on development than purchasing with ‘stamp duty paid’ deals impacting margins

• The Chancellor should scrap extra stamp duty on homes above £1 million and, instead, use the planning process to secure an enhanced level of affordable housing

• Although market conditions are changing and there are fears of an over-supply at the lower end of prime, opportunities exist in mixed use and mixed tenure developments

• Significant growth likely to be seen in British regional economies as major infrastructure commitments, population and employment growth drive prime demand

• Market will recover when sales values rise relative to construction inflation between 2018 to 2020.

Page 4: London Prime Residential Pipeline 2016

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Page 5: London Prime Residential Pipeline 2016

77 BILLION SALES VALUE

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Page 6: London Prime Residential Pipeline 2016

DEVELOPMENT CONTINUES TO SURGE AHEAD

6000

5000

4000

3000

2000

1000

0

Homes per year 2014 index2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Homes per year 2015 index

Our pipeline is based on a snapshot analysis of new private residential projects being built or planned for delivery in central London through to 2025 with an average sales value greater than £1,350/ft2. Given the complex nature of planning, funding and phasing the delivery of these developments, estimating the delivery dates of schemes is not an exact science. However, by producing a theoretical timeline, we are able to discuss the headline trends and shape of the ten-year pipeline.

The market has cooled in recent months with some developers reporting a slowdown in sales and enquiries. In spite of this, the development pipeline has surged ahead 40 percent since last year with over 10,000 additional homes now planned for construction.

A major reason for this has been the continued attraction of prime London new build to a wide range of international investors. Developers from the likes of Malaysia, Hong Kong, USA, India and UAE, as well as the UK, have entered the market acquiring sites later in the cycle to bring forward new schemes with revised and intensified levels of development. Many of these are now forecast to complete between 2019 and 2025.

In terms of timings, we predict a two-year peak in the number of new prime homes being completed in 2017 (5,414) and 2018 (5,130). At this point, construction will have completed on just under half of the total number of homes currently planned, leaving a staggering £36 billion worth of property still to be built. Given the amount of development remaining and the possible need to re-configure the product mix in response to the current market dynamics, it is conceivable that the some projects could take longer to be completed.

Homes per year 2014 versus 2015 index

SHORT TERM(2016 - 2018)

MEDIUM TERM(2019 - 2021)

LONG TERM(2022 - 2025)

16,947 Homes

48% Pipeline Volume

£41 Billion Sales Value

9,622 Homes

28% Pipeline Volume

£22 Billion Sales Value

8,486 Homes

24% Pipeline Volume

£14 Billion Sales Value

Page 7: London Prime Residential Pipeline 2016

MAPPING OUT LOCATION

1,754589

401

343

1,960

1,104 1,600

933

17

427252

10,9148,863

5,898

Chelsea & Fulham - 10,914

Southbank - 8,863

City & Fringe - 5,898

Victoria & Pimlico - 1,960

Midtown - 1,754

Docklands - 1,600

Kensington - 1,104

Bayswater & Paddington - 933

Mayfair - 589

St. John’s Wood - 427

Belgravia - 401

Knightsbridge - 343

Marylebone - 252

Hampstead - 17

KEY

The exclusive west London postcodes of Chelsea & Fulham are currently proving the most popular areas of the capital. Here, almost 11,000 new luxury homes are planned with a sales value of around £20 billion. This figure, however, is heavily influenced by the future regeneration of Earls Court which represents around two thirds of the planned development in the area, and for which the programme is currently being reviewed.

In the main, however, the concentration of new build activity has been focused on emerging locations. These areas are outside the traditional ‘golden postcodes’, where developers see potential for house price growth fuelled by regeneration schemes creating improved business links, social and retail amenities and, critically, new transport infrastructure.

One such area is the Southbank where continuing transformation has seen the area swiftly establishing itself as London’s third major business district. Here, the value of prime residential development has reached £14 billion, up 37 percent on 2015. Likewise, in the City and fringe the ‘tech city’ revolution coupled with new Crossrail stations is proving a growing draw for investment. The total number of homes planned in these areas has seen a 40 percent increase on last year.

Page 8: London Prime Residential Pipeline 2016

DIFFERENT GRADES OF LUXURY AVOIDING THE SQUEEZE IN A CONSTANTLY CHANGING MARKET

When it comes to types of home, in terms of sales values, over two thirds of new build prime properties are now valued between £1,350 - £1,750/ft2 with a further 21 percent valued between £1,750 -£2,250/ft2. This demonstrates that the bulk of the units are at the bottom end of the prime market.

0

5000

10000

15000

20000

25000

1,350 -1,749 1,750 -2,499 >2,500

Units per year 2014 index

Number of units 2014 Number of units 2015

Looking ahead, we predict that the financial viability of prime residential development will be under pressure for the next two-to-three years. During this period, construction costs are forecast to rise faster than sales values, making further erosion of developers’ margins a possibility until values for prime property recover. This is forecast by several leading agents to be between 2018 and 2020.

Our view, supported by conversations with several clients, is that because of the disparity between construction prices and sales values, it is likely that developers of prime residential will now need to find at least 10 percent cost savings to achieve their desired internal rate of return and remain viable.

In addition, we are also seeing strategic reviews being carried out on a number of projects. This is in order to refine the proposed product mix and unit sizing to reflect the changing purchaser demographics of a market which now has a greater focus on owner occupiers and domestic home buyers.

In the current climate, the development control process needs to be stronger than ever before. Fully exploring the relationships between costs and value is vital when it comes to both creating fundable schemes and securing the best possible returns. Given a blank sheet of paper, our recommendation is to work backwards from a sales aspiration target when shaping a scheme, but the inevitable reality is that developers are challenged by having to deliver more for less.

By contrast, we have seen very low rates of growth in the number of super prime and prime in more central locations such as Kensington, Knightsbridge and Belgravia. This reflects the higher land values in these areas, coupled with a typically smaller average size of development. In comparison to fears of over

Number of units per sales band 2014 vs 2015

supply at the bottom end of prime, there still appears to be opportunity for smaller and differentiated boutique schemes at the top end of the market in excellent locations.

Page 9: London Prime Residential Pipeline 2016

Design and build has been the predominant form of procurement and delivery in the prime residential market in recent years. However, many of these successful projects were secured under contract prior to the rebound in market prices in 2014. Since that time, developers have found it increasingly expensive to pass delivery risk to the point at which the viability of projects is being threatened.

In our view, more innovation in procurement practice is needed as some clients can no longer afford the multiple layers of back-to-back risk pricing passing through the supply chain to a main contractor. Clearly, smarter approaches than ever before are needed when it comes to managing value creation and optimising the technical elements of buildings, such as the mechanical and electrical services and infrastructure, in order to help developers ‘beat the market’ and stay viable.

-10

-5

0

5

10

15

20

25

30

35

40

Arcadis TPI % annual increase Arcadis TPI cummulative

Savills cummulative index Annual capital growth %

Perc

enta

ge c

hang

e in

dex

market recovery

2012 2013 2014 2015 2016 2017 2018 2019 2020

COST PRICE GROWTH VERSUS VALUE GROWTH

It will not be until 2018 that capital values will start moving ahead of build costs, suggesting a window of recovery for the prime new build market between 2018-2020.

Page 10: London Prime Residential Pipeline 2016

April 2013

March 2014

Introduction of tax on ‘enveloped dwellings’ valued over £2m. Capital gains tax introduced for AETDs at 28% on gains

December 2014Replacement of the stamp duty ‘slab’ system seeing a higher tax burden on properties at the top end

Capital gains tax payable on profit of the sale of property within 30 days

April 2014

Expansion of the ‘enveloped dwellings’ tax rules to cover properties valued at over £1 million and also over £500k from April 2016

Tax free period reduced when converting a main residenceinto an investment property

April 2015

April 20163% stamp duty surcharge on all second property purchasers

April 2017Capping of mortgage interest tax relief down to 20%

April 2017Removal of permanent non-domicile tax status for those living in the UK more than 15 of the last 20 years

Full transition to taxing landlords based on turnover rather than profit

May 2019

April 2020

15% stamp duty rate imposed on purchases by ‘non-natural persons’ (corporate entities)

TAXING TIMES FOR PRIME PROPERTY IN THE CAPITALThe government initially encouraged investment in the prime housing market as a means to stimulate economic growth. However, since then, it has changed its policies mid-way through a development cycle, raising taxes to fend off voters’ concerns over rising house prices and a consequential lack of supply for British families.

The ongoing catalogue of far reaching tax reforms and fiscal regulations have made the UK a more expensive and complicated market in which to invest. Not only has this impacted many large developers who have already committed significant funds, but it also risks a downward spiral of less affordable homes being built and supplied elsewhere, defeating one of the core purposes of the reforms.

Since the end of 2014, significantly higher stamp duty rates have been introduced for transactions at the high end of the market. On top of this, as of April this year a punitive, additional three percent surcharge on second home ownership was introduced. This rate now applies to all buyers regardless of where they are from or the whether or not they are purchasing through a company structure, and have proven damaging for the central London prime market. Certain parts have virtually ground to a standstill as a result.

Many homes in this bracket with an average value of between £4-£5 million have seen the stamp duty levy increase by over £150,000. While for those intending these properties as a second home, the levy has grown by around £275,000. This increase alone is well over the average house price in the UK.

Wider tax increases have also created problems. Initially observed as unlikely to dampen investors’ appetite for prime property, the increasingly convoluted and expensive regime has since been met with global currency devaluations, shocks in the stock market and falling commodity values. PwC observe that the British property tax system is also now the most ‘complex’ in the world, endangering London’s reputation as an investment haven.

The full impact of the government’s tax tinkering is still unclear. Nevertheless, a convoluted tax system and the spectre of further possible changes is, undoubtedly, in danger of undermining confidence in a market that previously attracted investors off the back of its track record for political and financial stability.

Tax Tinkering – a chronology

Page 11: London Prime Residential Pipeline 2016

STAMP DUTY CHANGES ON PRIME PROPERTY

£1mPROPERTY

PRICE

£40,000

£43,750£73,750

OLD RATE - PRE 4 DECEMBER 2014 NEW RATE - PRIMARY RESIDENCE NEW RATE - SECONDARY RESIDENCE

£3mPROPERTY

PRICE

£210,000

£273,750£363,750

£5mPROPERTY

PRICE

£350,000

£513,750£663,750

£10mPROPERTY

PRICE

£700,000

£1,113,750£1,413,750

Homes in £4-£5 million bracket have seen the stamp duty levy increase by as much as £275,000

Page 12: London Prime Residential Pipeline 2016
Page 13: London Prime Residential Pipeline 2016

THE UNINTENDED CONSEQUENCES OF TAXING AT THE TOPSeveral industry experts have commented that the government has overshot its mark by taxing the upper end of the market too severely at 12 percent. The higher rates of stamp duty on prime properties under the new slice system came at a time when the market was already suffering from falling off-plan sales and rising construction costs. Despite fears of an over-supply of prime properties in London, the reforms have inadvertently exacerbated an excess of properties at the top end of the market by increasing the total costs involved in purchasing them. The inevitable stand-off which has resulted between purchasers and sellers has induced a level of anxiety in the development and finance markets that is not conducive to stimulating further new build. This means there will be less in stamp duty receipts to the Treasury, and

fewer affordable homes being delivered across the London market, potentially aggravating the well-documented housing crisis.

Home ownership is one of the most important levers of social mobility. However, if the purchasing process is too costly for prime property, wealthy homeowners are less likely to buy upwards. This, in turn, leaves no room for middle-income buyers who also wish to climb the ladder or the lower-income buyers beneath them in the chain. In the medium term, the result of this stagnation is fewer transactions going through and prices increasing further as supply continues to outstrip demand.

Another flashing light on the dashboard is that of the mid-market. With stamp duty growing rapidly at the highest price brackets, there are also signs that those looking to invest in residential property are now beginning to acquire properties valued around the £1 million to £1.5 million mark. This rush to market is at risk of causing something of a distortion. Developers are now being forced to focus on building more one bedroom flats and fewer family homes in order to keep purchase prices below the magic £1.5 million threshold.

Furthermore, the choking effect of the new higher stamp duty rates is leading, in some cases, to delayed or cancelled starts for new build prime developments. Consequentially, the badly-needed affordable housing contribution made by these schemes is also cancelled out. Meanwhile, fear also exist that landlords will also just simply increase rents to offset the impact of the reforms, making the capital even less affordable for renters.

The choking effect of the new higher stamp duty rates is leading to delayed starts and putting affordable housing contributions at risk

Page 14: London Prime Residential Pipeline 2016

OSBORNE’S HAIRCUT FOR DEVELOPERS The key issue with stamp duty is that it has to be paid with cash. In a buyers’ market of dipping asset values, many developers – particularly those of larger schemes – who cannot merely wait for the market to shift are particularly under pressure to offer incentives such as ‘stamp duty paid’ in order to secure sales. The end result being that stamp duty is increasingly a tax on developers rather than buyers.

Assuming the extra cost of the new stamp duty rates are discounted from the sales prices, as agreed on many new build schemes, we estimate the charges take a serious chunk out of gross development values and developers’ margins.

The potential erosion to gross development value and margins linked to stamp duty discounting is now a significant issue for developers, especially when considered in combination with unforeseen increases in construction costs. The overall result of this is a potential double whammy for developers to navigate in their appraisals.

There is also a risk that higher stamp duty charges could result in exponential downward impact on values, as price-sensitive investors sit out the cycle and wait for the bottom of the market prior to purchasing.

Prime London DevelopmentsScheme of circa 240 apartments at a sales value of £1600/ft2

Super Prime London DevelopmentsScheme comprising circa 70 apartments at a sales value of £4000/ft2

hit onmargin

4%extra stamp

duty

£9m

All units sold off-plan to investors

7%hit on

marginextra stamp

duty

£36m

All sold to second home owners or investors

To ensure a buoyant housing market across the board, a reduction in the top rate of stamp duty must be imposed to release pressure on developers who have committed to land purchases under the coalition government and prior to December 2014. Alternatively, the Chancellor should scrap the extra stamp duty costs on new build schemes and, instead, negotiate directly with developers for a higher direct affordable housing contribution at a more viable level. This would avoid frightening developers and investors away from the London market, holding back regeneration and badly-needed affordable housing supply.

Page 15: London Prime Residential Pipeline 2016

‘Flight to quality’ Large-scale, multi-unit schemes have boomed at the lower end of prime, while the pipeline for new build above £3,000/ft2 has remained quite flat. Overseas developers, in particular, may prefer to invest in small to medium sized projects with fewer units in higher value locations where supply is lower, such as Kensington, Knightsbridge, Mayfair and Marylebone.

Mixed useDevelopments close to stations and transport hubs have big potential.Combining prime residential with retail and grade ‘A’ o�ce space – we forecast continued growth in the pipeline at Canary Wharf, Paddington, Victoria and Hammersmith locations where new transport infrastructureis gathering pace and values are increasing between 25 and 30 percent.

According to Oxford Economics, the sheer pressure of populationgrowth will see London house prices double by 2030. We predict that areas in London where flats are currently valued at less than £1 million, and houses under £2 million, will be the next areas for prime development. We expect to see growth in locations such as Camden, Kentish Town, Maida Vale, Clapham, Canada Water, Wapping and Old Oak Common.

The new £1million neighbourhoods

Acute under supply of housing will increasingly mean that Outer London Boroughs and commuter towns will have to absorb the population overspill from Central London. This will see prices grow substantially. As a result we expect additional growth in locations such as Wembley, Stratford, Croydon, Brent Cross, Cricklewood, Tottenham Hale, Havering, and Abbey Wood.

Outer London Boroughs and commuter belt

WHERE NEXT FOR DEVELOPERS?Developers need to be nimble and turn the difficult market to their advantage. Given the fears expressed about a potential over-supply of prime London homes and recent anxiety that investors may walk away from deposits on new build projects, we may see changing patterns over the coming months and years.

In essence, the medium-term impact of growing costs for prime residential property will see developers target locations where buyers can get more ‘bang for their buck’. This is particularly the case with homes in the sub £1,000/ft2 bracket with a greater variety of tenure. Such a move may bring developers more closely into direct competition with house builders, or encourage more joint venture working.

Page 16: London Prime Residential Pipeline 2016
Page 17: London Prime Residential Pipeline 2016

EXPANDING HORIZONS With some investors finding themselves priced out of the traditional London market, the UK’s regional markets are fuelling opportunities for development, with the likes of Manchester, Birmingham, Leeds, Bristol, Edinburgh and Glasgow coming into sharper focus. Institutional investors have seen the attraction of these locations in terms of accessible land values, capital growth and yield.

The British government’s commitment to improving connectivity, including the likes of HS2 and HS3, are breathing renewed confidence into regional markets, such as Manchester and Birmingham. Businesses are being encouraged to locate operations in these less expensive areas that offer improved prospects and infrastructure. In turn, the growth in business interests is drivingpopulation growth and an increase in demand for housing in prime regional city locations valued between £300/ft2 to £475/ft2.

The real game changer that will accelerate future regional growth is the move to fiscal devolution deals across the UK. Devolved combined assemblies are empowered to take control of collecting business rates and co-ordinating the spatial planning and infrastructure priorities across their regions in line with a common economic development plan. So, too, will enterprise zones create clustering opportunities for businesses, along with improvements in amenities, social infrastructure, education, health and housing.

Midlands Engine West Midlands Combined Authority region

The Northern PowerhouseManchester, Liverpool, Leeds, Sheffield and Hull

West of England City Region Bristol, Bath, North Somerset and South Gloucestershire

Oxfordshire and Cambridge

Areas of opportunity

London

Page 18: London Prime Residential Pipeline 2016

WHAT DOES 2017 PROMISE FOR PRIME?The challenges facing developers have risen over the last twelve months. The market has flattened considerably as demand from overseas purchasers has waned and successive rises in stamp duty have hit hard. Taken within the context of a June referendum on EU membership, all of this combines to ‘frighten the horses’ and a period of inertia has set in.

Following six-to-seven years of unprecedented growth, it appears the market has reached the mid-point of the pipeline delivery cycle and the government has acted to stem this in order to quell fears over a prime London asset bubble crash.

Ironically, the high levels of taxation brought in at the top of the market now threaten to drive a flood of vendors into the city’s mid-market, depriving families of more affordable housing stock in the suburbs, while simultaneously precipitating the risk of a glut of prime London homes valued above £2 million languishing on the market and creating distressed assets and investors.

Several developers detected some time ago that the ‘cheese was moving’ in London and have responded accordingly. Some are now actively pursuing mixed tenure schemes and mixed use developments located in outer London locations, the commuter belt and other regional cities where the mainstream UK owner occupier is the target. Other developers have remained focused on building out their committed projects in the prime central locations and responding to shifting market need by refining their product mix, specification, delivery programmes and sales strategies.

2017 prime predictions

Slowing pipeline growth in 2017 caused by market uncertainty and a potential Brexit

Growth in City and Fringe, Canary Wharf and prime outer London to continue at pace

Strategic reviews of projects leading to re-positioning of product mix aligned towards owner occupiers and smaller apartments below £2m

A renewed focus on cost reduction, leading to reduced basement and amenity provision where business case is marginal

Programme reviews for larger schemes linked to deferred delivery, phasing of build and re-financing

Shifting moods in procurement attitudes among developer clients away from simple ‘one size fits all’ two stage design and build procurement

Clients becoming increasingly open to more hands-on control of risk and supply chain relationships in order to optimise price

Increase in joint venture partnerships between developers and house builders to access supply chain and spread risk

Continued trend towards mixed use development including offices, hotels and retail

Increasingly polarised market with well-located, smaller boutique prime / super prime schemes and build to rent becoming preferred assets

Possible re-awakening of the Asia capital markets in the event of post-Brexit devaluation of sterling.

Page 19: London Prime Residential Pipeline 2016

Without a cut in stamp duty, the next few years are likely to see slower growth in the prime London market. Against a background of low transaction levels, we may also see more developers delay bringing forward projects and regeneration schemes that would, in turn, benefit London’s civic amenity, create jobs and aid the City’s competitiveness.

In the meantime, the current squeeze on viability and the imbalance between construction costs, sales values and higher transaction costs, coupled with concerns of over supply in some locations, suggests a period of adjustment. We expect recovery in the prime central London market will come about once sales values, as predicted, rebound again between 2018 to 2020.

Until this happens, we expect the lion’s share growth to be centred around the fringes, prime outer London and in certain regionaleconomic centres.

CONTACT

Mark Cleverly

Head of Commercial DevelopmentT +44 (0)7736 900 211E [email protected]

Some are now actively pursuing mixed tenure and mixed use schemes in outer London locations and the commuter belt