London Property Market Update 2023

2023 has brought a series of formidable challenges to the housing market. Surging mortgage rates have significantly inflated borrowing costs, reducing the demand from homebuyers. Leveraged buy-to-let investors are either withdrawing from the market or engaging in fewer transactions.  Developers are transacting less, despite build costs falling. Economic turbulence, together with high inflation and economic slowdown, has led to a cautious mindset among consumers, leading to a decline in housing transactions and a substantial impact on consumer spending.

A sharp imbalance between supply and demand persists, with the London-versus-England disparity adding an additional layer of complexity. Certain regions are experiencing a more pronounced downturn than others, a reminder that London property market is more robust.

The rental market is under pressure as escalating rental costs outpace income growth, placing a significant financial burden on renters. A limited supply of affordable rental accommodation is a serious problem for renters. 

Our landlords who own leasehold properties are facing exorbitant service charges and are seeing the value of their leasehold properties drop year on year. Landlords are faced with higher property maintenance costs, high taxes with the exceptionally high mortgages. Higher market rents fail to match these expenses.

Residential sales remain under pressure.

Average UK house prices in 2023 fell by approx. 1% according to property portals Rightmove and Zoopla.  This demand slump has led to a significant slowdown in house price growth, with some regions seeing that drop from as high as 9%.  Yet Halifax data indicates that average house prices rose by 0.5% in November, marking the second consecutive month of growth. Nationwide attributed this improvement to the Bank of England's decision to maintain the base interest rate at 5.25%, after raising it 14 times consecutively. This suggests that mortgage costs may be stabilising (or even declining) and with inflation dropping faster than expected, potentially fuelling increased activity in the housing market as the year ends.

The number of house sales decreased significantly in 2023, with transactions falling by 25% compared to the previous year. This decline can be attributed to several factors. Firstly, the Bank of England raised the base interest rate five times in 2023, from 3.5% in January to 5.25% today. This increase in mortgage rates has made borrowing more expensive and less attractive, particularly for first-time buyers and mortgage-dependent individuals. As expected, this has led to cash driven auction houses seeing near record highs in the number of lots being offered for sale. 

Moreover, banks have tightened their lending criteria, reducing the pool of eligible buyers. This tightening of credit has further dampened the housing market by limiting the number of potential transactions. 

Richard Donnell, an executive at Zoopla, comments, “House prices have shown more resilience than many anticipated in response to higher mortgage rates. However, the significant decrease in the number of people moving homes is due to increased uncertainty and reduced purchasing power. Modest house price falls over 2023 imply that it will take longer for housing affordability to reset to a level that encourages more people to move homes again. While income growth is outpacing inflation, mortgage rates hovering around 5% or higher remain a hurdle. A lot depends on what happens in the labour market and the true trajectory of mortgage rates”.

Savills anticipates that the housing market has already moved beyond its most challenging phase, although it foresees slight declines in the coming year before witnessing a resurgence in house prices in 2025. Analysts caution that housing forecasts remain uncertain, contingent upon the improvement of the UK economy, job market, and interest rates.

Residential lettings will be impacted by wider policies.

The UK rental market has undergone a significant shift, with rental growth outpacing earnings growth by approximately 10% in 2023. This is a stark contrast to the 6% increase in earnings. Rental growth is typically fuelled by faster earnings growth and the impact of high mortgage rates. These factors are keeping more individuals within the rental market as purchasing a home becomes increasingly challenging.

Landlords have increased rents as tenant demand rises, driven by the limited supply of rental properties.  The government's decision to delay the mandatory introduction of energy efficiency standards and to postpone other legislative changes in private rental properties have been welcomed.

The Chancellor's Autumn Statement, which focused on supporting income growth through an increase in the living wage in London, could help to narrow the gap between earnings and rental costs. However, even with this support, the imbalance between supply and demand in the housing market is expected to reduce rental growth only gradually. The significant contribution of higher mortgage rates and uncertainty about long term capital growth, makes buying a home less attractive compared to renting.

Looking ahead to 2024, the rental market imbalance shows no signs of subsiding. Current forecasts suggest that London rents for new lettings are expected to be around 3.6% with regional cities seeing 6% growth. This ongoing rise is attributed to persistent supply constraints and sustained high mortgage rates.

Contrary to what most people think, many landlords do not want to see high rent increases year on year as this often leads to intervention from government, which can often be late.  For rents to be more manageable the job market needs weaken, fewer people need to move to the UK, and mortgage rates need to go down, although these changes haven't fully happened, yet they are in motion. A drop in mortgage rates could lead to a decrease in demand for renting as first-time buyers are more likely to consider homeownership, reducing the demand for rental properties.  Notably, in inner London, rental inflation is expected to slow down more rapidly due to the already high rents, significant number of new build-to-rent units, and affordability issues. These factors could temper London's rental growth, bringing it to more sustainable levels.

Commercial property has not performed well.

In 2023, London's commercial property market encountered challenges characterised by a surge in inflation and the escalation of interest rates. These factors substantially heightened the cost of borrowing, exerting significant pressure on investment decisions and property ownership within the market.

The industrial sector demonstrated remarkable resilience, driven by the rapid expansion of e-commerce. This sector benefited from the changing consumer landscape, maintaining its stability amid market turbulence. In stark contrast, the retail sector grappled with diminished consumer spending and a fundamental shift in shopping behaviours toward online platforms. High streets and retail units faced particularly challenging times dealing with these changing dynamics.

Office spaces underwent a significant transformation, marked by an escalating demand for top-notch, energy-efficient buildings. This shift was influenced by the rising popularity of agile working practices and the implementation of new regulatory standards such as the Minimum Energy Efficiency Standards (MEES). A noteworthy strategy in response to this shift was adopted by Great Portland, who proactively acquired and renovated older office buildings, positioning themselves to leverage the growing demand for modern, well-equipped office spaces. However, vacancy rates remain high for unmodernised office buildings.

Investment patterns within the commercial property market experienced a noticeable decline in transaction volumes. This decline prompted a comprehensive re-evaluation of investment risks and the anticipated yields. For commercial property investors, the confluence of surging inflation, high interest rates, and stagnant commercial rents created a profoundly uncomfortable and challenging environment. Consequently, this led to a substantial decrease in the capital values of their commercial portfolios, with some mixed London commercial portfolios experiencing a considerable drop of approximately 25% in their values.

The outlook for 2024

The economists and mortgage lenders are predicting a modest fall of 1% national decline in house prices. This decline is expected to be offset by rising incomes and stable interest rates, which will improve housing affordability. The UK interest rates are not governed by the UK housing market, they are determined by the US and its impact on the UK economy with inflation in the front seat. The FED is signalling that a drop in interest rates by approx. 0.75% in 2024 is possible (40:60 chance according to experts).

Rents are anticipated to increase in the coming year due to the persistent gap between supply and demand. However, this upward trajectory has already been hitting an "affordability ceiling". We have been seeing this impact on new lettings since October 2023.  Mortgage rates, a critical factor in the equation, are predicted to remain elevated well into 2024, gradually decreasing by the second half of the year. This prolonged period of high rates will further weaken activity in the housing market; it particularly affects millions of homeowners reliant on mortgages with approx. 5 million fixed rate mortgages coming to an end within 2 years. High rates potentially benefit the rental market. 

There is significant news about the possibility of rate decreases due to future deflation risks. This could lead to a sharper decrease in mortgage rates, fostering greater confidence in buying homes and investing in property provided we do not fall into a recession. As Kamil Kovar, a senior economist at Moody's Analytics, points out for the eurozone, we may soon be more concerned about low inflation than high inflation.