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How Best to Invest in London Property
21 August 2018
Over the years, many Cypriots have invested in prime London residential property. For some, this has provided a home for their children whilst studying at London’s prestigious universities. For others, it has provided a base for holidays, or a helpful additional income. But behind all of these reasons has been the belief that residential property investments will offer strong capital returns over the long term.
However, values have slipped over the past 18 months and the tax regime is a lot less friendly than it used to be. Should Cypriots now consider selling their residential investments and acquiring commercial property instead?
Falling Residential Property Values
Recent research from leading estate agents Savills and Knight Frank, as well as the Royal Institute of Chartered Surveyors (RICS), paints a concerning picture. RICS reported that by the end of 2017, fears over the stability of the market in the aftermath of the Brexit vote had resulted in a 15% drop in London residential property values since Britain voted to leave the EU. In prime central London specifically, there has been a 9% drop in residential values between August 2015 – the latest market peak – and June 2018. Knight Frank notes that while residential properties will inevitably involve more personal motivations, thanks to Brexit we are experiencing an even more unique situation in which ‘sentiment has become a more important driver of demand, which makes the future direction of the market less predictable.’
The residential lettings and sales markets are both facing serious challenges. Increased stamp duty has been a factor pushing down sale prices. As so few people are buying in London due to combined political uncertainty and these stamp duty taxes, owners are putting properties on the rental market instead. This increased supply of rental properties is causing rents to stagnate. Savills anticipates that ‘the current supply imbalance at the top end of the market likely to supress rental growth for the remainder of .’
At the same time more pre-existing landlords are considering selling up, with their rental income so much less reliable than it was, only to find that it is also an extremely difficult market to sell in. Knight Frank is currently seeing their sales and lettings teams invited to 70% of the same property appraisals in South Kensington – historically one of London’s most popular residential boroughs – when a year ago only 10% of property owners would have been looking at both options in parallel. All in all, London owners of prime residential properties find themselves in a vicious circle.
Taxation of UK Residential Property
Consulco works closely with our London-based tax advisors, Lewis Golden LLP. Lewis Golden have highlighted two major tax challenges that have impacted residential property in the last three years:
1. Tax relief on rental income mortgages are now restricted to the basic rate of tax, meaning that while landlords used to be able to acquire buy-to-let properties and use rental income as an untaxed means of paying a mortgage, rental income is now taxed according to their income tax bracket.
2. There are now reliefs for first-time buyers of properties up to £500,000, but stamp duty remains a major consideration for properties in the upper value echelons. The highest bracket affects properties over £1.5m – which covers a large proportion of the London market – at a stamp duty rate of 12%. Given that London property values are so out of line with the rest of the UK, many consider this to be a means of unfairly penalising London property owners, where – as opposed to in other parts of the country - £1.5m does not necessarily denote an especially lavish property. It is for this reason that the so-called ‘mansion tax’ levied on these higher value properties is often deemed a misleading indicator of exceptional wealth.
Time to Consider Commercial Property?
Consulco Real Estate, our London-based subsidiary established in 2010, acquires and manages commercial real estate investments. Our team of experts has acquired 32 assets, currently valued at £100m. We favour retail and restaurant investments in central London, close to transport hubs and in areas with high numbers of tourists and / or workers. Consulco has particularly targeted Soho, Covent Garden, Farringdon and trendy east London – locations where demand for space remains strong.
Although some of our clients prefer to hold their own assets, many join our investors clubs. By pooling funds together, we are able to acquire multiple assets, diversifying risk and widening investment exposure.
Management of Commercial Property
The management of commercial property is a relatively straightforward compared with residential and therefore less risky. In the UK, most properties are let on a fully repairing and issuing basis – this means that the tenant is responsible for all repairs (both internal and external) and must pay the insurance premium. Insurance covers the cost of rebuilding, but also three years of lost rent if the property needs to be rebuilt. Therefore there is very little ‘leakage’ from the rent received. Leases of retail and restaurant premises tend to run for 10 to 20 years, with upward-only rent reviews. This provides investors with a secure income stream that grows over time.
There is a very different set of circumstances with residential rental properties, which generally expose a landlord to more risk. The landlord is responsible for all repairs and insurance, with tenancy terms that are typically much shorter, on average one year, leading to void periods in between tenancies or if a break clause is exercised in the middle of the tenancy.
Think About Demand and Supply
There is virtually no new supply of retail / restaurant space in our central London target markets. It is notoriously difficult to persuade shoppers to leave the ground floor and so the market for retail space in commercial hotspots like Soho and Covent Garden is finite.
Once more, compare this to residential property. There are 115 tall towers (classified as such by being over 20 storeys) currently under construction in London, and a further 395 are planned. There is a strong pipeline of new residential property at a time when the tax regime has become much tougher. Whilst some of the planned projects may not proceed, we are already seeing falling values in locations such as Vauxhall and Battersea where substantial new supply has been created in just a few years.
Taking all of this into consideration, Consulco believes we should challenge convention and consider commercial, rather than residential, as the investment asset of choice in central London. Our latest vehicle, Sparta Capital Holdings Ltd., is open to new investment and provides a diversified portfolio of commercial properties with significant opportunities to add value. We have decades of shared expertise and are led by director David King, who has previously worked for institutional investors including Credit Suisse and AXA, and created and managed property funds for more than twenty years. With a deep understanding of London’s property market evolution, we are enviably placed to make the most of emerging opportunities that will stand the test of time. This is evidenced by our strong track record which has significantly outperformed the market’s challenging conditions, as we successfully make the most of today’s unique circumstances.