Forecast: cloudy

The recession may be over, a new Government is in power and an emergency budget announced… so what does this mean for the future of property markets in Scotland?

When asked to look into the crystal ball, “Just more of the same” was all the enthusiasm one solicitor could scrape, while wistfully recalling the heady days of soaring property prices during 2007-08.

Since then the residential market has bombed and, although prices are now recovering slowly, most industry experts still see lean years ahead as confidence in the economy remains weak, public sector jobs are threatened and restricted access to finance continues to strangle the market.

Although the investment market enjoyed a resurgence towards the end of 2009, it too has fallen into the doldrums and the only interest for the near future will be in the prime properties in the market.

In fact, this is true for all property sectors and the old adage “location, location, location” still holds up in post-recession Scotland.

Residential: more affordable?

While one industry insider described the fall in the commercial market as like looking into a black hole, there are some signs of light to draw comfort from – but not that much to help illuminate the path forward, as the prospects remain mixed across most of the property sectors.

When the banks pulled the rug from under housebuyers by scrapping their fabled 110% mortgages and demanding deposits of at least 20%, the residential housing market literally collapsed – along with the aspirations of first-time buyers trying to get on to the property ladder.

As a result, mortgage lending in the UK dropped significantly from its peak in 2007.

According to the Council of Mortgage Lenders (CML), house purchase lending in Scotland mirrored the rest of the UK by falling 33% in the first three months of 2010.

There were 9,700 loans to Scottish homebuyers (worth £1.1 billion), down from 14,400 (worth £1.6bn) in the last three months of 2009.

The fall largely reflects the fact that many homebuyers who would have normally bought in the early months of 2010 brought forward their purchases to take advantage of the stamp duty holiday on properties valued at under £175,000 before it ended in December last year.

However, compared to the first quarter of 2009, mortgage loans in the first three months of 2010 were up 28% by volume and 36% by value.

First-time buyers accounted for 40% of all house purchases in Scotland in the first quarter of 2010. This totalled 3,900 new loans – a 39% increase on the trough seen a year previously. What is interesting is that the average deposit put down by first-time buyers was 23% of the property value. This is the first time average deposits for this group have been below 25% since the end of 2008 and the CML said this is evidence of some modest easing of affordability criteria for Scottish first-time buyers.

While is it good news that more first-time buyers are getting their feet on the property ladder, they are still relatively few on the ground.

Reema Mannah of title insurer First Title Insurance believes that more lower value residential properties are currently changing hands compared to the high end stock: “Individuals who own lower value properties are becoming more realistic about the value of their homes and the need to move on.” She expects to see knock-on effects from public spending cuts.

Curious spread

Scotland has a wide geographical variation in house prices: some of the highest prices are found in Edinburgh and, ironically, the lowest in Fife, just across the water. And Aberdeen lives in a world of its own – the city may be culturally twinned with Regensburg in Germany, but its economic soul is twinned with the price of Brent crude!

The table on the previous page shows the range of geographical house price variations across Scotland.

Most solicitors agree that the residential property market is unlikely to return to the heady days of the 1980s-90s and they would be more than grateful to have a taste of the activity of 2007 again… but they are not too hopeful.

Gordon Cunningham of Tods Murray said: “During 2009, we saw very little activity, mainly because there wasn’t much on the market as homeowners either did not feel confident enough about the future or were put off by the fall in property prices.

“This year is different, thank goodness, as we have seen more people return to the market in the first half of the year to test the waters. We’ve seen a very gradual – but steady – improvement in house prices, but it could be better as we believe there is a lot of pent-up demand out there that is being held back by the difficulty of getting finance.”

Mark Hordern, spokesman for GSPC, said that the signs of an upturn are almost here. “More properties are on the market and we are seeing movement in prime properties in the west end of Glasgow, which is always a precursor to an upturn in the wider market. However, it is still early days.”

In Edinburgh, Wilson Hunter of Gillespie MacAndrew said that there has been a steady turnover in the higher end of the market, but lack of executive relocations has really hit the volume of sales.

He believes the next 12 months will see steady growth in the non-prime residential market, but cautions whether the new Government’s programme of public sector savings will dampen the market as people fear for their jobs.

Prime lead

Savills is more bullish in its forecasts and believes that price movements in the Edinburgh prime market herald a recovery for Scottish property as a whole.

In its new Scottish Property Market Research report covering the first quarter of 2010, it foresees Edinburgh’s equity-rich homebuyers leading the Scottish market out of the doldrums.

Savills’ Research Director Lucian Cook said history is repeating itself: “In the mid to late-1990s, the prime Edinburgh market led the recovery, and with values rising 6.6% in the last six months, according to Scottish prime indices, a similar pattern seems to be emerging.”

The report explained that London prices are usually the first to recover following a recession, with the effects being felt in the Scottish markets between six months and one year later.

Cook added: “In Scotland, where affordability is higher than the rest of the UK, the market is traditionally less volatile and deposit affordability among homeowners is marginally better than the rest of the UK.

“We expect a secondary lag of potential price falls to be less severe than south of the border, but equally for price growth thereafter to be more modest. The prime markets, which are much less mortgage-reliant and more driven by equity-rich purchasers, will perform much more strongly over the next five years,” he added.

Well oiled

Aberdeen tends to move in different cycles to the rest of Scotland’s property market. Its fortunes are very much tied to the relative health of the oil industry, as shown by the ASPC average property price in quarter 1 of 2010 of £188,995, well above the UK average of £168,000 – a difficult market for first-time buyers since the large majority of properties are over £125,000.

Despite a run of steady and high oil prices, Denise Merson, Residential Property Director of Ledingham Chalmers and Director of ASPC, said that there is still a degree of hesitancy in the housing market which indicates that full confidence has not yet returned.

She said: “Although we’ve seen more properties coming to the market, rising from 92 in the first week in January to a peak of 232 in May, sellers’ expectations have risen and there has been a spate of competitive closing recently that has driven prices up, in some cases by 20%, above home report valuations.

“I feel that there are a lot of people watching and waiting to see how the market develops. It is reasonable at the moment, but it’s certainly not as strong as a couple of years ago,” she added.

Rural property: supply and demand

The rural market includes a wide range of properties, from shooting lodges and farms to forestry and land suitable for renewable energy projects.

According to William Jackson from CKD Galbraith, the sporting estate market has held up well, as “trophy assets” are still a favourite purchase with the world’s rich elite who either like the privacy or the entertainment value of running their own fiefdom in the wilds of Scotland.

He said: “The strength of this market is in its limited supply, as most are in family hands and kept for future generations. However, some owners do decide to sell after they have had their fun running an estate, and to ‘downsize’ to something a little less stressful.”

There’s quite a price range to choose from: you could buy a small sporting estate in the Scottish lowlands for as little as £750,000, but a “proper” estate could cost between £3 and £5 million, and that doesn’t include the running costs which can exceed £100,000 per annum, depending on your staff… and your entertaining!

Despite the common perception that Russian oligarchs are buying up Scotland’s ancestral heritage, the main buyers in the market in recent years have been British, European and American. The last sale to a Russian was Aberuchill Castle Estate in Perthshire for £6.8 million in 2005, hardly denting the steel magnate buyer’s £5.4 billion fortune.

Farming: limited activity

There is much more liquidity in the Scottish farm market, either from farmers retiring or wanting to get out of the business completely.

Higher food prices have helped farmers, but farm prices have been adversely affected by higher running costs for fuel and fertiliser and there is uncertainty about future income from subsidies due to the reform of the Common Agricultural Policy. This has also made banks keen to renegotiate overdraft facilities.

The Scottish farm market was kept buoyant in recent years by Ireland’s appetite for farming, fuelled by the country’s booming economy, but this interest has since waned.

However, with little on the market at present, prices have held up. The same goes for rural housing as the increase in purchases of holiday homes over the past few decades has reduced supply, particularly on the west coast and on the islands – much to the chagrin of local people trying to get on the property ladder.

The recent Government push behind the development of renewable energy in Scotland has also had a positive effect on land prices, particularly with the introduction of feed-in tariffs to allow landowners to sell surplus power back to the grid. This has led to speculative acquisitions and sell-offs of land with exposure to high winds, good access and located near existing grid connections. The Government’s go-ahead for the Beauly-Denny upgrade will also give a premium to suitable land as its power line develops.

Access to funding has been less restricted in the rural property market compared to the residential market, as the main banking specialists in this field include the Co-op Bank and Clydesdale Bank, whose more conservative approach to banking has left them relatively unaffected by the “casino” antics of their larger competitors.

However, two areas that have dried up because of finance and lack of demand are the development of steadings for residential or business premises and the selling of land for new housing developments.

Commercial property: changed world

The main problem facing the commercial property market is financing. About 75% of the market in Scotland was funded by two banks – RBS and HBOS – and other banks, wary of this market, have significantly tightened up their lending criteria.

This is not a problem for institutions who can access their own funds, but it has effectively killed off speculative property development.

Susie Thornton from Tods Murray said the market has entered a new era in financing. She said: “Property finance is still available, but not at the same conditions as before. Loan-to-valuation ratios have fallen to typically 60-70% and far more due diligence work is required now on the serviceability of the loan, the underlying value of the asset and income forecasts.”

As there is some new commercial property development in the pipeline, this will be beneficial to the property market in the long term – but it is of little help now.

Douglas Hunter of Dundas & Wilson takes a positive stance and believes there will always be a market for prime UK property. He cites the Investment Property Forum’s recent UK Consensus Forecast which predicts “a sharp improvement in performance in 2010, followed by a dip in 2011 and recovery in 2012”, with the best return in the office sector.

Offices: steadying the ship

Scotland has shown some resilience in the face of the recession, with major organisations such as Shell, BNP Paribas, National Trust for Scotland, Wood Group and Deloittes taking significant office space in Glasgow, Edinburgh and Aberdeen during 2009.

According to Ryden’s latest Scottish Property Review, sales and lettings are now at a reduced but steady level, running at around 75% of the long-term average.

It’s certainly a demand-led market at the moment, with landlords, even with grade A space, offering substantial incentive packages to occupiers who can reciprocate with strong covenants.

However, this level of discounting is not sustainable as the supply of grade A property is restricted, and with little new office development in the pipeline, it will ultimately result in a reduction in the level of incentives and an increase in rents.

Industrial: modernising

Once again, Scotland appears to be more resilient to the recession, but this was due to the shortage of modern industrial premises going into the downturn and, with little new development since, this has kept the industrial property market buoyant.

Rental levels have remained steady and there is particular demand for smaller units and those that have good access to major transport links.

Retail: patchy

With many famous retailers going to the wall over the past few years, it is surprising to see that the retail market has kept its head above water.

Ryden’s report highlights how food and large discount retailers, plus those located in out-of-town shopping centres, have done well out of the reasonably strong level of consumer expenditure during the recession.

However, the market for non-prime property on or off the high streets of Scotland has suffered.

Investment property: asset banks

Last year, the smart money was in property with a surge of investment acquisitions that helped lift the prime section of the market. But this spending spree has since dried up.

According to Paul Jenning of Bell & Scott, the market has been very subdued this year, with the only real interest in grade A properties in core locations with strong covenants.

Reema Mannah of First Title Insurance says institutional investors are once again looking for long term yields. “Not surprisingly, there is a lot of activity in the market around renewable energy sites.” A market that is increasingly risk averse is fuelling demand for title insurance.

Douglas Hunter from Dundas & Wilson is worried about the future of the market and believes it is sitting on a potential time bomb.

While property investment has become an anathema to most banks, they are still sitting on considerable property assets and are under considerable pressure to get rid of them.

Hunter explained: “The Government has told banks to reduce their property portfolios to create more balance in their underlying assets, but the banks are in a catch-22 situation: a fire sale of property would depress the market further and erode the value of their assets, while to hang on to them longer will just exacerbate the situation.”

And there are more properties being released on to the market from the portfolios of companies such as Kilmartin and Kenmore that went into liquidation.

It would appear the timing of property sales will be a real issue for the banks to retain the maximum possible prices for their assets without tipping the market into freefall.

What next?

Crystal-ball gazing for most commentators on the property market is at best hazy and most are writing off any signs of significant improvements this year, hoping for better times in 2011-2012.

Confidence is the key driver for the property markets and it’s not at high enough levels to galvanise the markets.

High on most people’s wish list is a period of steady economic growth, but the jury is still out on what influence the new Government’s fiscal policy measures will have, particularly as it is looking for considerable cost cutting in the public sector – a significant employer in Scotland.

“Subdued” and “fragile” are two words that many commentators chose to characterise the markets for the near future.