Knightsbridge in London acts as a bellwether for the performance of superprime property

The fallout from the collapse of Lehman Brothers, the US bank, in September last year was strong enough to shake the foundations of even the most luxurious property markets, as the previously separate worlds of subprime and superprime housing collided.

At the time, September 15 did not appear to mark an instant turning point. Estate agents’ telephones did not suddenly go silent nor did their BlackBerrys stand idle. In retrospect, the events of that day were the catalyst that pushed the property market over the edge in so many locations across the world.

The Lehman collapse, together with the turmoil at US mortgage financiers Fannie Mae and Freddie Mac and insurer AIG, marked an important juncture in the credit crisis and confirmed the limits of world governments’ ability to manage the downturn, generating an almost panic-like reaction in the financial sector.

London is perhaps the single most important link in the global prime property market, through which both buyers and wealth flow. And at the heart of this market lies Knightsbridge – a locality that acts as a bellwether for the performance of superprime property.

In the weeks that followed the Lehman collapse I repeatedly visited Knight Frank’s Knightsbridge office to monitor how the worsening credit drought was affecting the market. Week-by-week sales were falling apart and buyers were reneging on deals – but not always because they had decided to call an end of their own accord. More commonly they had no choice as mortgage offers were withdrawn and valuations downgraded.

HOT SPOTS

Markets on the march

King’s Cross and Bloomsbury, London
The regeneration of the former railway lands to the north of King’s Cross station and the newly restored St Pancras terminus in north London is under way. Within less than a decade this area will be a significant residential and commercial quarter, with arguably the best transport infrastructure anywhere in the UK capital. The scheme will lift a much wider area, including Bloomsbury and even Fitzrovia to the south. This is a locale full of period character with opportunities for individual building refurbishments and wholesale redevelopments.

Upper East Side, New York
All of Manhattan’s residential districts have felt the chill of the downturn, with prices down 25 per cent from the 2007 peak. Even the most expensive neighbourhoods have seen price-drops of this level. The attraction of such an established location as the Upper East Side is precisely because it is established. There is no need for gentrification here; instead this is a market that is proving the maxim that in difficult times there is a “flight to quality”. Demand here has remained far more resilient than other more recently improved localities.

Costa Brava, Spain
In spite of well documented issues undermining international demand for property in much of Spain, the country continues to attract huge interest from overseas buyers and there are areas where overdevelopment or poor planning regulation and practice do not create such problems. The Costa Brava and the countryside just inland historically attracted high-end international visitors and remain popular with wealthy Spanish families. Values both for land and property appear very competitive against other parts of Mediterranean Europe and Knight Frank believes there is a good chance the region will re-establish itself. Barcelona, Girona, beautiful countryside, the nearby Pyrenees and the world’s top-ranked restaurant, El Bulli, near Girona, are all big regional attractions.

By October the central London market was falling fast. Prices for properties valued at more than £5m fell 20 per cent during the following three months. Away from London, across the south of England, demand for country estates dried up. By the end of 2008 the only people selling were those who had to. These vendors tried to fight agent recommendations of 15-25 per cent price reductions – only to find bidders coming in substantially below even this new lower level.

Evolution of the crisis

The credit crisis had been taking shape for two years before the demise of Lehman Brothers. The first symptoms of the malaise began to grip the US housing market in mid-2006 and the Spanish and Irish markets were next to crumble a few months later.

Throughout 2008 sales volumes plummeted in property markets across the world as borrowers were cut off from mortgage finance and residential values dropped rapidly as confidence evaporated.

Sailing above these imploding national markets was the luxury sector. Led by a network of world cities, – from New York to London to Hong Kong, and including the European and US snow and sunbelt resorts, Caribbean islands and the emerging Asian hotspots – this is the collection of markets where wealthy international buyers congregate. But by late summer 2008 even these were cooling. Prices had slipped, buyers were becoming more aggressive in their negotiations and forced sellers were beginning to emerge. But these were still functioning markets. Rather incredibly the very top tier of properties was enjoying a late boom. We still managed to exchange on a flurry of properties in the first two weeks of September but it soon became clear that this would be the last blast for some time.

With the arrival of autumn in London the superprime sector, which had seen more £10m-plus sales in the first half of the year than in the whole of the previous two years, was beginning to run out of steam.

As the dust settled after the Lehman collapse the significance of the downturn was brought home to me by the actions of Russian buyers. For almost a decade no other nationality has done more to lead, shape and direct taste and demand in the global prime market and Russians have dominated markets in London, the south of France, the Alps and New York.

I have the benefit of an inside track on understanding this critical market in the shape of Knight Frank’s London-based Elena Norton, a leading property fixer for the Russian super-rich. It was my conversation with her in late September 2008 that confirmed for me the direction the market would take during the following six months. Some of her buyers were staring bankruptcy in the face as business losses racked up and their credit sources closed.

Only a handful of Russians were buying overseas. These were the seriously wealthy, who were trying to add to their second-home portfolios at reduced prices in the south of France. Back in Moscow the situation was worse. Prices fell 30 per cent in the three months up to Christmas and even at these low levels buyers were staying out of the market.

What went for the Russian super-rich was also true for more recent arrivals in London. Wealthy Indian buyers had had less time to establish themselves at the top of the market but by 2008 they were vying with the Russians for the best houses. By November this market, too, had shut down. Business failures and bankruptcy in India were having a sobering effect on the demand for overseas second homes. Even the domestic Indian market was suffering.

The ripples from Lehman’s collapse spread rapidly. My insight into the New York market is provided by Jonathan Miller of Miller Samuel real estate consultants. His experience confirmed the same trends as were seen in London: an already slowing market suddenly freezing up in the weeks after mid-September. Once again the apparently more insulated luxury market suddenly saw prices fall 20 per cent and more in a matter of days.

In the Caribbean it was the islands that had seen the most recent boom in prices that suffered most from the late 2008 downturn. Those locations that did not enjoy good infrastructure or regular flights lost out to the best endowed locations, such as Barbados (for UK buyers), the Bahamas (for the US) and St Bart’s (for the French). Even in the safer markets prices fell 15-20 per cent in December last year.

Unexpected recovery

While the immediate impact of Lehman was very negative for the property market, it also had an almost cathartic effect. Since 2007 there had been a degree of uncertainty regarding the potential immunity of the luxury sector to the downturn. It quickly became clear that no market could escape a correction. But the dramatic nature of the downturn meant that it was both deeper and more rapid than anybody could have predicted.

Ironically, the severity of the impact spurred new activity. We suddenly found that we became much busier as investors from the Middle East, the US and UK became desperate to position themselves to buy distressed properties and to capitalise on rapid price falls. From early January there was a tentative upswing in buyer interest. What the market really needed was a deal, a significant sale to draw a line in the sand. Then in January – after an absence of nearly four months – Norton’s Russian clients came back into the London market with serious intentions to buy.

The critical deal took place in Kensington in late January: a house was bought for £12m – the first £10m-plus deal since November. Norton’s buyer had, in effect, called the floor in the market. In the country house market it was a £20m sale in Surrey, south-east England, in February, again to a Russian buyer, that helped to switch buyer sentiment, and momentum kept building throughout the spring.

In New York, the recovery at the top end has not been as clear cut. The market has certainly improved since the beginning of this year but buyers even for the most expensive properties are generally nervous of committing too early.

Across the UK and other European markets the recovery has been marked by rising buyer numbers that have outpaced the volume of available property to buy. This lack of stock has helped to generate the competition that has fed through to price rises over the summer. According to Knight Frank’s data the price of prime London houses has bounced back 6 per cent since the market reached its nadir in March.

The diversity of demand for luxury property has helped to underpin the capital’s market. For example, overseas buyers have regained some of their traditional share of the £5m-plus London market. Their portion peaked in the second quarter of 2008 at 68 per cent as the late superprime boom worked its way through. By the end of last year this proportion had dipped to less than 40 per cent. As international buyers gained confidence from the fact that prices were 25 per cent down on their peak, and weak sterling offered another discount, their share of the market grew to more than 50 per cent again by the summer.

The biggest change in the nationalities of those buying has been their spread, which keeps widening year on year. In 2009 significant demand has been seen from South Africa, Nigeria, Kazakhstan, India, Jordan and the United Arab Emirates and especially Italy, France and Greece. The Chinese are just beginning to make their presence felt – but Russians at 12 per cent of all foreign buyers are still a serious force.

One year on from the Lehman collapse there is a new danger creeping. Markets have bounced back from low levels but these rises have been based on very low stock volumes that have generated strong competition for good properties. We also have the benefit of very unusual ultra-low interest rates, which particularly aid equity-rich buyers. The recovery to date is explicable but if it continues at this rate it could pose problems in the future.

Despite this warning note, there has been a change to market psychology. It is a more sober, educated and moderate market that we inhabit this September compared with last year. Buyers are no longer banking on growth and neither are lenders. We will no doubt make the same mistakes in the future as we did in the last boom – but for now we are in a better place.

Liam Bailey is head of residential research at international estate agency Knight Frank