How seriously should we take warnings that prices could fall by a third or more?
It goes without saying that we are in a period of extreme uncertainty. The main cause, of course, is Brexit, and the question of whether Britain can achieve an amicable divorce with the EU or whether such hopes disappeared with the end of Theresa May’s premiership.
Then there is the risk of a hard-left Labour government. It is hard to imagine the Labour leader in a rugby shirt but, as our new premier Boris Johnson once put it, Jeremy Corbyn is indeed waiting for the ball to come out of the back of the scrum if the Tories and the Brexit Party succeed in dragging each other down.
What does all this mean for property? Is there a safe haven to be found in bricks and mortar? Or is property in the line of fire, highly vulnerable when the cold winds really start to gust? It is an intriguing question.
Property professionals have had one or two reasons to curse Mark Carney, the outgoing Bank of England governor, in recent years. Sometimes it has been because of his warnings of imminent interest rate hikes, most of which came to nothing. Of late it has mainly been because of the Bank’s no-deal Brexit warnings. When news first emerged of the governor’s warnings to the May Cabinet last year, which included a fall of more than a third in house prices, most people thought this too fantastical to be true. But the Bank was required by the House of Commons Treasury committee to publish these warnings, and the house price fall was in there. Cue a collective banging of heads on desks in estate agents’ offices across the country.
Headlines are dangerous, not least those relating to house prices; they need to be set in context. The context for that dramatic house prices headline was that this was one of the elements of the latest stress test the Bank of England had set for the banks. It included, as well as that big fall in house prices, its likely causes: a rise in official interest rates to 4% and a large increase in unemployment.
Now, while there are circumstances in which interest rates could rise so rapidly, including a crashing pound, we have to consider what is likely. Bank rate has been below 2% for well over a decade (having never been below 2% for the previous three centuries) and a no-deal lurch into recession would hardly seem the occasion to break with that pattern. We should also consider the resilience of house prices in recent years, which has been impressive. Yes, there has been weakness recently in parts of the country, notably London, and yes, the post-crisis recovery in many other regions has been small or non-existent. But Armageddon has been avoided.
Nationally, prices soon recovered from their falls during the 2007-09 crisis and the impact of the referendum has been quite limited. The main effect, according to the official house price index produced by the Office for National Statistics, has been a slowdown in house-price inflation from around 8% at the time of the referendum to around 1% now. Transaction volumes have been disappointing, as they have since the crisis, but prices have avoided collapse.
That does not mean there is no risk to housing from a no-deal Brexit. Most measures of housing activity, including mortgage approvals, held up well over the summer.
Prices have been dull but not noticeably weak. But this may be the lull before the storm, and a no-deal Brexit would still represent a storm. Any effect on house prices would, I suspect, be quite modest, though – a single-figure percentage price fall; a long way from the Bank’s stress test scary scenario. As in the wake of the June 2016 referendum, the Bank would be much more likely to cut interest rates than raise them, helping support the market after a no-deal Brexit. That probably makes housing more of a safe haven in troubled times.
What about commercial property? It will be recalled that there was a shock effect immediately after the referendum, when several commercial property funds had to be suspended to halt withdrawals, though these suspensions were not long-lasting.
The Bank of England, in its latest Financial Stability Report, highlighted the vulnerability of commercial property.
This also featured in those stress tests, which included a fall in commercial real estate prices of 40%, though the same probability considerations apply to that as to the house price fall headlines. The Bank had, however, noted a sharply reduced flow of foreign investment into UK commercial property this year.
And it warned: “Given their share in transaction values, foreign investors’ decisions are likely to be an important determinant of UK CRE [commercial real estate] prices. Prices continue to appear stretched, particularly in central London markets, where foreign investors are most prevalent, at 67% of transaction values. The fall in foreign investment in 2019 Q1 accompanied a 0.7% fall in CRE prices. CRE is widely used as collateral for corporate borrowing, so a downturn in CRE valuations could affect the real economy by reducing companies’ access to funding.”
There is a safety valve for commercial property, of course, as we have seen in recent months. This is that a lower pound increases the affordability of UK assets for foreign investors. And there seems little doubt that, in the event of a disorderly Brexit, sterling would fall significantly. Some UK commercial property assets, particularly those that are domestically focused, will remain attractive.
We should not be too gloomy. There is no reason to anticipate anything more than an echo of the sharp falls seen during the financial crisis, however scary the numbers in the Bank’s stress test scenarios. Capital Economics, for example, expects a no-deal fall in commercial property values to be limited to between 5% and 9%.
According to a recent assessment by S&P Global Market Intelligence, “The resilience of the country’s property market in the face of such political uncertainty has led many within the industry to conclude that whatever happens as a result of Brexit, the long-term prospects for the country’s economy and real estate market are promising given the strong fundamentals the UK offers businesses and investors.”
For others, however, it will be a question of wait and see, even with the incentives provided by a lower pound. Some aspects of commercial real estate, notably shopping centres, are already under a lot of pressure. It could be quite a rocky ride.
