Two months ago the view from Berkeley Square was cautious, particularly on Brexit and retail, but one could see ‘clear blue water’ (even if bitter tasting!). After a disastrous Tory manifesto and even worse campaign, the waters are muddied and in Kensington Gardens turning red! It’s hard to imagine a more challenging outcome for property investment and for intermediaries. The problem now for property markets in the UK is the uncertainty. This new Tory/DUP government could break down at any moment, but even if the coalition staggers on for two years until the Brexit deal (or no deal) becomes clear, it is the political uncertainty which will affect property markets.
The UK consumer?
Post the EU referendum, the UK consumer was remarkably resilient, based on low interest rates and low unemployment, assisted by weaker sterling. The home-builders are a good barometer, and after a few days of low activity after the referendum result, levels of viewings and sales of new housing bounced back strongly. Consumers surely now need to be more cautious on job prospects, the cost of borrowing, and potentially higher taxes, particularly at the higher end of the housing market where activity is already weakened by the effects of stamp duty. The sad irony is both Labour and the Tories pledged to build a million new homes, which now looks an impossible target. The higher end of the second-hand market will be the worst affected, making downsizing more difficult (in spite of the compelling demographic demand for all forms of retirement living). The lower end of the new build market (the 200k-250k) should remain active but very reliant on Help to Buy. There needs to be clarity on whether this policy will be extended, or if a termination date is set, how it would be phased out – otherwise there’s a potential cliff edge here.
And retail sales will surely suffer. The resilience of the British consumer (and in particular Generation X) is not to be underestimated, but big ticket items and the more discretionary spend will be softer – it’s just a question of how soft. Combined with higher imported inflation and the unstoppable march of internet sales, major retailers will again revise their store requirements (and the pricing). Who would be a retail landlord? The one bright spot has remained central London retail, helped by lower sterling and tourism. Terrible events in London and Manchester may however reduce tourist numbers, both domestic and international – let’s hope not, but economic uncertainty combined with an increased terrorist threat may have an impact on retail and leisure spend in the capital.
Commercial activity?
To date, take-up levels in London offices have remained solid in spite of the obvious hard Brexit risks. However, with each quarter the levels of ‘active’ (future) demand are steadily declining. To date great space at good value rents has been taken up at close to or above ERV, but I expect the second-hand space market to now further weaken. There is an argument that a hard Brexit is now less likely, but this won’t stop the investment banks (and accounting and legal professions) from making their plans – they can’t afford not to be ready in the event that all EU related financial services have to be conducted from inside the EU. And if a soft Brexit is more likely, so is a more prolonged debate and timetable, so that putting in place interim measures is likely to become essential, but also further delaying the eventual terms of Brexit (potentially by several years). But my bigger fear is that the restructuring of the global investment banks will now accelerate – the big winners will be New York, Mumbai and Shanghai, not Paris or Dublin or Frankfurt.
But I am not so bearish medium term on London offices. New office development supply will be further delayed (and banks will become even more cautious funding new spec development) and there is a real possibility of shortages of quality new space emerging even in a market suffering from weaker demand. And much of our office stock remains unfit for purpose, and so the business model of upgrading obsolete buildings and sites remains a good one. The issue is that amount of second-hand space available will now rise faster and rents on this space will fall. This should feed through to investment values and land values – but expect a two tier market.
Investment from overseas?
To date investment into the UK from overseas investors has been voracious, with Asian buyers in particular looking to get money out of China into safe haven assets helped by weaker sterling. There is now a risk that overseas buyers become more selective, both in residential as well as commercial. Investment activity and volumes will most likely reduce, and the intermediaries will have to work harder or smarter, and I expect more ‘off market’ transactions where vendors look for certainty rather than risking publicity and potentially an aborted transaction. Meanwhile a number of UK entrepreneurs will be looking at their options. Having looked down the barrel in 2008/9, and made good capital gains over the last 7 years, I wonder if a few may want to take some money off the table while tax rates are relatively favourable? Overall investment markets are likely to become less liquid and less efficient, and curiously this may prompt a few cash rich countercyclical entrepreneurs to come back into the market at more attractive price points.
The Union?
One important political and investment aspect is clearer this week, with the SNP losing seats to the Tories in Scotland, reducing the likelihood of another Scottish referendum on independence. And so a cloud hanging over the property market in Scotland is removed, but so is the potential upside of Edinburgh becoming an alternative EU financial centre. And some investors may conclude the future for Belfast is bright, with the DUP likely to demand material financial investment in Northern Ireland in return for their loyalty in Westminster. But for how long can this coalition last?
Perhaps I am being too bearish (too scarred by the experiences of the 1970s!), and so for the record the upside case is a strong Tory/DUP coalition, a good Brexit deal, and an improving economy in two years’ time in a property market undersupplied of good quality commercial space and lacking an adequate supply of new housing, all contributing to an attractive investment case for UK property. However, the probability of this outcome has reduced or at least is deferred…
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