Seeing the wood for the trees: distinguishing cyclical change from Brexit effects
We should be wary of attributing any change in the commercial property market solely to Brexit. The main influence on the property market is cyclical change, caused by fluctuations in supply and demand. In 2009 property development reduced dramatically, due to economic uncertainty and a drop in development finance.
In the City this led to a shortage of supply as tenant demand increased from around 2013. Developers launched projects to meet the shortfall, in turn leading to predictions of oversupply by 2017/18. If Brexit reduces the volume of development projects, this could correct the anticipated oversupply and delay a cyclical downturn. The key point is to understand how Brexit interacts with the cyclical nature of the market.
It would also be a mistake to overlook long-term trends in the market, particularly those occurring outside the capital. Whereas the London market is dominated by office space, in the regions retail properties are more important, but this market is being transformed by major shifts in shopping behaviour. Regardless of Brexit, this sector has seen huge change in the past decade and will likely change yet more in the coming decade.
In the lead-up to the referendum, property investment volumes were declining quarter on quarter; volumes fell around 25-30% this year compared to last. However, this drop is less alarming when you look at the figures in the context of last year being a record year, and that global volumes also fell around 10-12%. In the UK, volumes fell much more sharply in London than the regional markets.
The impact of Brexit on the commercial property market
There are two important impacts on the property market that are unambiguously linked to Brexit. The first is a modest correction in UK property pricing, which is likely to resolve at around 5-8% by the year’s end.
The second change is a repricing of the pound. The initial shock of the referendum vote led to a drop of around 12-14%, and then stabilised, before dropping further after the PM’s announcement that Article 50 will be triggered in early 2017. By the end of the year the repricing will likely be around 7 or 8%. The changed value of the pound makes the UK a more attractive investment location compared to Paris or the big German cities, particularly given current gilt and bond yields are at historic lows. The lower pound could extend the investment cycle and bring in additional investment from dollar dominated investors.
Are we set to see an exodus of financial services?
Will London’s role as a global financial hub be diminished by Brexit? The cost and disruption involved in relocating a large organisation should not be underestimated. It is also hard to see which rival locations in Europe offers the amenities, transport links, labour conditions and quality of life available in London.
Major financial bodies may defer key decisions about extending or expanding their presence in the UK, pending news about how financial passporting will be affected by Brexit. However, sudden decisions to move to a new country are unlikely. For the property market, this could cause stagnation as decision-makers delay making investments in premises. Conversely, some financial organisations may decide to move functions abroad pre-emptively, rather than wait until political developments force their hand.
The impact of Brexit on UK national spending
There are political decisions to be made about national spending post-Brexit, with conflicting imperatives that will be difficult to square. The government will be under pressure to reduce personal and corporate taxation to remain competitive internationally, but this could shrink the size of the state and make it harder to fund investment in infrastructure and skills.
The areas of the UK that supported Brexit most enthusiastically were also often the regions that received the most in EU structural funding, such as Wales and Cornwall. People in these areas are said to feel left behind by globalisation and economic development in other parts of the country. This sense of alienation will increase unless EU funding is replaced or exceeded by national funding following Brexit.
However there will be many other calls on the national exchequer for projects that could lead to greater returns than spending in these pro-Brexit areas. Existing projects such as HS2 and the Northern Powerhouse could be prioritised, unless they suffer from being seen as legacies of the last government. They may also suffer from a shortage of parliamentary time as Brexit continues to dominate the schedules.
The government will continue to court international investors to help sustain the economy. The decision to allow Hinkley Point C to go ahead with French and Chinese partners is reflective of this. Maintaining continuity will show investors from countries such as China and Japan that the UK remains a good place to invest.
What are the top investment opportunities post-Brexit?
Brexit needs to be considered in the context of other major trends in the markets. For example, we currently face not only a rapidly ageing population but also an increasingly youthful working population; in eight years’ time, around 75% of workers will have been born after 1982. Automation and technical innovations such as driverless cars could also have a dramatic impact on social behaviour, the labour market and the economy.
At present it is difficult to find sustainable income streams, given low interest rates. Prime commercial property, particularly in London and other major UK cities, continues to provide good value with yields around 4-5%. Private investors from the Middle East and Far East continue to be very active in UK markets, and many international investors are considering making investments in the UK depending on a favourable Brexit outcome.
In general, there is a shift towards occupational premises in the regions as the public sector and large organisations decentralise and move functions out of London to reduce costs. A buoyant and flexible private rental sector is essential to support this trend. Brexit will inevitably increase government activity, adding to office demand outside London as new accommodation is sought to supplement the Whitehall estate.