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What would a Brexit mean for real estate?

Brexit

A new wave of populist political parties across Europe, and disenchantment with the political and economic system, is making the UK referendum quite an emotive topic. But what does it mean for real estate?

It is important not to underestimate the potentially disruptive influence this Brexit vote will have on UK (and European) economic output and policy, which is still in the fairly infant stages of normalisation post the GFC. The referendum risks "pitting political short-termism and emotion against long-term economic logic,” never an attractive backdrop for investment (domestic and foreign) and financial markets. Should a Brexit occur, one can assume the associated disruption to growth will be marked, although ultimately it will be shaped by the "terms of the divorce" and the prevailing economic climate; neither of which look great nor will be resolved swiftly. During this period of trade and policy renewed negotiation (predicted at about two years) across EU and non-EU nations, confidence will suffer, and business decisions will understandably be put on hold. These negotiations will be no easy task, and will put pressure on the Sterling, raise question marks over the UK’s credit rating, and could push bond yields higher; a concern given its high current account deficit; all of which will have an impact on commercial real estate pricing.  

Financial markets do not like uncertainty. There is no question that the uncertainty up to the referendum on 23 June 2016 will do anything but dampen much needed business investment and capital expenditure/occupier demand as risk aversion dominates. The added prospect of a change in leadership in the Conservative Party will only add to some degree of repricing risk in the market. The extent and longevity of such a repricing will depend on how markets digest the process of Brexit negotiations. However, the potential hit to valuations should not be compared to 2008. The number of well-capitalised domestic and overseas buyers of UK property should provide a ceiling to any valuation adjustment, particularly given the Sterling’s weakness, whilst real estate will not be alone as equities and bonds digest a Brexit outcome and its financial market short-term risk. Furthermore, one should not forget the opportunity that may arise in the market should the market undergo an unnecessary correction ahead/after the referendum.  

The impact the referendum debate will have on commercial real estate is difficult to determine or quantify, although it is not favourable. Our base commercial real estate forecast implies a very gradual softening in pricing offset by a slow, but steady improvement in occupier demand from a growing occupier base. Notwithstanding the pull-back in investment and occupier demand in the run-up to the vote, which will act as a drag on performance, should the UK vote to remain in the EU, the impact on the real estate market could prove temporary and minimal. This should allow real estate to offer a rather steady, but relatively attractive, medium-term performance. However, there are clearly some marked negative business impacts of a potentially disorderly Brexit. Domestically, a dampening impact of a fall in investment and hiring would hurt growth and occupier demand, and the UK’s (principally London’s) financial role in Europe would also potentially come under scrutiny; leading to a marked valuation hit in the capital. Changes to the free movement of labour and a preference of firms to locate within, rather than outside the EU, may hurt the UK’s competitiveness and productivity. Much would depend on the degree of crisis management post a pro-Brexit vote, but it is difficult to perceive new trade/regulatory agreements could be renegotiated swiftly. This would harm the attractiveness of the foreign direct investment (FDI) into the UK, and directly into commercial real estate, adding to pricing volatility. Financial uncertainty linked to changes to longer-term growth estimates would also lead to a shift in low-term borrowing rates, and therefore asset pricing. This could lead to returns being scaled back over the medium term from already modest expectations of 4-6% p.a. Whilst the fall in Sterling may hurt retailers, the retail sector is likely to prove to be more stable than other traditional sectors. It will, however, be unable to buck a downgrade to performance expectations from a lower UK growth potential, subdued consumer spending, and reduced migration inflows.  

From a European perspective, it is likely that a UK exit from Europe, and the associated risk aversion that will prevail, will dampen an already meagre growth and inflation outlook, whilst heightening political risk in the region. Whilst French and German elections are not until 2017, the Brexit result might coincide with new elections in Spain should the political deadlock persist. Whilst Mario Draghi famously stated the ECB will do all it takes to support the single currency, its credibility is under scrutiny, and is likely to lead to further bond and equity volatility. In Europe, lower growth, inflation and business investment would feed through to a lower commercial real estate return outlook; and any potential shift in the risk-free rates raising questions around historically keen pricing. A positive fillip to core European cities could be a weakening of London’s position as the centre of European finance; although this is purely hypothetical. 

This article is intended solely for the use of professionals and is not for general public distribution. Any assumptions made or opinions expressed are as of the dates specified or if none at the article date and may change as subsequent conditions vary. In particular, the article has been prepared by reference to current tax and legal considerations that may alter in the future. The article may contain "forward-looking" information or estimates that are not purely historical in nature. Such information may include, among other things, illustrative projections and forecasts. There is no guarantee that any projections or forecasts made will come to pass. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments. Past performance is no guarantee of future performance. The value of investments and the income from them may go down as well as up and are not guaranteed. Rates of exchange may cause the value of investments to go up or down. Any favourable tax treatment is subject to government legislation and as such may not be maintained. The valuation of property is generally a matter of valuer’s opinion rather than fact. The amount raised when a property is sold may be less than the valuation. Nothing in this article is intended or should be construed as advice. The document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. TH Real Estate is a name under which Henderson Real Estate Asset Management Limited provides investment products and services. Issued by Henderson Real Estate Asset Management Limited (reg. no. 2137726), (incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3BN) which is authorised and regulated by the Financial Conduct Authority to provide investment products and services. Telephone calls may be recorded and monitored. COMP201600122

Michael Keogh

Mike Keogh

Director of Research

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