The many uncertainties unleashed by Brexit
For the UK’s real estate market, the ill-winds of volatility can be particularly damaging
Even if it is effectively business as usual for the UK in terms of trade and legislation until 2018, such a major change will create short term uncertainty in real estate markets. The vote for Brexit brings a new dawn for Britain and Europe along with considerable uncertainty as trade agreements are recast and elements of UK law are rewritten.
Independent experts suggest a cumulative loss to UK output and incomes ranging between 3 to 10 per cent over five years post-Brexit. While there will be fiscal savings from an EU exit, these are likely to be offset by the cost of lower growth. Beyond 2020, long-term economic performance is harder to gauge.
The old adage ‘markets hate uncertainty’ rings truer than ever and it was evident as Sterling slumped to a 31-year low as markets opened on June 24.
Although a well-managed exit could confine the fallout to the UK, with limited degrees of contagion to the rest of the EU, the vote does set a new precedent and there is speculation that other countries may consider a similar referendum.
In the short-medium term, there will be spillovers to other EU markets, with Ireland most vulnerable due to its dependency on UK markets. Elsewhere the impact is judged to be relatively small (at under 0.5 per cent on GDP over two to three years), but still negative.
UK prospects after the initial two-year grace period to agree exit terms will also depend on the negotiation of new trade agreements, which could take much longer. Bilateral negotiations can be lengthy and may mean the UK reverts to less favourable World Trade Organisation (WTO) rules, at least initially.
The implied loss of ‘passporting’ rights for the financial services industry, which allow easy access to EU markets and are not covered by WTO rules, could be particularly damaging for the UK. Membership of the European Free Trade Area (EFTA) would maintain access to the single market and reduce the headwinds.
But this may require the UK to agree to freedom of movement of labour and EU contributions, the very conditions that caused many to vote leave.
We have already seen weaker confidence and delays in investment during the vote and this effect is likely to continue.
It will take occupiers longer to digest the implications. Occupier demand will weaken in line with economic growth and declining business sentiment. The impact on rents may be limited by tight supply, but activity will be adversely hit.
There is likely to be a negative capital value adjustment over next two years (estimated at up to -10 per cent with yields moving around 50 basis points). London sectors remain most vulnerable to correction given current pricing and their multinational occupier base.
Many businesses will review their real estate footprint in the UK and some sectors, such as finance and manufacturing, will be more affected than others where the decision will make very little difference.
The residential market is expected to cool despite lower interest rates, but any correction will be mild, aside prime London values which are significantly more exposed.
Paradoxically, however, investors may well identify opportunities in this market over the short-term, particularly international buyers that can benefit from the currency arbitrage that has opened up by a weaker Sterling.
For existing homeowners, the picture is uncertain, especially in the capital. The London housing market will feel the effects of the “Leave” decision more deeply given its interconnected trading relationship with the rest of Europe.
As the dust settles, a more familiar picture is likely to emerge. Investors will continue to consider longer term fundamentals like tenant demand and transparency and growth prospects.
The initial correction may be most severe, followed by an upturn as opportunities re-emerge in UK core markets and benefits of a weak Sterling are recognised.
Sentiment and relative pricing will be key and much will depend on the speed of negotiation, the wider political picture and whether a clear and favourable direction of travel is established early on.
With the resignation of UK Prime Minister, David Cameron, and the main Opposition party in disarray, UK domestic politics now pose a key risk to the housing market. Regardless of the Referendum outcome, protracted political infighting poses a longer term threat to the UK economy and any chance of a timely recovery from the expected economic slowdown.
The writer is with JLL’s EMEA Research division.