The UK electorate is about to take the most important decision for a generation.
A recent report issued by HM Treasury concludes that the damage inflicted on the UK economy by a vote to leave the EU would be considerable and not just limited to the short term. This report was issued in the same week that opinion polls are suggesting that the electorate is split down the middle making the outcome on the referendum to decide the UK’s future relations with Europe too close to call.
The economic arguments appear indisputably pro-EU. A 2013 review by the Centre for European Policy Studies of the “balance of competences” between the EU and its member states concluded that the present balance works well for Britain. Comprehensive change would be against the UK’s national interest.
A paper published in December 2015 by the Centre for Economic Policy Research finds that UK GDP per capita was 9% higher after 10 years of EU membership and 24% by today. These are much bigger effects than the Treasury has just estimated.
Most businesses want to stay in the European Union but some are cautious about saying so for fear of offending customers or clients. A survey by the Confederation of British Industry found 80% of members for Remain, with only 5% for Leave. The Institute of Directors and the British Chambers of Commerce, with memberships that have a higher share of SMEs than the CBI, find most in favour. Even a majority of the Federation of Small Businesses narrowly backs Remain.
Thanks to foreign ownership and investment attracted by a gateway into the EU single market the British car industry accounts for 800,000 jobs and12% of British exports. Britain now produces more cars than France. Fully 77% of the members of the Society of Motor Manufacturers and Traders favour Remain,
Toyota, Nissan and BMW, whose UK businesses include Rolls Royce motors and Mini, have all warned that exit from the European Union would reduce competitiveness, increase costs and prices and reduce jobs.
Major aerospace and defence manufacturers such as BAE Systems, Babcock and GKN, believe that Britain must remain part of the European Economic Community to protect opportunities for investment, partnership and growth.
It is a similar story for financial services. The City of London Corporation has come out strongly for Remain in line with the views of the overwhelming majority of City firms. HSBC has published research which concluded that working to complete the single market in services and reforming the EU to make it more competitive were far less risky than going it alone, given the importance of EU markets to British trade.
Businesses therefore are very strongly in favour of remaining within the EU. The vote, however, will be decided by an electorate focused on immigration and egged on by the mainly Europhobe papers that are passionately pushing Brexit. What then is the outlook for UK commercial real estate in the last remaining 2 months before the vote and indeed afterwards.
In March the Financial Policy Committee (FPC) at the Bank of England said that uncertainty as the date of the EU referendum approached and a period of pro-longed uncertainty following a vote to leave has the potential to increase the risk premium required by investors on UK assets.
Domestic investors are exposed to the risk of asset values softening. Overseas investors are also exposed to currency risk. Sterling has already depreciated by 6% since the start of the year and by 9% since the middle of last year. Rolling 12-month investment by overseas investors has decreased in each of the last three quarters and fell by 15% in Q1 2016.
Bank lending to property has fallen in every quarter since Q3 2009 with the sole exception of Q1 2015. In anticipation of the risks, the FPC is providing banks with options for extra liquidity in the weeks around the 23rd June referendum date. It is also raising the minimum capital levels for the UK’s largest banks; which should have the effect of reducing lending further and raising the cost of debt.
The Scottish referendum should have alerted UK asset management companies to the “destabilising” effect of the vote to leave. The Scottish vote triggered £1bn of outflows from UK equity funds in the week before the referendum, and many Scotland-based financial groups were forced to consider shifting their headquarters south of the border in the event of a Yes vote.
The Investment Association represents UK investment managers responsible for managing more than £5.5 trillion for clients around the world reported that UK investors pulled more money out of property funds in February than in any month since 2008.
Land Securities CEO Robert Noel said in February that a vote to leave the political bloc would cause demand for office space to fall and values could plummet. The FTSE Real Estate index lost 7%in the first quarter, wiping £4.6bn off the value of UK commercial property groups. In February, the two largest UK Reits, Land Securities and British Land, were trading at their biggest discounts to net asset value since 2011.
EU referendum clauses are being added into contracts with deals agreed to complete on 24 June, the day after the vote, but with an option not to proceed if the vote goes in favour of Brexit.
Recent data releases have confirmed suspicions of a slowdown in the direct market. According to CoStar investment in UK commercial property declined 19% in the second half of 2015 from a year earlier. Property Data records a decrease of 16% in the second half of 2015 from a year earlier.
The attempted sale of the City of London’s Heron Tower to the Chinese insurer Anbang, which fell through in September, is illustrative of this slowdown. Another major asset, Devonshire Square, was put up for sale but then removed from the market and a series of other properties on the market for about £100m were subsequently withdrawn.
Of course, the breakdown of these transactions may not be solely attributable to the Brexit referendum. Other concerns include China’s weakening economy and falling oil prices reducing the levels of investment into the UK from overseas.
Union Investment Germany’s biggest manager of real estate mutual funds, however, was more specific. Talks to buy 51 East cheap for about £50m were suspended at the end of February. The fund had planned to extend and refurbish the building but Union’s CIO said they were apprehensive ahead of the referendum and were cautious with speculative investments in London which have leasing risk.
Many of the risks flowing from a vote to leave the EU may be more focused on core Central London markets which have enjoyed the greatest interest from overseas investors and international business occupiers. As a consequence values and rents are now in excess of peak 2007 levels.
Investors have started to shift their focus to the regions of the UK. Some £4.6bn flowed into the nine largest UK regional cities in 2015; the highest level since before the 2008 financial crisis.
Union may have pulled out of the East cheap deal but it isn’t pausing all its UK activity. The fund manager is now in talks to buy Allied London’s XYZ Building in Manchester for about 85m pounds.
In the weeks and months leading up to the referendum it is likely that transaction volumes will decrease further particularly from overseas investors. For the less risk inverse investor the next two months could present an opportunity. If the Remain campaign is successful, there is a general expectation that commercial property values could react positively in the second half of the year boosted by a pick up in lending. But if the vote goes in favour of Brexit, a pro-longed period of uncertainty whilst the UK’s future relationship with the EU and the rest of the world is negotiated may see current commercial property values coming under increasing pressure; particularly in Central London.