Brexit set to have positive and negative effects for UK commercial property markets
Image Confidence in the UK’s commercial real estate markets will unquestionably fall due to the Brexit uncertainty with a ripple effect set to spread beyond London, according to a new analysis.
It is likely that decisions will be pushed back in the period of heightened economic and political uncertainty that no one can define or quantify and it will most likely take several years for people to fully understand the implications of the decision to leave the European Union, says the report from Fidelity International.
But there are likely to be positive as well as negative effects due to the referendum decision. ‘The question is whether resultant pricing volatility is a fair reflection of inherent risks or a potential mispricing opportunity,’ said Adrian Benedict, the firm’s real estate director.
He pointed out that before the referendum, transaction volumes were already down 50% in the year to date compared with the same period in 2015. ‘We anticipate volumes to remain modest for the rest of 2016 as investors assess the implications,’ he added.
‘As we saw in the aftermath of the 2008 financial crisis, we can expect real estate investors to seek refuge in the relative safe harbour markets like London West End or long leased assets. However, unlike then, values are already 10% to 20% above long term levels,’ Benedict explained.
He believes that many investors will be turning their attention to the occupier market, in particular evaluating the impact on financial and business services companies; anyone with those type of tenants are going to be more circumspect but the impact won't just be confined to London.
‘We can expect to see a ripple effect across the country. Bournemouth for example has a high proportion of people employed by financial service companies and it would be naïve of us to think the impact will be contained to the capital,’ Benedict said.
‘So long as occupiers remain cash generative, we’re unlikely to face a material pricing correction arising from weak fundamentals. Supply of new space remains very constrained and vacancy rates in the key cities across the UK have largely recovered,’ he added.
He also pointed out that having short leased assets doesn’t necessarily mean occupiers will move out. ‘Fidelity’s experience suggests less than 25% of occupiers chose to exercise their option to terminate leases or move at expiry. Rather than selling or buying real estate ‘markets’ a greater emphasis will need to be placed on underwriting the occupiers and the certainty of their cash flows,’ he said.
‘As with most clouds, there is a silver lining. Over the last 12 months international buyers accounted for 40 percent of commercial property deals in the UK, a near doubling within 10 years. The relative attractiveness of the UK market is explained by a strong economy but also a relatively weak currency. In US$ terms, the UK real estate market is now back to pre-2004 pricing levels. The question is whether international investors will view this as an attractive entry point or defer making a decision,’ he concluded.
Patrick Scanlon, a commercial research partner at Knight Frank believes that the referendum result creates both threats and opportunities for the central London office market. ‘Economic uncertainty is rarely a positive for any market, and in the short term we should expect some occupiers to delay committing to new office moves as they take stock of what the new landscape means for their businesses,’ he said.
He pointed out that London represents the largest market for euro-denominated trading, and major banks with euro trading desks in London may find that they need to relocate some of these functions to office markets within the EU. ‘While this does not necessarily mean a wholesale relocation, we should expect some vacant space from banks to come to the market once this restructuring has taken place,’ he added.
He also pointed out that many businesses with a large London presence are focused on markets outside the EU, and the UK’s exit from will have a limited impact on them. Indeed, since the general election just over a year ago there has been above- average office take-up suggesting firms have adopted a business as usual approach and global operators such as Deutsche Bank, Thomson Reuters, Ashurst, Google and Facebook have made significant long term commitments to London.
‘There is likely to be some release of office space as businesses tighten their belts to weather the period during which trade treaties are being negotiated. However, currently availability levels are particularly low and the development pipeline remains fairly limited. The market has capacity to absorb a rise in supply before there is a possibility of a fall in prime headline rents, Scanlon explained.
However, he things that the impact on the investment market is likely to be less obvious. ‘While the economic uncertainty during our exit negotiations will undoubtedly deter some domestic investors, the relative discount available to purchasers in foreign currencies will attract significant interest,’ he said.
‘In the medium term however, central London commercial property will continue to offer a higher yield than most other asset classes, and may even benefit from the instability in the equity markets,’ he concluded.
