27 Aug 2019
The unintended benefits of Brexit for UK real estate
If the headlines are to be believed, there are few positives arising from the ongoing Brexit stalemate.
For the real estate sector, there have been pockets of the market that have benefited, including overseas investors taking advantage of sterling depreciation and an uptick in regional investment.
On the face of it however, the indecision and uncertainty that has arisen because of there being no clarity on how the UK may change has caused transaction volumes to fall, a stagnant housing market and a share price slump for huge swathes of the listed sector.
From our development and investment finance perch, the picture is a bit more nuanced. Rewind to mid-June 2016 and there were all the classic signs of an overheated market. Numerous bidders chasing land and willing to pay increasing prices. Market wide assumptions about favourable rental growth and yield compression. What seemed like new lenders coming to market every week. The launch of new private equity platforms. It was classic late cycle behaviour.
This confidence and increasing competition meant the 2016 market was becoming very frothy. Central London office construction by new starts was at its highest ever level1. Average Loan to Values were above 60%. All of this was underpinning some quite rapid capital appreciation. A sharp correction felt imminent.
Many people predicted that the real estate sector would be one of the biggest casualties of that fateful June 2016 vote. The reality has been very different.
Then came June 23. Everyone trying to make sense of what it meant. Should I sell? Should I invest? Should I reallocate away real estate?
The unexpected vote put the brakes on rising values. The resulting uncertainty flattened the market. Since 2016, commercial rental growth flatlined2, whilst house price growth in London, the Southeast, East and Southwest regions has risen by 4.3 per cent, less than one-fifth of its growth in the previous three years3.
For a lender, an ideal scenario is a market that doesn’t rise or fall during the two years of funding a development. We will agree development terms at say 65-70% Loan to Cost and will finish at 55%, driven by borrower value creation, not increasing market valuations.
There’s a default perception, I wish prices would go up all the time, which I feel is misguided. Prudent developers don’t factor in any movement up or down in values when calculating how much they will pay for land. Yes if prices do go up then great, you might get lucky and get out at the time your scheme comes to market, but the more prices rise, the more exposed you are to a downward correction.
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At the same time, Brexit has consumed the UK government. In a recent FT article titled ‘How Brexit is killing domestic policy’, Dr Emily Andrews, associate director at the Institute for Government, said “The politicians are completely distracted by Brexit and the civil servants are increasingly taxed by preparations for no deal. Many major domestic policy issues facing the country are not being addressed4.”
For the real estate market, this lack of policy change has been welcome. The two years leading up to June 23 saw two stamp duty changes hammer the housing market, the repercussions of which will continue to be felt for years to come, and further meddling with the Buy to Let market via changes to landlord tax relief. Anyone who had invested in the sector, whether you’d just bought the land, were trying to sell houses or were funding a new development, was affected.
Many people predicted that the real estate sector would be one of the biggest casualties of that fateful June 2016 vote. The reality has been very different, and flatter values and a lack of political interference haveplayed a big part.
Having been driven by caution and boredom, there are now signs that the market is coming back to life, with investment growth particularly strong in sectors like PRS, student accommodation and retirement living that are all underpinned by larger demographic changes.
The Brexit saga hasn’t future proofed the UK real estate market, and earlier this month the Confederation of British Industry warned of ‘the damage to the UK economy, jobs and livelihoods’ of a no-deal. However at the same time, by accident, Brexit has delivered a market where valuations are sensible and outside interference has been pleasantly absent, which has been welcomed by investors, developers and lenders alike.
Whether this period of relative stability remains given the new Prime Minster and Brexiteer cabinet, with a laser focus of exiting the EU by 31st October “do or die”, is much less certain.
This article was originally published by React News.
4. Financial Times (8/2/19)