Easier monetary policy could weaken Brexit effect on UK real estate
The hit to UK real estate sentiment that many experts predict will be sparked by the vote to leave the European Union may be limited by easier monetary policy, it is claimed.
While uncertainty in the run up to the referendum had little effect on domestic real estate pricing this year, investment activity slowed but an analysis report suggests that this hasn’t been exclusively caused by Brexit fears but largely reflects greater investor caution as the market reaches the top of the cycle.
However, according to Chris Unwin, head of global research at Aviva Investors, the vote to leave suggests there is now little hope of any bounce in sentiment. ‘Indeed, it may be many years until we have clarity on the UK’s constitutional arrangements and trading agreements,’ he said.
He pointed out that the financial markets’ reaction to the vote was swift and dramatic with Sterling falling to its lowest against the US dollar in over 30 years and 10 year gilt yields reaching a record low. And, as equities plunged, real estate shares were particularly badly hit.
He believes that mounting fears of an economic shock and in the short term, uncertainty as to the UK’s constitutional arrangements and trading agreements, will dampen activity and may trigger a recession by the end of 2016.
In the longer term, the economy is likely to be impaired by reduced access to European markets and poorer demographics, weakening the UK’s fiscal position and potentially damaging productivity growth. On top of this calls for a second referendum on an independent Scotland will grow and great further uncertainty.
‘Domestic capital values now look likely to decline moderately over the remainder of the year. It is worth noting, however, that some commentators believe Brexit will hit real estate returns, and the economy, more severely. By contrast, we had expected to see a slight increase in capital values over coming months had the UK voted for the status quo,’ explained Unwin.
He expects to see prolonged illiquidity in real estate markets pending renegotiation of international agreements and transaction activity to be low while heightened risk aversion will reflect lower growth expectations and political risk. ‘To compensate, some widening in yields is probable. Secondary assets are likely to be hit even more,’ he added.
However, Sterling depreciation could support demand from overseas investors but Unwin pointed out that this needs to be balanced against the UK real estate market’s diminished ‘safe haven’ status along with additional caution in Scotland resulting from pressure for a further independence referendum.
Unwin thinks UK occupier markets could be affected significantly less than investment markets. ‘In the short term, a rapid deterioration in the labour market is not expected. Demand for space is not set to fall rapidly,’ he said.
‘If the weakness of sterling is maintained, UK retailers could be hit, particularly those operating on low margins. On the other hand, it may boost prospects for markets dependent on tourist spending, like prime central London,’ he explained.
He also explained that central London offices, specifically in the City, are particularly exposed to leave risk. ‘Some activities currently undertaken in central London, such as euro-denominated wholesale banking, are under threat. But London remains a leading global centre for a broad range of activities, many of which would be relatively unaffected. It continues to benefit from a low corporate tax rate, a diverse talent pool and relatively low regulation,’ said Unwin.
But looser monetary policy is likely to support pricing. ‘The pricing of UK real estate relative to government bond yields was attractive before the fall in bond yields. With spreads relatively wide, the asset class is likely to continue to appeal to domestic income seekers,’ Unwin pointed out.
‘Clearly, the referendum result will weaken UK real estate prospects, both in the short and medium term. However, the deterioration may be limited somewhat by easier monetary policy. And, if interest rates remain even lower for even longer, high quality real estate assets may benefit from their safe haven status. Remember that in times of heightened uncertainty such as this, attractive investment opportunities will arise,’ he concluded.