A chain reaction of uncertainty in the property market

As the aftermath of Brexit continues, the impact of uncertainty is spreading across a number of markets. Currency took an early hit, as did foreign investment, and now the UK property market is the latest topic to dominate the headlines.

In an article by Judith Evans of the Financial Times, according to Lambert Smith Hampton, investment into UK commercial property has slumped to its lowest level in two years, with the vote to leave being held responsible for several major deals falling through and seven property funds being forced to halt withdrawals in the face of large redemptions.

Cazenove Capital Management believes that the funds have been gated in order to organise the sale of some underlying assets to raise cash before accepting redemptions again, which will reduce the need for a fire-sale of holdings should the downturn continue.

In normal circumstances, property values are determined by transaction values, however, there has been little transactional evidence since the referendum. As a result, values have become more subjective. As funds continue to sell assets to finance redemptions, the transactional evidence that valuers use will inevitably begin to point to lower property values, which will in turn prompt other funds to close.

This decline has also been supported by findings from the RICS, who revealed that the net balance of surveyors seeing an increase in investment enquiries fell to a negative 16% from a positive 25% in the first quarter of 2016 and that investment demand from overseas and London fell to -27% and -41% respectively.

Jeff Matsu, Senior Economist at RICS said:

“Political and economic uncertainty in the aftermath of the referendum result has clearly dampened sentiment in the commercial property market, with the tone becoming visibly more cautious right across the UK and the drop in confidence being most pronounced in London.”

The residential market is proving it isn’t immune to the Brexit effect either, with prices already falling on properties previously valued at £1m or more. Société Générale has warned that high end prices could halve, as many non-UK banks and other financial companies, who base their European operations in Europe, may be forced to relocate when the UK leaves the EU.

They said:

“We see a classic housing bubble in London and Brexit as the trigger for the correction… Given the current ratio of prices to incomes in London, a price correction of even 40-50% in the most expensive London boroughs does not seem impossible. With the average London house price 12 times average London earnings, Brexit could push these stretched conditions to breaking point by forcing 3,000 senior employees of financial firms to sell their London home to relocate to Europe.”

Savills have a slightly more optimistic view on the residential market, stating that:

“London sellers were already adjusting prices, interest rates were expected to stay low and the sterling’s fall could attract overseas investors to buy property”.

They also think that whilst uncertainty is likely to remain for some time to come, “we expect the newly formed UK government to be highly motivated to protect London’s position as a major global financial centre in any negotiations with the EU.”

Despite the negative views, commercial property has had a couple of very good years and, in a world of low growth and low interest rates, it has proven to be a relatively stable source of income, when compared to government bonds, for example. Cazenove Capital Management also reported that they do not believe we are headed for a repeat of the 2008/2009 crisis due to the fact that valuations are not as stretched as they were, we do not have as much debt-financed property supply and, if we do enter a recession, it is unlikely to be as severe as 2008/2009.

RIC’s Matsu continued:

“……following several years of strong capital value and rental gains, momentum had already appeared to be slowing. Whether or not the sharp deterioration in the RICS survey data is a knee-jerk reaction that will unwind as the result is digested, or the start of a more prolonged downturn, remains to be seen.”

This option was supported by Ezra Nahome, Lambert Smith Hampton’s Chief Executive, who said:

“The fall in values that we forecast for the remainder of the year is magnified by our position in the investment cycle. Values have been stretched across a number of sectors for a while, especially Central London, so the referendum result has arguably accelerated the return to fundamentals that would have happened anyway.”

LaSalle Investment Management also said it expected the downturn in UK commercial real estate to be relatively contained and the correction in real estate pricing to be largely restricted to the next 18 months.

If you would like to discuss how property market activity may affect your investments, please contact your Finura Partners adviser.

Sources:
http://www.cazenovecapital.com/uk/private-client/insights/strategy-and-economics/the-impact-of-uncertainty-on-property-funds/
https://www.theguardian.com/money/2016/jul/18/brexit-could-cut-london-house-prices-by-more-than-30-says-bank
http://www.independent.co.uk/news/business/news/brexit-commercial-london-property-prices-rics-office-real-estate-eu-referendum-a7147706.html
http://www.ft.com/cms/s/0/a1524f3a-4e83-11e6-8172-e39ecd3b86fc.html#axzz4F2L2Djl1