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Brexit and the UK real estate market

By Egée O’Neill and Fanni Varkoly

Initially posted on the BSPEC blog

In June 2016, the result of the Brexit referendum shocked the market: stocks plummeted, and the British pound dropped to a 31-year low. Three and a half years later, the UK’s withdrawal has been delayed three times, and many buyers and sellers are apprehensively sitting on their hands waiting for some clarity about how Brexit will take shape.

With the December 12, 2019 general election approaching, given the previous ultimatums postponed, it is unlikely that a deal with the EU will be reached anytime soon. Yet despite the tumultuous twists and turns of the Brexit deliberations, it is business as usual for British real estate. For now, the UK’s real estate market seems to be showing greater resilience than had been anticipated by investors. However, it is likely that there will be some variations in investment performance between different types of properties.

How has the UK real estate market reacted to the Brexit? What are the current trends? And what are the predictions for the post-Brexit future of the UK’s property market?

Commercial property market

Purchases of UK commercial property plummeted by almost 50% before the vote in the first half of 2016, as investors backed away from the market and awaited the outcome of the referendum. Following the Brexit vote, office prices in London’s financial district experienced the largest drop in seven years and transactions took longer to complete as investors remained cautious.

In real-estate, the biggest losses in the aftermath of the Brexit vote were taken by the UK’s open-ended real estate funds, which had to freeze their trusts due to investors scrambling to withdraw funds. This forced them to sell prime properties in order to raise cash to meet redemptions.

Office market

Foreign investors’ appetite for UK commercial property surged due to the sharp drop in the pound. In March 2017, the Cheesegrater Building (formerly owned by British Land and Oxford Properties) in the City of London was sold to Chinese investors for £1.15bn and in July, a Hong Kong company bought the Walkie Talkie office tower (Land Securities and The Canary Wharf Group) for £1.3bn in the largest-ever deal for a single office building in the UK.

While Chinese demand for UK commercial property reached record heights in 2017, many UK office REITs opted to return money to shareholders rather than reinvest in a deeply uncertain market. British Land returned £300m to investors via share buyback after the sale of its 50% stake in the Cheesegrater office, Landsec issued £475m to shareholders after the sale of its 50% in the Walkie Talkie tower, Great Portland Estates and Derwent London both returned capital through special dividends announcing that they did not see many opportunities to add value through acquisitions and that they had enough cash on hand to fund existing developments.

The international financial firms experienced different reactions to Brexit. More than 330 financial services firms have relocated parts of their business ahead of Britain’s imminent departure from the EU by October 2019. On the other hand, some companies have doubled down on their UK domicile after buying new HQs or signing long-term lease agreements in London. A prime example of this includes Citigroup’s purchase of its London headquarter in Canary Wharf from Middle East-backed private equity group AGC Equity Partners for £1bn in April 2019. The purchase is in line with Citi’s strategy of owning rather than renting offices to reduce costs, yet it also demonstrates that London continues to appeal to international businesses despite the risks surrounding the UK-EU divorce. Citi’s Wall Street rival, Goldman Sachs, is pursuing a different real estate strategy; it negotiated a £1.2 billion sale and 25-year leaseback of its new London headquarters with Korea’s National Pension Service in August 2018.

Retail market

Regarding commercial property investments, the current situation of retail stores is bleak according to British Land Chief Executive, Chris Grigg. Retailers of all kinds have been struggling in part due to low consumer confidence and increased financial pressures on the retailers. Online competition continues to weaken the performance of brick and mortar stores, eroding their market shares. A growing number of failing businesses forces tenants to close down their stores thereby creating new vacancies which are solely being filled with short term leasing and which increases portfolio volatility. Private investor demand is currently focused on long and secure incomes, hence major investment funds are attempting to dispose of some of their largest retail portfolios. British Land has divested £236m of retail properties during the past six months according to the Financial Times. Property Data reports that only £788m was invested in retail property in the first quarter of 2019, the lowest level of investment activity since 2000.

According to Cushman & Wakefield, alternative properties such as data centers, healthcare, hotels, self-storage and student housing, represent 37% of year-to-date UK commercial real estate investment volumes and have been the most active part of the UK property investment market so far this year, overtaking offices in terms of transaction volumes.

Housing market

House prices did stagnate momentarily following the referendum in June 2016, however, this was normal for that time of year: prices generally grow in spring and peak in August before falling slightly beginning September (see chart below). With Brexit looming ever closer, house prices fell much more sharply than usual after summer 2018. However, it is difficult to draw a direct link between Brexit and house price activity: tied in with demographic and lending factors, it’s impossible to accurately state the extent to which Brexit has influenced the figures.

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The demand for new housing is increasing, however real estate developers remain timid with respect to pursuing new ventures amidst the uncertainties of Brexit. To help the struggling housing construction sector and real estate developers, the UK Chancellor of the Exchequer, Mr. Sajid Javid, pledged new funds to prop the construction sector (as part of his infrastructure funding plan) to regain the confidence of private investors.

Some private investors such as DTZ Investors have already moved beyond Brexit fears and partnered with The Collective, a global co-living pioneer, to create the first fund dedicated to buying and building communal housing in London (COLIV). With an initial round of more than £70m of seed capital, the fund aims to build a portfolio of about £1bn pounds over its 10-year lifespan, with target returns of 8% to 10%.

Brookfield’s CEO, Mr. Bruce Flatt, declared that real estate investment funds continue to be considered as value investments, and that these funds are focusing their strategies on long term gains and are poised to seize opportunities that will arise in the wake of the Brexit outcome. All in all, the outlook for the property investment and housing markets appears positive, even if it is heavily dependent on opportunistic investments in the Real Estate asset class.

Opportunistic strategy related to the Brexit

Despite the uncertainty surrounding Brexit, Brookfield, a Canadian asset management company, is confident that London will remain the pre-eminent global investment destination for real estate. Brookfield’s European real estate managing partner Zach Vaughan said“On the buyer side, London is one of the largest, most liquid and most transparent commercial property markets on the planet, and that’s not changing. If buyers from one particular jurisdiction begin to pull back, right now there is another group waiting in the wings to take their place.”

Similarly, the Blackstone Group’s CEO, Stephan Schwarzman, views Brexit as a window of opportunity. He pledged his company would expand its operations in London despite the Brexit debacle. According to Jonathan Gray, President and Chief Operating Officer of the investment firm, “Blackstone has been acquiring at better prices as other investors have become skeptical about economic growth amid uncertainty surrounding Britain’s pending exit from the European Union”. With its brand-new European fund Mileway, Blackstone’s new strategy holds onto the fact that as demand for e-commerce increases steadily, there is a necessity for urban last mile logistics warehouses to shorten the last mile of delivery, allowing for faster delivery of goods and services. Ranging from Deliveroo dark kitchens to e-commerce companies (such as Amazon), this new trend in real estate investment is technology driven and has tremendous market shares to gain given that the UK has the highest online shopping penetration rate in Europe, with shoppers making approximately 22% of their retail sales online. Since its €8bn portfolio launch, Mileway has already invested in 200,000sqm in Manchester, the second financial center of the country and a city outperforming London with respect to real estate investments. 

What will the property market look like after Brexit? 

The Brexit deadline has been extended to 31 January 2020 and the UK will vote for a new government on 12 December 2019. What this means for real estate investors is difficult to answer, considering that many outcomes are possible, from further Brexit delays, a revised deal with the EU to a no-deal departure. A further delay is still the most likely scenario, which would bring little change to the current state of affairs.

Whatever the eventual outcome, London is likely to be most negatively impacted by a no-deal Brexit.  KPMG has stated that house prices are likely to fall by approximately 6% in the event of a no-deal Brexit but could plummet by as much as 10-20%. In this scenario, the Bank of England will likely cut interest rates to stimulate the economy. The pound may tumble, making UK more attractive for foreign investors. However, a no-deal Brexit is considered the most unlikely outcome. A Reuters poll shows that the chances of a no-deal Brexit diminished in the last month because Prime Minister Boris Johnson appears set to win the December 12 election and could secure the necessary backing in Parliament to pass his new Withdrawal Agreement. According to the polls, the chance of a no-deal Brexit dropped from 30% in October to 20% by November which marks the lowest probability since a poll taken in May – soon after the EU granted another delay to Britain’s departure.

Green pastures will see investors flock in droves. If a Brexit deal is reached by January 31, 2020, an uplift in market activities can be expected as actors who had been delaying their real estate decisions could regain confidence and return to the market. For instance, in the case of a “good Brexit deal” Landsec plans to invest £3bn to boost its development activities. The company has been cautious about new developments since 2014 and halted speculative development after the 2016 referendum.

On the other hand, sellers who haven’t put their properties on the market for more than three years to avoid taking valuation haircuts, could create a ‘Brexit bottleneck’, leading to over-supply and falling prices.

While taking positions on which way the Brexit wind will blow would be ill-advised (audacious at the very least), the good news is that, for the most part, the UK real estate market is weathering the storm reasonably well.

Editor: Eric Peghini

Authors: Fanni Varkoly, Egée O’Neill

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Bocconi Students PE Club
The Bocconi Students Private Equity Club (BSPEC) is a student-led organization at Bocconi University. The club publishes articles related to private equity and venture capital, conducts interviews with active PE professionals and hosts events featuring funds and advisors. BSPEC is one of the oldest and most active student associations at Bocconi University and its alumni are currently employed at top tier investment banks and PE funds. Learn more at https://bspeclub.com/

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