12 Nov 2016

Britain has never been so divided

London, 12 November 2016 – written by Richard Croft, as published in Estates Gazette:

For students of economics, the four months since 23 June have been fascinating, baffling, concerning and often extraordinary.

Against a backdrop of great political flux, it is very difficult to plan either as an investor or as a business. Whatever the rights and wrongs, the Brexit vote has created uncertainty for the UK, and the government apparently has no agreed plan. This lack of coherency (with Hinkley, HS2 and the London airport fiasco providing further examples of government’s lack of leadership) raises the possibility that the things that make the UK such an attractive place to do business might get washed away.

As I have written before, I think an exit from the EU is a sub-optimal outcome for the UK, but even if I am wrong and this leads to sunnier economic and social uplands, the path is fraught with political and economic danger, not least because I am not sure Britain has been so divided since Naseby and Marston Moor.

So how does this affect the UK real estate market? There are, of course, two main commercial real estate markets – occupier and investment – with many submarkets. By definition, they do not always act in tandem, as they have different drivers. Today the investment market is driven by a lack of fixed income and historically low costs of borrowing and a pound sterling that is auditioning to be a submarine. This has protected the investment market from any real distress bar the redemptions-led distress experienced by the retail funds in the first couple of weeks after the referendum, and will continue to do so for the next 12 months or so.

Investment volumes are down, but I think most people would agree that we still have a liquid market. Beyond 12 months, however, it becomes very difficult to forecast as the dynamics of the occupier market become ever more relevant to the investment market.

At M7 we have yet to see a great difference in the UK occupier market post-vote, but talking to tenants and other businesses, it is clear that major decisions are being postponed unless they have to be taken.

We are a case in point: we need more space in London, but I am unwilling to commit long-term to new space until we know what this politics means. For us, a hard Brexit may result in some jobs being moved to Amsterdam. About 80% of our business is on the continent, so keeping our investment management function in London under such circumstances makes limited sense. Many businesses are facing similar issues.

Currency fluctuations also affect planning, particularly for SMEs whose sterling income has increased because they earn in euros or dollars (we fall into that category), while others’ costs (because they import dollar-denominated raw materials) have gone through the roof, causing cashflow issues and repricing conversations with customers. The upshot of this will be a degree of stagnation, with many businesses putting off decisions around relocating and making do if they can.

This is good and bad for the investment market. The good news is that, in the short term, tenants are likely to be stickier and retention rates should improve, particularly for asset management-focused landlords. The bad news is that vacant space will become more difficult to fill, as people and businesses wait to see what the government does next. I therefore think that the UK regions are currently a less risky investment than London.

Many regional markets are internal, so less influenced by international events and, perhaps most importantly, the investment values are often below construction cost, resulting in naturally constrained supply. Conversely, London faces the double whammy of being highly influenced by international events and no current constraint on new supply. If the government mishandles Brexit, there is a real risk of job migration away from London just as new supply comes to the market. This will suppress the occupier market and that will feed into the investment market.

To conclude, there is no real pressure in either direction on the investment market as a whole, as income in itself is seen as a key commodity and commercial real estate provides that. However, the ongoing uncertainty around Brexit will have an impact on the occupier market and the question is how and when that feeds through to the investment world. The next 12 months are likely to be as fascinating and extraordinary as the last four.