By Tom Leahy on June 21st, 2017
The agreed mantra in the commercial real estate world is that investors loathe uncertainty. The U.K. got its second dose of political uncertainty when the results from the recent snap general election confirmed Theresa May’s lackluster campaign had lost the Tory party their House of Commons majority. So with Brexit negotiations finally underway, does the potential for further domestic political deadlock give another pause to investors considering deploying capital in the U.K.?
It’s worth taking stock of where the market was sitting before the election. It is clear 2015 was the high watermark for the U.K. for this cycle. Yes, there has been plenty of capital coming in to Central London from Hong Kong and China – over £3b ($3.8b) already in 2017 – but this is not sufficient to offset the drop-off from almost every other source. U.S. players have bought just under £2b of U.K. direct commercial real estate so far in 2017, versus just under £4b by this stage in 2016 and £7.5b in 2015. Similarly, domestic investment, at £9.2b, is down 30% versus 2016 and 45% versus 2015.
The fall in investment has been sharpest in London, where volumes at the end of Q1 were down 46% against their peak in Q4’15. (This does not mean the market has come to a juddering halt, though: more than £22b was invested in the 12 months to the end of May, a third more than in Paris, Europe’s second biggest market.)
This slowdown seems to be the means by which the market has adjusted to the new investment environment and though prices have softened (the RCA/PD Central London CPPI shows a 11% drop over the 12 months to Q1’17 and average top quartile cap rates have moved out by 30 bps to 3.8%), it is not to the extent that they did in 2008-09. In fact, with few, if any, forced sellers left in the market and many players sitting on their hands, the lower volumes are likely to continue in the short term.
In London, prices have largely been sustained by overseas players diversifying their portfolios, while outside the capital, U.K. councils have emerged as some of most active players in the market as they spend cheap public money on real estate to augment falling income from central government.
Notwithstanding the oft-quoted structural factors that make U.K. real estate an attractive asset class – rule of law, longer tenancies, transparency, time-zone, etc. – in the medium-to-long term, the market’s prospects are, in a large part, reliant on a positive outcome from the Brexit negotiations.
Perhaps then, the one bright spot to have emerged from the hung parliament is the chance that a hard Brexit – perceived to be the highest risk in terms of future economic growth by many commentators – won’t be served up to the British public, as Theresa May is forced to make concessions to get parliamentary approval for legislation.
The litmus test will come over the next six months, with reports that a number of trophy buildings in London are for sale. The pricing that assets such as St Katharine Docks or the 50% share of the Walkie Talkie building achieve will be a good indicator of how investors have reacted this additional uncertainty.