Brexit ,purplebricks.com investor, impacts on the property market overall and on aggregate consumption in the economy will be limited.
A paper discussing the United Kingdom’s relationship with Europe and the impact of ‘Brexit’ on the British economy.
Britain’s relationship with Europe is of increasing importance to UK investors. It is a complex, emotive and highly political debate – and one that we have been frequently asked to comment on from an investment and economic perspective by our investors.
Surprisingly, there isn’t a great deal of objective, independent research on the economic impact of Britain either staying in the EU or coming out. That’s why we commissioned a leading economic research consultancy, Capital Economics, to write a report for us looking at the likely impact of Brexit on the UK, purely from the perspective of economics. We are pleased to share this report with you, which you can access using the link below.
You can also watch our video, below, of Neil discussing the report’s findings and what they mean for his investment strategy and see our infographic for a quick summary of the report’s findings.
Consumption and property market
It seems clear that the City is the part of the British property market that has most to lose if the United Kingdom opts to leave the European Union. It is certainly possible to tell a story in which the damage done could be considerable, but the role of the financial services sector in holding up the property market is probably overstated, leading us to believe that any negative impacts will be small, certainly at a macroeconomic level.
We anticipate that the impacts on the property market overall and on aggregate consumption in the economy will be limited. In the case of the latter, they may well be positive due to beneficial effects from independent policymaking on immigration, trade and regulation, as well as savings to the exchequer (which may then be disbursed in the form of lower taxes).
Foreign direct investment and the British property market after Brexit
If Britain lost its free access to the single market, there is a worry that this could rapidly change the country’s status as a commercial gateway to the rest of Europe, with adverse consequences for both occupier and property investment markets. If demand from overseas buyers did drop following Brexit, the impact on the market could be significant. After all, by value, overseas buyers have accounted for roughly half of all transactions in the British commercial property market over the past few years. (See Figure 27.)
However, if we are right that overall foreign direct investment flows will hold up rather better than is sometimes suggested, there is little reason why those same factors would not continue to support the demand for British property. After all, most purchases of commercial property in the United Kingdom by overseas buyers are for investment rather than for operational purposes.
Factors such as the legal system and the language, as well as the size, liquidity and transparency of the British market are not a function of our European Union membership. Therefore, unless the majority of buyers took issue with our view that Brexit would not harm the United Kingdom’s underlying economic growth prospects, it is hard to see why property investment would suddenly slump.
The City, the property market and Brexit
There is more reason for concern over the impact of Brexit on the City of London and, subsequently, the British property market. The argument here is that Brexit could damage the City, by forcing institutions to re-locate to the continent. In that scenario, vacancy rates could rise and the premium commanded by Central London office space could shrink.
It seems likely that leaving the European Union would hit the health of the City and it is plausible that a number of overseas institutions would close or scale back their London operations, putting a dent in occupier demand. That drop in demand could come at an unfortunate point in the development cycle. Over the next few years, the office development pipeline in central London is likely to run ahead of recent rates of net absorption, with the bulk of that surplus space destined for the City. A sharp drop in demand could see vacancy rates spike higher and rental values start to fall. (See Figure 28.)
If that was to happen it is possible that investors might begin to reassess the price premium commanded by City office space. A rolling 5-year average of the difference between City office yields and the yields for regional office markets shows that this premium has been growing steadily over the past 20 years – it has more than doubled over that period. (See Figure 29.)
If investors felt that the City had been permanently damaged by the United Kingdom’s departure from the European Union, a jump of between 50 and 100 basis points in City office yields, knocking 8 to 15% off capital values, would not seem implausible.
However, agency sources suggest that financial services firms have not been the key driver of central London office take-up in recent years, even in the City. Employment data point to a similar conclusion. Within London, financial services account for roughly 16% of the stock of office-based jobs. But over the past 2 years, they accounted for only 6% of the new jobs created. Instead, it is professional, scientific and technical services that have been driving London office job creation. (See Figure 30.)
Moreover, the City office vacancy rate currently sits at just 5.0%, some 3.5 percentage points below its long-term average. It is therefore quite possible that occupier demand has been held back in recent quarters by a shortage of suitable space. If that is the case then, even if demand from financial services firms was to fall, increased demand from other sectors could help to mitigate the overall impact on vacancy rates and rents.
Brexit, the British economy and consumption
It is argued that leaving the European Union would damage property markets and the macro-economy, resulting in lower consumption.
Based on our analysis in sections 1 to 6, we are, on balance, sceptical of the more extreme claims made about the costs and benefits of Brexit for the British economy. It is plausible that Brexit could have a modest negative impact on growth and job creation. However it is slightly more plausible that the net impact would be modestly positive. There are potential net benefits in the areas of a more tailored immigration policy, the freedom to make trade deals, moderately lower levels of regulation and savings to the public purse. In each of these areas, we do not believe that benefits of Brexit would be huge but they are likely to be positive. Meanwhile, costs in terms of financial services and foreign direct investment are more likely to be short-term and there are longer-term opportunities from Brexit even in these areas. In this chapter, we have seen that that there may be a limited impact on the level of occupier demand for property, mainly via the City of London channel.
Overall, the resultant effects on consumption could well be positive and are certainly not likely to be large. We continue to think that the United Kingdom’s economic prospects are good whether inside or outside the European Union. Britain has pulled ahead of the European Union in recent years, and we expect that gap to widen over the next few. (SeeFigure 31.)
Summary: Small property downsides, small consumption upsides
It seems clear that the City is the part of the British property market that has most to lose if the United Kingdom opts to leave the European Union. It is certainly possible to tell a story in which the damage done could be considerable but the role of the financial services sector in holding up the property market is probably overstated, leading us to believe that any negative impacts will be small, certainly at a macroeconomic level.
We anticipate that the impacts on the property market overall and on aggregate consumption in the economy will be limited. In the case of the latter, they may well be positive due to beneficial effects from independent policy making on immigration, trade and regulation, as well as savings to the exchequer (which may then be disbursed in the form of lower taxes).
Ultimately the issue is likely to hinge crucially on the terms that the United Kingdom can negotiate in the event that it does decide to leave. In turn, that may well depend on how the government’s attempts to negotiate European Union reform are received and how fearful leaders on the continent are that if Britain was to vote to leave that could set an unwelcome precedent for others.
Disclaimer: This report has been commissioned by Woodford Investment Management, however the views expressed remain those of Capital Economics and are not necessarily shared by Woodford Investment Management. While every effort has been made to ensure that the data quoted and used for the research behind this document is reliable, there is no guarantee that it is correct, and Capital Economics Limited and its subsidiaries can accept no liability whatsoever in respect of any errors or omissions. This document is a piece of economic research and is not intended to constitute investment advice, nor to solicit dealing in securities or investments.
© Capital Economics Limited, 2015