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38 (133) 2019
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British investments beyond Brexit

Brexit Update – The Implications for the Economy and Real Estate

By Simon Rubinsohn, chief economist, RICS
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Any judgment about the impact of Brexit on the UK economy and its real estate markets needs to be heavily caveated at this point for obvious reasons.

[More than two and a half years after the referendum, Parliament is still struggling to agree a position on what the new relationship should look like. Building a consensus in the near term looks fairly implausible if the response of politicians to the defeats of Teresa May’s Withdrawal Agreement is anything to go by. A limited extension to Article 50 beyond 29 March was always a possibility but going beyond a few weeks raises issues including the likelihood that Britain will have to participate in the forthcoming European elections. As a result, most commentators have raised the possibility of a ‘no-deal’ departure.]

  • The impact on the economy of the decision to leave coupled with uncertainty about the future relationship with EU has already had an impact on the economy. The most well-regarded analysis suggests that national output is currently some 2% to 3% below where it would otherwise have been. Moreover, the best lead indicator of economic activity in the UK slipped in the final three months of last year to its lowest level since Q3 2016.

  • Following GDP growth of 1.4% last year, forecasts for 2019 currently span a broad range with the gloomiest at just 0.8% and the most upbeat at 2%. The average projection is actually little different from 2018. A key point underpinning most if not all these forecasts is that some form of deal is agreed with the EU before the end of March. Beyond 2019, the economic projections rest very heavily on assumptions about the relationship agreed with the EU and the scope for other trade deals (with third parties) to be put in place. A key risk (which I share) is that securing these deals will prove rather more tortuous than envisaged by leading Brexiteers.

  • Even advocates of a no-deal departure acknowledge there will be at least some short-term disruption to the economy in the immediate aftermath of the UK leaving the EU without a deal. Manufacturers are reporting precautionary stock-building to manage the supply chain while service firms are highlighting an impact on business-to-business demand.

  • Analysis by Oxford Economics suggests the additional trade frictions and depreciation associated with a ‘no-deal ‘scenario would result in a significant slowing in the UK economy even if there were some loosening of fiscal and monetary policy. Their modelling puts GDP just over 2% lower than the baseline forecast by end 2020 and nearer 3% by end 2023.

  • Investment into the commercial real estate sector last year was around £55bn according to Property Data. This was down on the £66bn in 2017 but ahead of the 2016 number. Overseas interest in the market has remained fairly solid accounting around 45% of total investment – typically, this is around 40 to 50%. Concerns about the impact of Brexit have been raised by analysts and, it is noteworthy, that yields have edged upwards through late 2018 although this likely reflects a market that was in places quite stretched from a valuation perspective.

  • The about to be released RICS UK Commercial Property Survey suggests that sentiment remains fairly resilient for now in both the occupier and investment space with the headline readings only very marginally negative. Within this, there are areas where the insight provided by RICS professionals is more downbeat such as retail, but this has more to do structural changes in the industry. However, research by others including Property Market Analysis draw out the risks associated with a ‘no-deal’ Brexit. In this environment, they could see a significant adjustment in capital values (of up to one-quarter) over the next couple of years which compares with a flatter picture on their central scenario.

  • Evidence from the RICS UK Residential Survey suggests that while Brexit related uncertainty is being widely cited by respondents as a factor resulting in a flatlining housing market, at this point it is largely reinforcing trends already in place. London and the wider South East, in particular, are feeling the pinch of affordability constraints following sharp price gains in recent years and tax changes.

  • The Bank of England has raised the possibility of a 30% drop in house prices in a disorderly Brexit scenario. It needs to be remembered this was part of a stress testing scenario for the banking sector and pushed a range of assumptions around the economy, interest rates and sterling to extremes. We view this combination as implausible and envisage the central bank acting to support the economy in a worst-case event (as it did after the Global Financial Crisis and the referendum) rather than, for example, pushing base rate significantly higher.

  • For now, construction output appears to be holding steady with the RICS (sentiment-based) measure of workloads showing modest gains likely to persist through 2019 although the outlook for margins could prove more challenging. However, a real estate shock linked to ‘no-deal’ is likely to shift the mood music quite quickly.

  • The Construction Products Association has suggested that, in these circumstances, output could fall by more than 5% over the next two years. Key issues for the sector will include cost, as the likely exchange rate adjustment leads to sharp input price increases, and skills, with additional difficulty in attracting EU labour.

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