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November 3, 2016

In the four months following the decision by the United Kingdom to leave the European Union, we have seen jittery financial markets and doubts about the future trajectory of UK, and particularly London, residential property markets.

British Prime Minister Theresa May confirmed this month that the UK’s official divorce from the EU will begin by the end of March 2017, a move that triggered the pound to drop to historic lows against some currencies. While the extreme volatility of the early days has now moderated, the medium term outlook remains uncertain as both sides prepare for mammoth negotiations leading up to a likely 2019 exit. As a result, many Asian investors with residential property in London are wondering what the best course of action is: get out, hold on or invest more.

Looking beyond the plethora of newspaper headlines resulting from the June 23 decision, the main short-term changes have been to the political landscape and to investor sentiment globally towards the UK.

Over the last decade, the London residential market has performed well for investors. Rents have risen, values are up and the economy has grown at a steady rate. The London housing market has for many years been one of the most attractive investment locations globally for individual investors. While recent tax and legislative changes have altered the landscape slightly, it remains one of the most liquid cities offering opportunities across the price spectrum. However, with noise about Brexit continuing, many of our clients are asking us if that situation is likely to change.

One of the key factors to consider as a residential investor is that London has an undersupply of housing that is unlikely to be resolved any time soon. This is an issue that blights many major cities globally and London is no exception. UK government figures show that there will be a significant annual shortfall between supply and the forecast 42,000 housing units needed each year for the next four years. With no short-term solution to this predicament, there is a natural floor under any significant downturn in pricing.

Adding to the existing demand for housing, London is now one of the world’s most important tech hubs with the technology, media and telecom (TMT) sector being the biggest new occupier of office space in the last seven years, meaning that a growing number of people are moving to London to work. In fact, the city’s population is set to rise by almost a million people by 2020, creating further demand for housing across a range of price points.
Much of the new population will come from countries outside of the EU, as well as from other parts of the UK. London remains the main source of career progression within the UK and such is the city’s global status that 80 per cent of all new arrivals come from outside of the EU. London will continue to attract people, placing ongoing pressure on housing levels, particularly at the sub-£2 million (S$3.4 million) mark.

Beyond the structural issues that have created this particular dynamic in London, there are other aspects to consider about the long-term status of the UK capital. According to a wide range of indices, London tops the rankings in terms of business environment, financial sector development, infrastructure, human capital and overall reputation as one of the top cities in the world. The UK’s flexible monetary and fiscal policy has made it a target for global capital, creating economic growth and employment across a number of sectors.

Despite the uncertainty brought about by the referendum, the UK economy is still forecast to perform better than the largest economies in Europe as well as the eurozone and EU over the medium term. The lack of structural reform in the eurozone will continue to hamper economic growth and ultimately this will be a much bigger issue than any short-term political volatility. Noises from the government indicate that the Chancellor of the Exchequer’s Autumn Statement in November will provide an additional economic boost. So, if the UK can show that it can survive just as well outside the EU then global capital will continue to flock there.
Something that many Asian investors will be considering is that the devaluation of the pound could offer a once-in-a-generation entry point, although historic lows against many Asian currencies are unlikely to last for a sustained period of time. Compared to other developed markets, including Singapore, Hong Kong and Sydney, London is competitive in terms of transactional and holding taxes.

All of this is encouraging news for those who have property in the UK or are looking to acquire some. But once Brexit negotiations get under way next year, what are the scenarios to prepare for? There is the possibility that once they begin in earnest in April 2017, discussions become acrimonious and take much longer than the proposed two-year timetable. This could result in a further weakening the UK economy with the pound dropping, pushing up inflation and interest rates. A “hard” Brexit outcome would be a negative in the short to medium term on all sectors of the economy.

Alternatively, it could be that negotiations swing back and forth once they start, with no clear winner. The UK economy plateaus, growing below trend for a number of years and the currency underperforms its global peers. “Uncertain” Brexit is the outcome and UK property prices could decline as a lack of domestic demand weighs on the rental sector and the lack of income growth subdues buyer demand.

More optimistically, it could be that negotiations get off to a good start with both sides willing to compromise. While investment and economic activity remain subdued in the short term, indicators pick up quickly and capital flows quickly back into an independent UK with good links to the rest of Europe. “Soft” Brexit is the outcome and residential markets improve on strong demand and a faster growing economy.

But irrespective of the outcome, the UK will continue to be one of the most important economies in Europe and the world. Based on the data and our understanding of the fundamentals of the market, there remain many more reasons to buy and hold than sell when it comes to London property.

This article first appeared in the Business Times

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David Green-Morgan

Global Capital Markets Research Director, JLL

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