With A New Monarch And New Prime Minister, UK Real Estate Faces A New World Of Uncertainty
In the space of two days, the UK gained a new prime minister and lost the only monarch the country had known for 70 years.
Inflation is at a 40-year high, interest rates are rising fast to curb it, the value of the pound is lower than it was during the currency crash of the early 1990s, and three years after it was ratified, the effects of Brexit are starting to be seen in the economy.
The UK has faced a series of political, economic and existential crises in the past decade, from a referendum on Scottish independence to the Brexit vote and Covid-19. Through all of them, real estate has sailed on serenely: Investment volumes have fluctuated, but values and rents have kept pace with or even surpassed those of other similar major economies.
The silver bullet of super-low interest rates covered all ills. But with a recession looming, those low rates no longer an option and political uncertainty a near constant, UK real estate faces a unique set of challenges.
“It feels quite depressed in the UK at the moment, and the death of the queen of course doesn’t help that,” said Aref Laham, Orion Capital Managers founder and managing director.
Orion is a London-based pan-European opportunity fund manager, and Laham sees the UK economy and real estate market as particularly fragile in this moment.
Because inflation in the UK is expected to peak at a much higher rate than in the eurozone (predictions call for up to 19% in the UK versus 9% in Europe), and stay higher for longer, interest rates will rise further in the UK than on the Continent, Laham pointed out. Currently the ECB’s base interest rate is 0.75% versus 1.75% at the Bank of England. That will cause real estate values to drop.
“I hope we don’t go into recession, because then demand for space will drop," Laham said. "If you develop something, will tenants want to rent it or investors buy it at the price you want? Something’s got to give.”
Financing will become more difficult to obtain, and banks will be willing to push for sales when existing loans come to maturity, Laham said, because their balance sheets are in a healthier position than during the Great Financial Crisis. And even though values have dropped and could still fall further, lenders are unlikely to face losses on their loans because loan-to-value ratios are typically lower than during the last boom.
The UK consumer is likely to become more stretched as five-year fixed-rate loans taken out at historic low interest rates have to be refinanced in an era of higher rates, he added.
New Prime Minister Liz Truss was speaking in the House of Commons, outlining an energy price cap that she said would avoid spiralling winter bills and a huge rise in the cost of living for both individuals and businesses, when news of the queen’s death started to filter through.
In essence, her premiership was put on hiatus less than a week after it had begun.
While not having a direct impact on how international real estate investors see the UK, "The Queen’s death does delay decisions being taken,” CBRE Investment Management Chief Economist and Head of Insights and Intelligence Sabina Reeves said. “We’ve already lost the summer, and people need help.”
While never an ambassador for UK business like some members of the royal family, the queen's death, for some, also signals the loss of a symbol of many reasons global investors put their faith into UK real estate.
“It’s not going to affect our lives in business, but she served with grace and dignity, and put the UK out there as an example of an open and modern democracy that also has a lot of tradition,” Apollo Global Management partner and Vice Chairman of Principal Finance and Real Estate Roger Orf said.
On Truss, Orf said the mandate on which she ran for conservative leader, one of low taxes and deregulation, would be welcome by business and property — if she was willing and able to implement it.
“The rhetoric, and I don’t call it that to diminish it, was very reassuring,” he said. “But no one knows Liz Truss; she’s had a distinguished career but brief. She’s been a Lib Dem, but then became a Conservative. She was a remainer and then she switched. And will she be in power for longer than two years [by which time the UK will have had a general election]? That’s an open question.”
Orf said he thought the fall in the value of the pound did not reflect the reality of how well the economy would perform in the UK. He is still an investor in the UK.
CBRE IM’s Reeves agreed the movement in the pound against the dollar was not necessarily tied to diminished prospects for the UK economy, which she said had more to do with U.S. interest rates moving up quicker, making buying dollars more attractive for currency investors.
She added the low value of the pound, coupled with a policy of deregulation, should, in theory, make it more attractive for businesses to locate in the UK, bringing in foreign direct investment and stimulating growth for business space.
“Wage inflation has been moderate here compared to the U.S.,” she said. “Having more of a free trade attitude should encourage multinationals to locate here.”
Reeves said the jury is out as to whether Truss’ cap on energy prices and deregulation would prove to be inflationary, and whether it would have a knock-on effect on real estate prices.
“We’ll have to see how people spend the money they will no longer spend on energy," she said. “In theory, deregulation should be good for growth, but it could prove to be inflationary. We’ll have to wait and see whether it is, and whether the Bank of England has to raise interest rates.”
There will be a balancing act as to whether any positive impact for real estate from improved economic growth offsets the negative impact of higher interest rates.
Both the cautious Laham and the more upbeat Reeves were confident on the prospects for London specifically as opposed the the UK more generally. They cited the city’s ability to reinvent itself consistently, something that will be required in the coming years if mediocre office buildings need to be repurposed to other uses.
“Being a global head of research based in London is amazing, because the market is so liquid, you get so much price signalling and information coming through,” Reeves said. “Some markets seize up, but you can always transact in London at a price. It is the first to drop, but the first to recover.”
Some said the issues facing the UK are not that much different from those facing other European countries — and global investors were already wary of Europe as a whole due to the factors afflicting the continent.
“There are a broad sweep of issues facing the UK that are the same across Europe, just with different government policy legacies affecting them,” PGIM Head of European Investment Research Greg Kane said. “If you’re a global, Asian or U.S. investor you look at Europe and see a different mix of risks and opportunities to other parts of the world: an energy crisis, a conflict on the doorstep. The UK is part of that story.”
As a nation, as an economy and as a property market, the UK is entering a new chapter of its own story. As Orion's Laham said: “We’re at an inflection point.”