A Brave New World: Brexit Is Here And Real Estate Still Doesn't Know What's Next
When the clock strikes 11pm on Friday 31 January, the United Kingdom will be fundamentally changed. Solemn for some, celebratory for others, it will mark the end of this sceptered isle’s 47-year membership of the European Union.
For commercial property it is expected to be not the beginning of the end, but the end of the beginning. The UK property press has written at least 6,838 stories that mention Brexit in the past five years. But for business the real story starts now: What will the UK’s future economic relationship with its biggest trading partner look like?
Boris Johnson, the prime minister, has said that a new trade deal will be negotiated with the EU by the end of the withdrawal period, 31 December 2020, come what may. That trade deal will be crucial to whether the UK economy can grow.
What elements of the trade deal will have the biggest impact for UK commercial property? For London, services are clearly the key negotiating point, and experts Bisnow interviewed said the expectation is that there won’t be a very favourable deal — but the capital should still stay resilient.
Beyond this, the negotiations on a customs deal and the imposition of tariffs on goods will have an impact on the industrial and logistics sector, with the potential for disruption to supply chains and thus demand for space. This will also hit retail although frankly, that sector has other issues to worry about.
Finally, although the trade negotiations about to get underway will not expressly focus on immigration — that is a separate policy — the issue of who gets to come in and out of the country is inextricably intertwined with Brexit. The immigration policy the new government chooses to pursue could have a major impact on the property sector.
Most important is that a deal happens and on schedule.
“Real estate relies on economic growth,” CBRE Global Investors UK Head of Strategy & Research David Inskip said. “There would be wide-ranging implications for the sector if there were no deal, or another extension.”
No deal could lead to an economic shock that real estate would not escape, while an extension, or even the threat of one, could lead to the kind of hiatus from investors that saw UK investment volumes drop 20% in 2019.
But the expectation from real estate professionals is that some sort of deal will be reached, even if in some areas it will be provisional and light on detail, with the intention that it can be expanded upon in future.
Experts Bisnow spoke to predict there will be only the barest agreement on whether London-based firms can sell services to the EU, whether there is equivalence between UK and EU firms, and to what extent the UK sticks with EU financial regulations. The UK sells more services to the EU than vice versa, so there is little incentive for the bloc to give easy access to UK firms.
While this sounds like it could be a major issue for the central London office market, with the companies that occupy space in the capital not having access to a big market, it may not actually be too much to worry about.
“I think since the referendum this has been the assumption that businesses have been working with, and they have planned accordingly,” Inskip said. “People have been moving some peripheral jobs, but there has been no mass exodus, and there will be no sharp shock. This is a process that will unfold over a decade, and if companies want to have staff in London, they will find a way to do that.”
Inskip pointed to the sharp increase in requirements for space from the legal sector as an example, with more than five firms having requirements of 100K SF or more.
“People might say it is no surprise that at times like this legal firms do well, but they need more space, and they are choosing to take it in London.”
While London’s appeal should remain robust on a big-picture level, there will be implications for owners and investors on the micro level.
“We think it becomes a granular, asset-level question,” Cushman & Wakefield Head of European Investment Strategy David Hutchings said. “If you’re investing in a building let to a global tech firm then you should be fine: Investors see London very much as a global city. If the building is leased to a European bank or fund manager, then you have a question about the long-term level of staff they will have there.”
For some, divergence from EU financial regulations offers the possibility of a big boost for the London office market, albeit with some caveats.
“Before the general election, the main call from business was that we should stick as closely as possible to the rules we currently have,” UBS-AM Real Estate and Private Markets European Real Estate Analyst Zachary Gauge said. “But now there is increasing commentary about the possibilities a looser arrangement might offer. There is a feeling that Boris Johnson has got through the chaos of the last few years, and having done that he is unlikely to just stick to EU rules.”
Gauge said looser regulation in areas like financial services might attract new occupiers to London, and also make those already here more profitable, thus increasing their need for space.
“Stringent regulation is having an impact on European banks, and that is affecting their profitability, which changes the size of the business,” he said. “U.S. banks have performed really well with less stringent regulation.”
It must be added that any boost for London offices that might come with lighter regulation has a potential downside: Light-touch regulation played a major contributory factor in the last financial crash, which decimated the need for space for London offices for several years.
Supply and demand
The picture is less clear in the world of industrial and logistics, the best performing UK real estate sector for the past five years, and the sector the Investment Property Forum predicts will continue to outperform between now and 2023.
While the EU might not be that fussed about striking a deal on services, a deal on customs agreements and potential tariffs on goods moving between the UK and EU are seen as being very important to the EU bloc since the UK is a big importer of European goods. How that deal shakes out will be vital for the sheds market.
“That is the sector with a big risk to the downside,” Gauge said. “Manufacturing has benefitted from the free flow of goods and materials, and supply chains are built across Europe. A move to World Trade Organisation rules [in the event of no deal] or significant barriers and tariffs would be a risk, and in that regard you would hope that we stay more closely aligned so that there wasn’t significant disruption in supply chains.”
Since UK industrial and logistics assets are concentrated in the UK regions, the Midlands and north of the country would be more affected by an increase in trade friction. But again, it is important to take a sector and asset-specific view.
The chemicals sector could be severely impacted by an increase in tariffs, but chemical manufacturing plants tend to be owned by occupiers rather than institutional investors, Inskip pointed out. Of more concern are the aerospace and automotive sectors, where institutional ownership of plants and supply chain property is higher.
“Those areas are big exporters to the EU, and you would have to look at what occupiers did with their supply chains. In the heartlands, the Midlands and North, that is where the disruption would come through.”
Who's in and who's out?
The question of immigration was at the heart of Brexit, with much of the pro-Brexit campaigning centring around the fact that leaving the EU would reduce the number of immigrants to the UK. So while the trade negotiation with the EU will not cover how many European citizens can enter the UK, the policy the Conservative party takes on border control will be under the spotlight in the coming year and will have a big impact on the real estate sector.
The new government has not set out a formal policy on immigration yet, but the rhetoric on the subject has emphasised how it wants to come up with a system that still gives access to highly skilled workers, while controlling numbers of lower skilled workers. But for real estate, both of these areas have problems.
“Another big downside risk is on the movement of people, particularly skilled workers,” Gauge said. “London has profited greatly from a strong flow of migrant labour, especially skilled workers. The latest theory is about a points-based system, but does it make the UK less attractive, simply by having to go through that process?”
Many sectors of real estate rely on unskilled labour. Care homes, shops, restaurants and hotels are to a large degree staffed by low-wage employees, especially in major cities. Limiting the pool of potential staff increases labour costs, which puts the businesses that occupy space in these sectors under greater financial pressure, at a time when they are already under strain.
Then of course there is construction, a sector that has become ever more reliant on immigrant labour over the last two decades. Labour costs are already rising, even before there is an end to the free movement of people from the EU. And things are about to get worse.
“Especially if the government has announced a big boost in infrastructure spending, that could put a big pressure on construction costs,” Inskip said. “That could actually support property values, because it limits new supply, but you want an economy that supports the market rather than costs keeping values artificially high.”