The Brexit Saga

The outcome of the ongoing negotiations between the United Kingdom and the European Union, which will shape their future relationship, is still not clear. While the analysis of all plausible scenarios is beyond the scope of this report, we will assess the impact of a worst-case scenario – a ‘hard’ Brexit, or no deal – on residential and commercial real estate.

In the short term, BNP Paribas Real Estate expects a tangible impact on the market, similar to what investors observed in the aftermath of the referendum. “The fall in the UK’s investment volume could reach 25%-30%, with capital values in City offices falling the most, by 15%, and by 10% in the West End. These will be driven primarily by rental falls, on the back of further weakness in the occupier market.” Even assuming a deal with the EU, the impact on the property market could still be somewhat negative, yet to a much lesser extent. “Investment volume is expected to fall by 11% with an average capital value fall of 5% p.a. over the next 3 years in London.” (source: BNP Paribas Real Estate). We remind the reader that the current uncertainty linked to Brexit is not the only factor responsible for the bout of market weakness. Anyway the London office market is entering the final stage of its current property cycle.

Nonetheless, we believe that London will always be popular among investors – institutional and private alike – and the commercial market should be supported by the weaker pound. A similar situation should be seen in the capital’s housing markets, with European investors progressively returning there.

Warehousing would experience much stronger demand around port areas in the event of a hard Brexit. “Processing goods and clearing them through customs at port locations will mean more storage is needed, especially in the short term. We are already seeing increased speculative development in storage space around the port of Dover. Further yield compression and rental growth in logistics property could be likely” (source: BNP Paribas Real Estate, September 2018).

The long-term future of the market is more difficult to predict, as it will largely depend on the nature of an agreement with the EU and the long-term performance of the British economy. Spillover effects on real-estate occupancy, with vacancy rates likely to increase sharply, will put downward pressure on rents. Selling pressure will emerge, forcing a correction in asset valuations.

Despite Brexit, American investors are still active in the uk

While some American investors are entering the property market in the UK, the ones already there are trading London for regional cities. Total real-estate investment by Americans in the UK reached a meagre USD 3.1 billion between the beginning of the year and mid-August. “This is a much slower pace than the USD 16 billion transacted in 2015, the year before the Brexit vote.” (source: Real Capital Analytics, August 2018).

Asian investors too

Asian investors continue to acquire London's trophy buildings, such as Plumtree Court, London's ten-storey building that will become Goldman Sachs' European headquarters. This building was purchased by the Korean National Pension Service (NPS) for GBP 1.17 billion as part of a sale and leaseback agreement (the transaction is expected to be closed next January, source: IPE, 23 August 2018).

American investors are willing to take higher risks, while Asian investors are less keen. The reason is simple: Asian investors can still find properties whose GIYs are trading well above those of similar buildings in their top-tiered home markets. This is not the case for American investors, with UK property capitalisation rates clearly below those in the US. Consequently, they must incur additional risks when investing in the United Kingdom in order to obtain a total return that is acceptable (at least to them).

Among the deals made by US investors outside London this year we highlight that of private equity firm LCN Capital Partners which bought the first phase of Aberdeen International Business Park – Aker Solutions' 335,000 m² headquarters – for around GBP 114 million, offering a return of around 6.9% (source: CoStar News, 22 March 2018). And the asset manager Invesco has announced that it is partnering with developers Patten Properties and Panacea Property Development to deliver 383 build-to-rent units in Liverpool City Centre (source: Wall Street Journal, 28 August 2018).

A big advantage for US investors is the lower prices when converted into US dollars. The weakening British pound – which has depreciated by about 15% against the greenback since the Brexit vote in summer 2016 – makes it cheaper for dollar-based investors to purchase in the UK. As a reminder, Americans have accounted for the lion’s share of non-British investors in the country for years. They have disbursed more than USD 90 billion on commercial real estate in the UK since 2007 (source: Real Capital Analytics).