Prospect of EU referendum clouds UK real estate market

The sigh of relief was almost audible at the weekend as the results of the most uncertain UK election in recent memory sank in.

The clear victory for the Conservative Party brings stability and certainty and for this reason it was welcomed by business and by the markets.

The real estate sector was no exception: the last year has seen a marked improvement in commercial real estate markets in the UK, driven by a strong economic recovery and good fundamentals, and the prospect of more of the same was welcome. Despite recent price gains, many experts believe that the context is in place for further upside in the short to medium term.

‘There is good reason to suppose the UK economy, that appeared to slow in the run-up to the election, can now resume a strengthening recovery, and this will be good news for both the commercial leasing and investment markets,’ said James Roberts, chief economist at Knight Frank.

Not that the commercial investment market seemed to be particularly rattled by the prospect of elections: the investment volume in the first three months of the year shot above the £17 bn mark, the strongest first quarter of the last 15 years. In the central London commercial investment market Q1 turnover was 28% higher than last year at £3.1 bn, over 60% of which from foreign buyers.

The recovery has spread beyond the capital: according to Savills, in the first four months of 2015 foreign purchases of commercial real estate investments outside London have reached £5.4 bn.

‘In the current macro-economic climate, commercial property remains a popular choice for savvy investors, surpassing other asset classes in providing substantial returns,’ said Mat Oakley, Savills head of European commercial research.

When compared to non real estate investment, commercial property is showing lower volatility, with returns outperforming equities, bonds and commodities. The possible threat of further deflation, which will result in rates reaching record lows, he says, is likely to further boost the rationale for investing in property.

But, while the picture for the residential market is uniformly positive under a new Tory government, the same cannot be said for commercial real estate. The residential market has been virtually frozen for the last few weeks of electoral campaign, living in fear of the ‘Mansion Tax’ which the Labour Party had promised to impose on all houses worth over £2 mln, and which would have had a disproportionate effect on the London market. So there was nothing but joy among estate agents at the election results, and their share prices duly shot up.

For commercial real estate the picture is more mixed. On the one hand, as highlighted above, certainty, stability, good economic management and the likelihood of a sustained recovery are clear positives. On the other hand, the fact is that the Conservative win also brings with it a less palatable certainty: that of an in/out referendum on the European Union, which prime minister David Cameron has promised to hold by 2017.

‘If the prospect of Scottish independence caused a market slowdown, the idea of the UK leaving the EU will surely do the same, probably on a greater scale,’ said Roberts of Knight Frank. ‘Some investors may decide to wait until after a referendum before buying; some occupiers might shelve expansion plans because a sudden fall or rise in sterling hits profits. A vote sooner rather than later may be the best outcome.’

EU referendum
The view is shared by many economists and market experts. According to Nick Spiro, Managing Director
Spiro Sovereign Strategy, Cameron has a serious 'Quebec problem' on his hands just when his party is now even more emboldened to hold a referendum on Britain’s membership of the European Union (EU). 'While short-term uncertainty has been lifted, markets must now contend with the start of a period of major political and constitutional uncertainty in UK politics,' he said.

‘Uncertainty surrounding the UK position within the EU could dent demand for office space from global companies in the long run,’ added Arno Kitts, head of BlackRock’s UK Institutional Business.

An EU referendum would have ‘a damaging effect on London’s attractiveness to US and Asian businesses who are looking for a European HQ,’ said Oakley of Savills. ‘However, the high returns and comparative political stability that the UK offers to international investors are likely to continue to make it the destination of choice for global cross-border investors in real estate.'

Roberts shares that optimism: ‘We should expect the odd air pocket ahead, but overall the election outcome was probably much better for commercial property than one would have expected a few days ago.’

David Hutchings, head of EMEA investment strategy, agrees there are uncertainties to be settled. 'The UK is still in an era of austerity and with more red lines drawn in the election over where tax or the axe will not be used, the new government’s room for manoeuvre is reduced and with no restraining coalition partner, there may be some surprises.'

Possibly of most immediate concern, however, the UK’s position in Europe is now more in the spotlight with the promised referendum on UK membership of the EU to come, he said. 'This will worry many investors and is a fundamental concern, most particularly perhaps in regional UK markets. The best that we can hope is that the referendum is brought forward to 2016 as David Cameron has suggested it may be and that this boil is lanced quickly – and hopefully with a rebalancing of EU powers that benefits the whole of the European Union.

Nicol Dynes
Correspondent UK