The COVID-19 pandemic has taken investors’ attention away from the UK’s departure from the EU, write
As Europe wades through the COVID-19 pandemic like the rest of the world, another rather important event, namely Brexit, has been pushed to the back burner. Britain’s departure from the EU is now less than six months away. We have passed the 30 June deadline to extend, which means the UK is on course to leave the transition period on 31 December 2020. Prime Minister Boris Johnson said he wanted the outline of a deal agreed by the end of July while the EU suggested 31 October as a more realistic deadline for the end of negotiations. Investors are now grappling with the many unknowns that result from what would have been the most impactful event in Europe for a generation, were it not for COVID-19 and the resulting dislocation.
The Brexit rollercoaster has been part of the European investing landscape for over four years now, following the June 2016 referendum. The optimism that followed the UK national election victory for Boris Johnson and the Tory Party on a ‘leave platform’ in December 2019 has been rudely interrupted by the pandemic. In addition, there is disagreement with ongoing political wrangling over several issues including fishing rights and European court’s jurisdiction being among the most contentious. Many commentators are now suggesting the UK might leave the European Union on 31 December without a deal, therefore leaving the UK to trade on WTO terms, an outcome that not many would have been expecting at the beginning of the year.
The obvious impact of trading on WTO terms and having border controls will make most products from Europe cost more and take longer to get. Some industrial players have started saying that Britain is moving from a ‘just in time’ to a ‘just in case’ inventory plan. We have already anecdotally seen some movement of people and manufacturing to the EU from the UK over the past four years, but many groups have thus far taken a wait-and-see approach assuming a deal would be reached.
What will be the impact on UK real estate?
While there is a lot of uncertainty as to what impact Brexit, and now COVID-19, will have on UK real estate, one thing is already evident: investors are prioritising western Europe over the UK. Aggregate value of deals in western Europe surpassed those in the UK in 2016 and 2017, with 2018 recording similar volumes, which was not the case prior to the Brexit referendum. A weakening Pound has not been able to mitigate this trend and entice investors back into the market.
First-half 2019 transaction volumes were 30% lower than the same period in 2018. European investors coming into the UK had an even more exaggerated decline, spending 50% less in the 1st half of 2019 than 2018.
The London office sector has seen an even sharper reduction this year, given the complications of the COVID-19 lockdown, with cross-border transactions between January and May of this year plummeting 70% compared with the same period in 2019. Central London office had been the most liquid real estate asset class in the world at the end of 2015, but that is no longer the case. Overseas investment was down 75% year over year, having previously accounted for 75% of acquisition activity over the past decade.
Strangely, pricing isn’t following the same downward trajectory as the plummeting transactions trend, with overall prices rising by 11.2% in 2019 from 2018. This positioned the UK as the best performer of all the country-level indices published by Real Capital Analytics. This may be since there are few, if any, forced sellers and the best quality properties are making it to market and finding buyers.
UK industrial assets have been the major winner with prices growing 11% per annum for the past three years (until the middle of 2019) versus 7% for the broader commercial real estate market.
In summary, the UK is grappling with two once-in-a-generation events simultaneously. The ongoing saga of Brexit has already driven transaction volumes significantly lower, but pricing has held up. Mirroring global trends, industrial assets have been performing strongly, but office, the largest asset class, is under a lot of pressure. The UK real estate sector will surely have a bumpy road over the next few months.
Jonathan Read is a principal at Hodes Weill & Associates