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Brexit? Don't panic...

15 August 16

Property briefing: despite the shock to the commercial property market from the Brexit vote, the fundamentals remain quite strong, and those in the sector should stay level-headed as to its prospects

by Jonathan Seddon

While there has been much doom and gloom written about the impact that Brexit is going to have on the Scottish (and UK) commercial property market, there are positives too. This article seeks to paint a balanced picture of the current environment, and also to put some of the more negative headlines into context.

Brexit experts everywhere

Commercial property lawyers have not traditionally been renowned for our intricate understanding of EU constitutional law. Yet here we are in August 2016, each of us now experts on all matters Brexit. In the space of a few weeks article 50 has become a term as readily understood as section 75.
I cannot remember another event in my career that grabbed my attention quite like Brexit has. Yes, the financial crisis of 2008 had a significant impact on our markets, clients, businesses and our people, but that was completely different to the situation we face today.

Is this 2008 all over again?

In a word, no. This is not a financial crisis. There is no “credit crunch”; in other words there is no lack of liquidity in the market.

This is not a global crisis. The effects are, admittedly, going to be felt further afield than these shores, particularly around Europe. But in general terms the Brexit repercussions, for better or worse, will be experienced primarily in the UK.

This is not a banking crisis. Banks are generally well capitalised these days, are prepared to lend, and are regulated to do so in a responsible manner.

We are not in a recession. There is no reason for this current state of affairs to lead to a recession in commercial property, unless those of us in the market (aided by the media) talk ourselves into one.

This is a period of political and constitutional (and economic) uncertainty. At the moment, it is nothing more.

Uncertainty, the enemy

The problem in our sector is that our markets don’t like any levels of instability or uncertainty. They are easily spooked, so it is understandable that there was a volatile reaction to the political chaos that ensued following the UK’s decision to leave.

But Theresa May’s appointment as Prime Minister, with her new cabinet now assembled, at least gives us some clarity. We don’t know what the UK’s relationship with the EU will look like in 30 months’ time, but we do know that at some point over the next few months the UK will start the negotiations leading to Brexit, and we know who is going to be leading those negotiations.

In terms of the commercial property market, most clients and agents are of the view that the fundamentals are still strong. There is occupier demand, there is money in the system, and values appear to be at a sensible level. That just leaves the question of investor appetite. It is helpful to consider each of these fundamentals in more detail.

More space please

Occupier demand, which underpins everything in the world of commercial property, is still strong across the main sectors. There are plenty of requirements out in the market, especially for office space, and that sector is usually a reliable barometer.

In Edinburgh, there remains a lag of supply in grade A office space, with new schemes such as Haymarket unlikely to come to the market before 2018. This has driven demand for existing space, and the signs are encouraging from both financial and professional occupiers as well as the rapidly expanding tech firms.

The Glasgow market enjoyed significantly increased takeup in Q2, albeit it is less clear what the future holds. Again, there is a lack of grade A space and a weak development pipeline, so demand will probably continue to outstrip supply for the next 12 months and more.

Retail, industrial, housebuilding and the other market sectors are showing similar signs of resilience. The main exception is the sharp decline in takeup of office space in Aberdeen, but that has nothing to do with Brexit.

Whereas some corporates may put off investing in the UK post-Brexit, others still regard the UK as an attractive location for various reasons. GSK has recently committed to expanding its manufacturing sites in the UK, including one in Scotland, citing the UK’s skilled workforce and competitive tax system as key factors. Wells Fargo is another to have made a high profile and significant commitment to the UK post-Brexit vote.

So occupier demand throughout Scotland looks steady enough.

Easy money

It is important to appreciate that there is currently no lack of liquidity in the commercial property sector. Anecdotal evidence suggests there is plenty of money to spend in the investment market, and with low interest rates, the relatively cheap cost of money provides an attractive opportunity for developers.

Fair values

Values are relatively sensible, and our recovery in commercial property over the last two or three years has felt (until the vote at least) much more sustainable. The RICS Q1 UK Commercial Property Market Survey noted that “Across the UK in aggregate, 67% of respondents sense commercial property is fairly valued.” That preceded the vote; however it is clear that there is currently no bubble that needs bursting, unlike 2008.

The issue, if there is one, is whether values have shifted, and if so by how much. It will take a few deals before this becomes any clearer, so investors who aren’t in a hurry are probably going to sit tight and wait until the market adjusts.

Don’t believe the polls

Investor appetite is the trickier one, because it is more subjective, and very much linked to confidence and sentiment.

Morton Fraser commissioned a YouGov poll amongst British property investors earlier this year into investor sentiment in Scotland, and indeed the rest of the UK. A summary of the key findings was published in Journal online news on 7 June. In one finding, 85% of those polled said that an exit from the EU would not affect their decision to invest in Scotland.

Speculation on the implications of something that you don’t think will happen, and how you actually deal with the implications when it does happen, are of course two completely different things.

In the same poll, only 21% of respondents said that Scottish independence was an important factor in their decision to invest. And that takes us to the next confidence wobble – Brexit means IndyRef2 means Scottish independence. Many investors are already looking ahead to that scenario, and will be increasingly nervous about some elements of the media already calling IndyRef2 as a racing certainty. But with the case for independence already looking more difficult on issues such as currency and migration, not to mention fiscal issues, than it did in 2014, a second referendum does look a long way off at the moment.

The recently published RICS Q2 UK Commercial Property Market Survey is much more negative than the corresponding Q1 survey, and highlights a drop-off in investor interest across the UK. It also notes a particular decline in foreign investor demand. That, I think, is a natural consequence of the Brexit vote, and should not cause the alarm that it has. Certainly some of the media headlines around this survey are over the top, and comparisons with the 2008 financial crisis are wildly inaccurate. In fact on one analysis, a weaker pound may make investment in UK commercial property more popular if foreign investors think they are buying assets at a discount.

The RICS Q2 survey revealed that the most pronounced drop in confidence was seen in Scotland and London. Probably not a coincidence that these were the two areas across the UK where the Remain vote was highest.

Thank goodness for low bond yields

Within the Morton Fraser real estate client base we have a range of views on the implications of Brexit. Some of our investment clients see this as an opportunity, and are very enthusiastic about a future deal in the pipeline, even in the short term. Other investor clients are deciding to sit tight for a while and wait for the dust to settle. Again, these clients do have money to invest in property in Scotland and the wider UK, so it is not, for the moment at least, the health of the sector or the economy that is holding them back. Their temporary inertia is partly to do with the constitutional uncertainty, and the timings around that, and partly because of the lack of reliable comparables in the market at the moment.

The news of property funds suspending trading made a big splash with the media, primarily because it’s a great doom and gloom headline. But again this is a logical decision to have taken in response to investors rushing to withdraw funds at a time when there would be great difficulty in actually valuing units in the funds because of market volatility. In addition to that, there is a view that many funds went into the referendum vote very cash heavy – some were reported to be only 70% invested, with the rest in stocks or cash.

In general terms, commercial property has been regarded as an attractive asset class again over the last few years, and the recent fall in bond yields means it is likely to remain so for the foreseeable future.

We’re not doomed

The purpose of this article is not to pretend that all is rosy in our Scottish commercial property garden. Brexit has been a shock and the after-effects will be felt for some time to come.

Rather, the article is intended to present a more balanced view of the landscape in response to some of the doom and gloom hysteria that we have seen of late.

We now have some level of political clarity, although precisely where the UK will get to with the rest of the EU is impossible to predict.

We have occupier demand, available funding and the likelihood of investor appetite taking an upturn in the near future.

There will be consequences, and undoubtedly there will be choppy waters ahead, but with that will come opportunities for those willing to take them. What we don’t need are doom and gloom merchants talking the sector down at a time when the fundamentals are actually still quite strong.

This is not 2008.

Jonathan Seddon, partner, Morton Fraser LLP

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