As the UK prepares to leave the EU, the lack of clarity on how the split-up will work confounds the outlook for both the British economy and UK property stocks.
The English have a rich history of retreats from the continent of Europe, but traditionally, a withdrawal was preceded by defeat inflicted by France or Germany. Uniquely, this time, the departure is voluntary, triggered by a majority of UK voters believing that the country’s economic and political future is best served in a wider global as opposed to a narrower European context. Next year’s Brexit will likely be keenly felt not only in the UK, but on the other side of the Channel as well. Already now, the still unclear terms of the separation are presenting particular uncertainty for both the UK economy and its property market.
29 March 2019: the impact on the UK economy
With less than a year to go before the UK leaves the EU, its biggest market, on 29 March 2019, the details of its future relationship with the bloc should become clearer as negotiations gather pace. The impact on the UK economy has thus far been mixed, with the worst-case scenarios of many in the remain camp yet to materialise. Despite this, expectations for future growth have been lowered and the top end of the housing market in London has notably cooled off.
Nonetheless, commercial property prices have not been severely affected, partly due to the robust interest from Asian investors in buying high-quality UK assets, particularly in London. Indeed, the UK’s Investment Property Databank property index has returned a respectable 8.9% p.a. in the three years to the end of February 2018 (Source: MSCI, February 2018). Equally, while there have been announcements of banks and EU agencies leaving the UK for continental destinations, there has been no stampede. As a result, the vacancy rate in the major London West End and City office markets, for example, has not risen significantly nor have rents fallen notably.
UK listed property stocks
Unlike the direct property markets, UK listed property stocks, along with the pound, were undeniably among the hardest hit assets immediately after the EU referendum. Indeed, UK property stocks underperformed their eurozone counterparts by 12% in local currency terms and by 25% in euros between the June 2016 referendum and the end of Q1 2018. However, once the initial shock wore off, UK property started to recover, narrowing the gap in performance with the continent. More positively, in the first quarter of 2018, UK listed real estate companies matched the performance of their eurozone counterparts, albeit in a generally declining market.
Total returns of UK and eurozone property stocks since Brexit* (total return in %, annualised)
*23/06/2016. Note: The value of your investments may fluctuate. Past performance is no guarantee for future returns. Source: Bloomberg, FTSE EPRA, Nareit, as of 31/03/2018
The impact on listed property stocks has been diverse. Companies with industrial, residential and healthcare companies assets have been among the better performers since June 2016. In contrast, retail companies and the larger-cap UK landlords, particularly those with exposure to the London office market, have been particularly hard hit.
Interestingly, the underperformance of retail companies in the UK is not too dissimilar to what happened with continental European retail property stocks and indeed global ones as retail landlords struggle to meet the growing challenge from online retail. The showing of a number of property companies focused on the London office markets is noteworthy, especially as demand for prime offices from foreign buyers has been very resilient in the face of the referendum outcome. The disconnect between pricing in the listed and private markets in London’s office markets is striking and is reflected in the current share price discounts to net asset value of UK office REITs.
Total returns of UK property stocks and companies since Brexit*
*23/06/2016. Note: these companies are mentioned for illustrative purposes only. This is not intended as a solicitation to purchase these securities, nor does it constitute any investment advice or recommendation. The value of your investments may fluctuate. Past performance is no guarantee for future returns. Source: Bloomberg, as of 31/03/2018
Many of the structural trends influencing UK property are global in nature and will likely continue to impact the UK market regardless of the colour of British passports after 2019. Whether Brexit will be viewed as a long-term economic success will be debated by historians in the decades to come. Regardless of Brexit, London remains one of a handful of true world cities and the UK will likely still be the largest real estate equities market in Europe, accounting for about 30% of the market capitalisation of Europe’s property stocks.
As such, we believe the listed, as much as the private, real estate market should continue to be of interest to international investors given the liquidity and quality of the quoted real estate sector.
More articles by Shaun Stevens
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