The Impacts of Brexit on Commercial Property
Britain officially left the European Union last month. Whilst commercial property should appreciate it in the long term because of population growth and productivity gains, ‘Brexit’ could trigger an out of cycle imminent downturn. Commercial property remains suitable for a long-term balanced portfolio, which also includes residential property, bonds, private and public equities. Commercial property commonly offers an attractive yield and protects investors from inflation through regular rent increases.
During a downturn, there are many more impacts than just a fall in property valuations. Rents often fall (which in turn impacts valuations), development activity slows, vacancy rates rise, tenants demand higher incentives and vendor activity increases. The key trigger for a downturn is slowing economic activity. Consumer spending and investment decreases, negatively impacting all types of commercial property. Higher vacancy rates further reflect rising unemployment rates.
The full impact of Brexit on migration, international relations, trade and overseas investment remains to be seen. Short-term declines in any of these activities will negatively impact commercial property, particularly retail.
Data from the Q3 2019 RICS UK Commercial Property Market Survey reveals that tenant net demand fell from -13% to -19%, while consumer sentiment towards a downturn in the property cycle increased from 53% to 62% (i.e. 62% of responders believe that the UK commercial property market is in a downturn). Industrial property was the only area of commercial property with demand growth, while office demand mildly contracted, and retail declined significantly (demand net balance of -60%). Retail vacancies and incentive rates continue to increase. 56% of those surveyed foresee further rent reductions.
Prime real estate is expected to outperform lower grades during downturns because of their durability, rental stability and high demand.
Low-Interest Rates and Low Exchange Rates
Low-interest rates (set by the Bank of England) help support all property (and equities) valuations. The yield on commercial property becomes relatively more attractive with lower interest rates as capital flows out of bank deposits into real estate. The cash rate currently sits at 0.75%.
Furthermore, a depreciated exchange rate (1 Pound Sterling currently buys US$1.29) makes UK real estate cheaper for international buyers. 5 years ago, the Pound was around 20% higher.
Large tech companies including Facebook and Google are expanding in London because of its skilled workers. This could attract investment from more multinational corporations.
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