I was recently asked to give a briefing on the UK property market for a range of foreign investors, mainly from South East Asia. This is an expanded version of some of my comments.
Investing in the UK
Since the Brexit vote many overseas investors have downgraded the UK. Simon French of Panmure Gordon estimates that the UK equity market trades at a discount of 18% compared with its peers.[1] The currency was overvalued at the time of the Brexit vote but since then has been generally weak – the sterling trade weighted index stands around 71 compared with 90 just before the date of the referendum.
Whether the perception that Brexit means that the UK is withdrawing from the world is correct or not, such perceptions tend to be long lasting. It is worth noting, however that the UK has taken a proactive role in Ukraine and European defence, that migration since Brexit has gone up not down (though from different countries) and the UK has negotiated many trade deals and will join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). This last could well revolutionise the UK’s economic relationships with South East Asia. So, the perceptions that the UK has withdrawn from the global stage may be overblown – but they are still likely to be influential for the immediate future.
Sterling
In addition, the UK has run a persistent balance of payments current account deficit close to 5% of GDP even before the Brexit vote. Although this narrowed as consumer spending was suppressed during lockdown, it has risen again to 3.8% of GDP in Q4 2022. There are a range of reasons – Brexit probably has some impact although in fact the deficit fell after the vote and again after the end of the transition period in 2020. UK competitiveness appears to be weak in most sectors and energy policy problems seem to mean that the UK is having to import more of its energy than would be ideal. So even if there is a revival of sentiment towards the UK, the currency may well remain weak.
Inflation and interest rates
UK core inflation is 6.8% compared with 5.8% in France and Germany and 5.3% in the US. Of the G20 countries only Argentina, Turkey, Brazil and Mexico have higher core inflation. There seem to be three reasons why UK core inflation remains so high: the UK’s very weak productivity performance pushing up unit costs; the Bank of England’s monetary management; the country’s chaotic energy policy which is feeding through into non-core inflation and hence into wage demands, supported by a tight labour market (which itself is partly a function of weak productivity).
This means that interest rates are likely to stay high. Our last forecast in May showed them rising further before declining gently in 2024 but the most recent data means that even this may be optimistic.
Residential property
In the circumstances residential property prices are falling slightly at the moment and are likely to fall further. We expect that the main effect of interest rate rises on mortgage rates are yet to come.[2] Meanwhile transactions have slowed down substantially. In addition, populist governments have ignored the laws of economics and substantially tightened regulations and reduced tax incentives for landlords, which in conjunction with higher interest rates has led to a collapse in the ‘buy-to-let’ market. Naturally this has led to the withdrawal of property from the market and hence pushed up rents. Our most recent housing forecasts show year on year falls in average house prices of 2% this year and 0.5% in 2024.
Commercial property
Rises in interest rates have combined with falling lettings to push down prices in commercial real estate – we estimate by around 20%. Since mid-2022, the average price in nominal terms has fallen by more than during the financial crisis and even more so in real terms. It will probably fall further and there almost certainly will be some fire sales as companies sell assets to finance debt repayments due in the coming years. Two Canary Wharf towers have gone into administration and Canary Wharf itself has had its bonds downgraded by Moody’s and Fitch. The scale of the fall in prices is such that for many properties, the amount borrowed against them is perilously close to or higher than the current market value.
Because the UK has a disproportionate amount of service businesses of a kind where working from home or hybrid working is possible, the impact of this on urban commercial property has been greater than in other countries. There will need to be substantial conversion of office space to residential (which will hold down residential property prices); also much office space will have to be reconfigured to shared space suitable for co-working. Values will depend much on the scope for convertibility.
Demand for warehouses and some industrial space is stronger and less affected by working habits but even these have been downgraded. And retail is moving in a similar direction to office space, matching the growth of online.
Overall
For brave investors, there are still opportunities and there may be some bargains available. The UK is generally considered a relatively safe place for investment with transparency, a familiar legal system and protection of property rights.
But the era when investors could park their money in UK property and just watch it grow in value has probably gone. There are very few free lunches now available!
For more information, please contact:
Douglas McWilliams, Deputy Chairman
Email: dmcwilliams@cebr.com, Phone: 07710 083652
Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.