Publicerad: 8 Mars 2019, 18:36
From London. Photo: Sverrir Thór.
Brexit is looming around the corner and in only three weeks the United Kingdom might leave the European Union. What will that mean for the UK? Bruce Dear and Tord Svensson of Eversheds Sutherland give us A Guide to Brexit Realities and Real Estate in Ten Songs.
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A Guide to Brexit Realities and Real Estate in Ten Songs
“Many Rivers to Cross”
Brexit is not a single event (like a tooth extraction). It is a ten-year-plus process of negotiation and treaty making. This is not cheering news for those desperate to stop hearing and talking about Brexit; but it is the truth. Politicians who say the real Brexit opportunity for Britain is over the next fifty years are right. For all of us in real estate, the effects of Brexit will be part of our daily market calculations until at least the time our youngest millennial retires.
“Breaking Up is Hard to Do”
Over the last 45 years the UK has become one economic body with the EU. You can’t separate such an intricately interwoven system easily or without pain. Interestingly, extreme 1980s British Euro sceptics argued their era was the last sensible moment to get the UK out of Europe. After that, they said, the economies would be too entwined to do it without profound damage to both. They may have exaggerated; but it is true that leaving must be done with immense skill and care to avoid unintended harm.
“River Deep – Mountain High”
Leaving the EU is the most complex peacetime challenge the UK has ever faced. Over the coming years, Britain must negotiate a multi-faceted free trade agreement with the EU and, at the same time, negotiate a long series of free trade agreements with all of the world’s major countries and trade blocks.
This work will be all the more formidable because the deals must interlink. Making sure they dovetail and don’t breach or compromise each other will not be the work of moments. This global process will be especially intricate because many countries (for example, Japan) will want the UK to deliver a close and open deal with the EU in order to make their own free trade deal with the UK more worthwhile. Achieving all of this will be like playing chess on a thousand boards – with all the pieces tied together.
To borrow a Sci-Fi phrase, the UK must “reverse the polarity” of its trade flows – compensating for the loss of access to EU markets by greater access to those of the wider (particularly Asian) world. True, the world’s growth and trade-flow patterns (the expected rise of Asia and decline of Europe) will probably help that task over time, but it is still a gigantic policy reorientation. It will take patience, phenomenal hard work, luck and ten to twenty years to achieve.
“I’d do Anything for Love (But I Won’t do That)”
The UK’s current red lines prioritise ending free movement. This means the UK must leave the Single Market because free movement is one of that Market’s Four Freedoms. Mrs. Thatcher was the Single Market’s proud midwife. It currently allows UK service businesses to sell, serve and send staff freely across a single Europe-wide regulatory universe. Outside the Single Market, UK service businesses simply won’t be able to do that. And 75% of the UK’s economy consists of services. So, let’s be clear (as the politicians say) – leaving the Single Market as part of ending free movement is an epoch-changing political decision.
To mitigate its consequences, the UK will need to negotiate services “arrangements” (to quote the Political Declaration) with the EU over the next decade (with doubtless many convulsive twists, turns and tensions) to re-secure the fullest possible access to EU markets for its service businesses.
Unless there is a change of government and/or policy, these negotiations will have to be done without the UK being able to play the free movement card. This will make the talks an intractable task, because the EU sees the four freedoms, with an almost theological intensity, as a kind of Holy Quartet.
As these negotiations unfold, always keep in mind that the EU enjoys a huge surplus in goods over the UK, just as the UK currently sports a massive surplus in services over it. So any deal that puts goods before services is likely to be good for the EU and bad for the UK.
“Que Sera Sera”
Brexit means (as well as, famously, Brexit) lots of different possible futures. The current UK government is a divided and minority one – and governments don’t get their own way, or last, forever. It is therefore possible that the UK’s approach to Brexit could suddenly soften. This could happen by cross-party compromise to get something (anything) through parliament to avoid a no-deal outcome; a backbench amendment forced on the government; or the election of a Labour government. This last one is the least likely because the UK’s Fixed Term Parliament Act means that – barring weird events – there will be no General Election until 2022.
Labour’s Brexit approach has (like the government’s) come in for much domestic criticism as a “my unicorn is prettier than your unicorn” policy. However, what Labour seems to be advocating is the redrawing many of the UK government’s current red lines. They might, for example, be more willing to trade free movement for Single Market access. They are also willing to keep Britain in a tighter Customs Union than many Tories would tolerate. This would make some aspects of negotiating the deal easier (whether better, we leave for others to judge).
However, where the current Labour leadership would have its own ideological and restrictive red lines would be over sovereignty. They believe (arguably wrongly) that EU procurement and state aid rules would prevent them building “socialism in one country” and nationalising, investing in and awarding contracts to British businesses as they see fit.
“What’s that Coming over the Hill?”
It’s cold outside. The US and China are both pursuing fervent nationalist projects to be “great again”. That’s their prerogative. The key point for the UK (and indeed the EU) is that, in this mood, both will be very difficult to negotiate with. History shows nation states almost always brutally seek their own self interest – whether as part of a trading bloc like the EU, or as sole traders. Therefore, pace President Trump, any free trade deal with the US or China (unless the UK rolls like a puppy) is likely to be protracted and painstaking to negotiate.
“Can You Deal With It?”
The post-Brexit deals the UK strikes with the EU and its other global trading partners will help determine the flow of FDI (whether to the UK or elsewhere), where international businesses and their staff locate and whether the UK economy can generate the money to address its housing and infrastructure deficits.
“I Will Survive”.
People should be reasonably optimistic about the UK’s prospects. Without a doubt the UK (and the EU) faces a big Brexit challenge. But even if Brexit hits hard, the UK will still be a top-eight global economy, with some of the world’s greatest cities and many of its most innovative businesses. It will remain a compelling place to invest and work.
“Making Plans for Nigel”
The unpredictability of politics (both domestic and international) means businesses have had to plan for a hard Brexit (either now or at the end of any adumbrated transitional period). Indeed, we are already seeing a slew of financial services and manufacturing businesses announcing and implementing such plans.
As a result, occupier office demand in the financial services sector will slow. This is not so much because businesses will be moving large numbers of people out of the UK. Indeed, so far, relocations for Brexit resilience reasons have tended only to involve setting up small offices within the EU and moving relatively few people into them (maybe a few thousand in total).
The real issue will be whether to locate new financial services businesses in the UK once it is outside the Single Market. Since ease of cross-border business is a key location driver for global services businesses, adding any drag on it to other calculations may swing the location pendulum against London and in favour of an EU city or New York or Singapore. How many financial service businesses are lost to the UK market will depend on the progress and outcome of the UK’s post-Brexit negotiations with the EU and with the rest of the world. Similar issues could affect manufacturing real estate, but ultimately we expect a deal on goods to be much easier to do than one on services.
In some ways, this potential consequence of Brexit for financial services space is only an acceleration of a pre-existing trend in the UK’s major cities. Since the GFC, financial services businesses have taken less square footage and technology and media companies much more.
As part of this, over the last three years, the FANGs have flooded into London. Brexit is of less concern to them than to financial services companies. They like the UK’s welcoming tax climate, its high-quality graduate workforce and the opportunities for regulatory and political arbitrage it offers. The office occupier market in the UK over the next ten years will probably be substantially driven by Tech (including Fintech) and media companies, rather than by financial services firms.
More widely, given the medium term uncertainties of Brexit, investors will need to focus on the deep tectonic forces that drive the UK economy: an ageing population, internet revolution, housing shortage and infrastructure deficit.
“When I’m 64”
The UK is getting older. By 2050, 25% of the UK population will be over 65 and the non-working will outnumber the working 2 to 1. Unless there is an unexpected disaster, this trend will continue through most of this century. It makes sense to get behind it and invest in senior and supported living, healthcare and long income real assets capable of supporting a variety of pension products.
Alongside this, UK asset inequality and the gap between house prices and earnings are arguably the worst they have ever been. For these reasons, in the long run all types of residential real estate should offer a robust Brexit hedge be they build to sell, build to rent or social housing.
Build to sell should remain attractive through the cycle as supply seems set to remain constrained, and because the UK government’s default route out of any downturn has become to pump prime the housing market. Some diversification into the BTR sector should offer good resilience against land prices dropping because then house builder competition will fall away, creating the optimum moment to kick start this incipient sector. Social housing will be a third important element because both the UK’s major political parties (but especially Labour) plan to expand its role.
Other economic drivers will trump the effects of Brexit. The ecommerce flood tide means all retail businesses must continue to reinvent themselves as entertainment, technology and delivery businesses over the next ten years – or die. Ecommerce coupled with continuing mass urbanisation ensures that, though a hard Brexit may temporarily interrupt its supply chains, the UK logistics sector will thrive for decades to come. The advent of electric self-driving lorries and drones may change the location of regional and last mile distribution centres, but it won’t change the need for them. Logistics landlords and the companies that occupy their space look set to be the market’s most Brexit-resilient players.
Inevitably, risk and volatility will play a big role in UK real estate markets over the next few years. Investors should hold their nerve and concentrate on the underlying tectonic drivers of the economy. They should couple this with a falcon-like focus on the Brexit story and the opportunities it will (sometimes accidentally) offer, such as mispricing, currency plays and regulatory arbitrage.
For those real estate professionals who can see beyond Brexit hysteria, the Brexit-disrupted market will be full of opportunities.
Bruce Dear, Head of London Real Estate, Eversheds Sutherland
Tord Svensson, Real Estate Partner, Eversheds Sutherland, Stockholm.
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