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June 2016

Today’s referendum result will have far reaching repercussions for the UK and indeed the global economy and property markets, argues James Roberts, Chief Economist, Knight Frank.




One of the first outcomes from the result of the referendum is that the value of the pound will inevitably fall in the near-term, as will the stock market. The chances of a technical recession, as business investment is curtailed, is high, and exporters and financial services firms will be in the forefront of the downturn.

In light of the above risks Knight Frank expect the Bank of England, seasoned by the experience of the Global Financial Crisis, to respond quickly. An interest rate cut of 25 basis points is a strong possibility at the Monetary Policy Committee’s July meeting, or perhaps earlier if required. We may also see a return of quantitative easing, if there are signs that investment is deteriorating.

This should in Knight Frank’s opinion help restore confidence as the summer progresses. Unemployment is a lagging indicator, so any job losses will take time to filter through to the statistics. Similarly, any inflation driven by the pound’s devaluation, will probably come through later.

Consequently, Knight Frank see the effect on the UK as consisting of a high speed mini economic cycle. In the coming weeks, a combination of falling sentiment and those investors who are over extended having to sell will result in some disposals which will be likely to weigh on asset prices.

This Knight Frank see coinciding with a devaluation of the pound. The combination of lower prices, plus exchange rate effect should then draw in overseas investors looking to acquire assets in the UK, attracted by a G7 country with a track record of achieving strong economic growth.

The re-emergence of inflation, resulting from the devaluation, will in the firm’s opinion push investors towards growth assets later this year or early next. Also, in the coming months, more indication will emerge on the future direction of the UK economy.

Consequently, Knight Frank believe asset prices for the more robust sectors could be back to roughly where they were pre-referendum by summer 2017.

Ultimately, it should be remembered that the UK is a country with 60 million wealthy consumers, and a high skill workforce. Consumer goods firms like Coca Cola and BMW will always want to access a market this big. Skills based employers like PwC and Google will always want to access such a large pool of talented workers. The underlying strengths of the UK economy remain in place, and ultimately real estate is an investment that works best for those who pursue long-term goals.

Sector focus – UK Residential

The UK vote in favour of Brexit has the potential to make a relatively swift impact on the housing market. The scale of this effect, especially in the medium to long-term, will depend on the outcome of negotiations on the UK’s exit.

In the short-term, consumer confidence is likely to be knocked by the continued uncertainty, especially with regards to trade. This may weigh on activity in the market, especially those making discretionary purchases, which could result in a slip in transaction volumes, and prices. However, uncertainty could also result in a further dampening of homes coming onto the market, and this lack of supply will provide a floor under prices.

There is also a chance that mortgage rates become detached from the base rate. While the base rate may well be cut in the coming weeks, lenders may raise their rates as a technique to control their lending levels. Both the reduced availability and increased cost of credit could put additional pressure on transactions as well as affordability. However, it is worth noting that much mortgage activity recently has been in fixed term fixed-rate deals, ranging from 2 to 10 years. Borrowers on such deals will not be affected by rising mortgage rates over these time frames.

In the longer term, any increase in inflation could trigger base rate rises, which would again translate into higher mortgage rates. This scenario would be more challenging for those on variable rate deals. If house prices are also declining, this will put the most pressure on highly leveraged borrowers.

The second-round effects from a slowing economy and growing unemployment will also be felt in the housing market, as these factors affect household incomes as well as sentiment.

In the short to medium-term, the fundamental demand and supply dynamics in the market are unlikely to change, with a continued structural undersupply of homes across the country, underpinning pricing in some of the most desirable and best connected areas.

Sector focus – UK Prime Residential

Sales activity and price growth in the prime London residential market have both slowed since mid-2014. The EU referendum has been only one of a number of headwinds which have impacted the market.

The UK election, the threat of a Mansion Tax, the imposition of higher rates of stamp duty as well as the additional rate for investors and second home buyers, have all conspired with the EU vote to dampen market sentiment.

The very strong volume of sales seen at the end of Q1, bolstered by the impending additional rate of stamp duty, was bound to weigh on deal levels in Q2, but it is fair to speculate that at least part of the decline since April has related to market uncertainty caused by the referendum.

There is no doubt that the vote in favour of Brexit will generate a period of renewed uncertainty in the prime London residential market. Some demand, especially from investors, will be delayed and in some cases redirected to other markets – although the significance of these trends should not be overstated.

Demand for prime London property rests on a wide range of drivers – most of which are unaffected by the referendum decision: the scale of London’s business cluster, depth of skills, education, lifestyle and language. It is not easy to identify an obvious alternative destination for investors despite short-term nervousness.

On the eve of the vote the pound sat 14% below its mid-2014 peak meaning pricing in the prime market was more attractive for dollar buyers. While a further weakening of the pound could increase inward investment, this impact will be constrained by the fact that around 80% of central London buyers are UK residents.

It seems a reasonable assumption to make that interest rates will be lower for longer, despite the risk of imported inflation from a weaker pound. While the long-term benefit of ultra-low interest rates on the housing market may be questionable, in the short term they will act to underpin demand especially for equity rich buyers with access to the best funding rates.

The prime country house market will be similarly impacted by the result. However while the market has performed relatively well over recent years, following a slow recovery immediately after the financial crisis, prices have not tracked London to date and there is scope for some outperformance in the short to medium term.

While we are entering a period of renewed uncertainty in the UK and London market, ongoing issues around EU and especially Eurozone stability, which will be highlighted in the run up to French and German elections, are likely to counter this risk and shore-up London’s safe haven appeal.

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