Brexit doesn’t alter the strong fundamentals that underpin the investment market

Regular readers of this column might have noticed my reluctance to dwell on the B-word. However, nearly three years on from the referendum on EU membership and the UK’s departure is again delayed, now seems like an opportune time to reflect on Brexit and consider its impact on the commercial property sector.

As we are all accurately aware, the property sector doesn’t work in isolation and the politics of Brexit have caused uncertainty for UK businesses.

In some cases this has undoubtedly held back decision making across the business sectors, impacting on commercial occupier demand. But more widely, other factors are at play.

Concerns are now rising over the outlook for the global economy, and growth appears to be slowing in the EU, which remains our main trading partner.

Against this backdrop, The UK economy has held up well so far in 2019, with growth of 0.3 per cent in the three months to February (compared with the previous three months).

However, slowing global growth plus the ongoing domestic uncertainty means that below-trend UK growth is set to continue, which is likely to match 2018’s performance this year.

There is evidence that the ongoing uncertainty has benefited the labour market, as firms, having lacked the confidence to invest, have instead hired workers.

The UK’s workforce has risen by 384,000 employees over the last year (to January 2019), according to the Office for National Statistics. The rise is not being driven by part-time or ‘zero-hours contracts’, as more than 90 per cent were full time. This has helped to support occupier demand for commercial property in particular.

So, how is the office market faring? On the face of it, the office sector is the most exposed to Brexit, given the potential for the relocation of certain office-based jobs to locations inside the EU.

Although some jobs are inevitably being lost overseas, this appears to be a trickle rather than a flood. In fact, broader shifts in occupier demand are having a much greater impact on the sector than anything Brexit-related, as the office market undergoes a quiet revolution.

The co-working/serviced office accommodation model continues to grow at pace, with demand moving up the size curve and rippling out from London to the regional markets.

The new International Financial Reporting Standard 16 is now in force and requires businesses to declare the extent of real estate liabilities on their balance sheets.

This will propel the adoption of more efficient operating practices and, perhaps, a preference for shorter leases, further benefitting the serviced office model.

In addition, occupiers are shifting their focus ever more from cost to quality and real estate is increasingly being used as a tool to attract and retain a high-quality workforce.

Brexit remains a key concern for the London office market although the initial predictions of a deluge of jobs leaving the UK in sectors such as financial services appear unlikely to materialise.

London’s employment base has diversified significantly over the last decade, reducing the potential risk. Away from Brexit, there are many positives for the market, including the capital’s strong population growth and major forthcoming infrastructure improvements.

For our market, and other key regional hubs, the main issue is a supply shortage of quality stock rather than a lack of demand. Many city centres will see little or no speculative space completed this year, and where speculative stock is coming through (in Birmingham, for example), this is helping to address a long-term supply shortage, and will quickly be taken up. Against this backdrop, prime rents in key city centre locations are likely to see a modest rise over the next year.

The commercial property investment market has remained active, although UK and overseas buyers have increasingly been adopting a ‘wait and see’ approach to potential purchases, and few investors are under pressure to sell.

This is apparent in the investment volume figures for Q1, which show transactions totalling just £8.8 billion reported to date for Q1, compared with an average quarterly figure of around £16 billion over the previous two years. Whilst Q1 is usually the slowest quarter of the year, 2017 and 2018 both saw Q1 activity of over £13 billion.

Investor demand has been strong over a sustained period and there has been relatively little stock coming to the market. This has pushed down commercial property yields, and the overall market is now looking relatively fully priced, although the gap between gilt and property yields remains historically wide.

Whilst Brexit uncertainty endures, thankfully the UK is still widely regarded as a ‘safe haven’. Demographics and structural change remain highly supportive of many occupational markets, including the office sector and whilst it continues to challenge, Brexit does not alter the strong fundamentals that underpin the investment market.