RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
Over the last 2 years or so, Brexit has been the main focus and risk factor for the UK. One of the casualties of this event has been London residential real estate. For decades, London residential real estate has been a favored and aspirational investment for many investors. Returns generated from this asset class have matched expectations, baring a few odd years. London is definitely a global, tier-1 city, along with New York, and for many foreign HNIs, from Russia, India, Gulf countries, is a preferred investment destination. Proximity to the home country and the relative ease of investing in UK real estate v. US real estate popularized London’s property market. Stability of the British Pound, dynamism of the UK economy and stability of its legal, political and other systems attract foreign HNIs. There are many other reasons for London’s popularity which have been well highlighted publicly.
Importantly, over the last 18 years, London residential real estate investors have been rewarded with 200%+/- capital gains. Adding, a net annual yield of 2%-3% the gains are very attractive. But, there have been periods of capital losses in this time-span. London residential real estate had negative returns from 2008 to 2013, and 2008 prices were surpassed in 2014. Since the onset of Brexit risk, 2016, London real estate prices have decreased or stagnated and the discounts from ask price to closing price have increased. Even the non-price statistics such as number of properties sold, days on market etc. have demonstrated a deteriorating picture. My focus is on “investment” properties and not ultra-luxury properties, like the recent sale (Jan 2019) of the London mansion for around $120MM. Based on various estimates, 2016 on-wards, residential property prices in London have decreased by around 7%-15%. Even the much vaunted Central London area is experiencing a slowdown. To that, add 20%+ depreciation of the British Pound against currencies like US Dollar and Euro. This compounds the negative returns for current foreign holders of London real estate in comparison to domestic owners.
But, does this negative effect translate into an opportunity for fresh buyers? Investors previously desirous of buying London real estate would be motivated by these same factors, lower prices than 2-3 years ago and depreciated Pound. On average, historically real estate has been a cyclical industry, globally, with a four year+/- down phase and an eight year+/- up phase. Further, the Pound is at an 18+ year low. Another attractive feature for London is that it saw a down phase during the global financial crisis and the US real estate bubble burst. So, this period could be viewed as a temporary “correction” in a bull phase. There is a good probability that over the long-term, 10+ years, London residential real estate could be a good “buy”. But, does that mean it’s the right time to buy now? It’s next to impossible to time the market correctly and enter the market at the bottom but it is very easy to time the market wrong. Even a good asset bought at the wrong time would be problematic.
At this time, Brexit risk that UK faces is unprecedented and TRULY NO ONE knows how this will play out going forward. It would be reasonable to assume that, Post-Brexit, it would minimally take 2-3 years for the situation to stabilize and clarity to emerge. Two of the biggest factors driving London residential real estate prices, till now, have been high-paid financial and corporate professionals in London and foreign HNIs. Comparing the growth trajectories of real estate prices in Central London versus those in other parts of the UK demonstrates the positive impact of the highly paid London professionals. Price gains in London have far out-performed other major cities and areas in the UK. Brexit has the potential of disrupting this momentum. The key factor is that many foreign companies, financial and non-financial corporates, use London as the base to access the EU. This resulted in strong employment and high paying/ high quality jobs in the London area. Now, many foreign companies have decided to either cut down or entirely give-up their presence in London. Additionally, EU-area regulatory bodies, like the European Medicines Agency, will also have to move to continental Europe. London’s banking access to the EU also stands to be curtailed and will affect high-earning finance professionals. These trends will adversely impact pay packages and number of jobs in the London area.
Many foreign HNIs preferred investing in London real estate because UK’s financial and investment criteria were more investor friendly compared to similar countries. Further, UK’s laws governing real estate matters (particularly in landlord/tenant issues, taxation of foreigners’ gains) were most investor-friendly among the major EU countries. This dynamic is also changing because price gains in London have resulted in dislocation and disruption of the local population and have severely hampered residential affordability. Middle-class Londoners reacted to these high prices and made their concerns heard to the government. The government has reacted to this by changing the tax and investment laws, increased stamp duties on foreign purchasers, increased taxes on capital gains for foreigners, among others. The government has also increased the scrutiny of the funds entering UK, especially for real estate investments.
These developments can potentially hurt two of the main factors driving UK prices. Currently, the government’s response to Brexit and the plan for UK’s exit from the common market is uncertain and confusing. This would definitely give investors pause. Even if the UK can coordinate Brexit appropriately or make changes to avoid Brexit completely, there will still be considerable uncertainty. Even if Brexit doesn’t happen, UK will need some time to restore the status quo because of all the current business and financial chaos and confusion. If a planned Brexit occurs, there will be some time-delay for the confusion/changes to get sorted and for the UK to set up a stable job/investment environment. If a disorderly Brexit ensues, the situation will be chaotic and uncertainty will be significant and prolonged. All these three scenarios point to a situation where uncertainty reigns, the time-span is debatable, and markets hate uncertainty. So, in my opinion, it’s a decent inference that jumping into London real estate now, based on the current discount to Pre-Brexit situation, may not be the most-prudent approach. There could be more pain for London real estate prices and even the British pound going forward, even in the best scenario. If one is truly interested in investing in London then the more prudent thing to do is wait for 12 months +/-, observe the situation and then revisit this decision. Getting the timing right is next to impossible but getting the timing wrong is easy and this could be one such instance.
Other cities will benefit from the current uncertainty in the London real estate market. Berlin is a great possible location because of the position Germany enjoys in the EU and the stability and strength of its economy. Amsterdam or other Dutch cities are also promising because of the high use of English in the Netherlands as compared to other major EU economies. Paris is a truly global and inspirational city, notwithstanding the issues facing France. All these places could definitely stand to benefit from the changes that would take place in the UK/London vis-a-vis the EU. The real estate in these cities could be beneficiaries of Brexit and recipients of HNI investment funds, high-paying professional jobs and business interest going forward.