U.K.'s Property Market May Be Next to Crash
07-06-2016
Another Brexit consequence: Investors' rush to the exits forced two U.K. property funds to slam the gates shut.
Antonia Oprita
The first consequences of Brexit are beginning to show: Investors' rush to the exits forced two U.K. property funds to slam the gates shut. Standard Life was the first. It halted redemptions from a flagship property fund worth 2.9 billion pounds ($3.8 billion) late on Monday, sending its shares and those of property companies down in morning London trading on Tuesday.
Standard Life's fund is the country's third-largest, open-ended commercial property fund, and its representatives said it halted redemptions because it needs to raise cash before it can return funds to investors. After all, property is an illiquid investment, especially in uncertain times such as these.
At midday on Tuesday, news emerged that a second property fund, Aviva Investors, decided to halt dealing in the fund with immediate effect. "Suspension of dealing will give Aviva Investors greater control in managing cashflows and conducting orderly asset sales in order to meet our obligations to investors wishing to redeem their holdings," a spokesperson from Aviva told the FT Adviser.
Worryingly, this could be just the beginning of a stampede to the exits from U.K. property assets. Fear of such news plastered on the front pages of the main business media was probably the main reason why Chancellor of the Exchequer George Osborne abandoned fiscal prudence last week, when he said it would no longer aim to balance the budget. It could also be why the Governor of the Bank of England quasi-guaranteed that easy money will start flowing soon.
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Both the chancellor and the central bank head know very well that a property sector crash would tip the U.K. into a deep recession and would possibly affect the banks, which are already struggling with low profitability because of low net interest margins.
They are, however, making a dangerous bet; it's never a good idea to lean against the wind. Property has been overpriced for years in the U.K., especially in London. The warnings that the real estate bubble would burst kept increasing even before the Brexit referendum. In April, UBS said that nowhere else in Europe was property more overvalued than in London, while media reports earlier in June showed prices of luxury property in central London falling by around 20% vs. last year.
Of course, there are those who say there is nothing to worry about. The weak pound will encourage foreign investors to buy property in the U.K. and the government will keep subsidizing house prices like it did before, with equity loans worth significant chunks of the property's value.
With the ballooning budget deficit no longer a worry for the government, there is indeed no limit to the amount of taxpayer money that can be thrown at the housing market. If investors in government bonds get skittish, the central bank can step in and buy government bonds. That way, bond vigilantes would be kept at bay, for a while.
However, this risks fueling inflation or even hyper-inflation. At a time of rising petrol prices and more expensive imports because of a collapsing currency, a central bank that is monetizing government debt is a recipe for higher prices. This would reduce disposable income even more.
Another problem is that it will be difficult to stoke demand after the Brexit vote. Already, anecdotal evidence is beginning to emerge about the upheaval that the vote has caused in the housing market, with reports of buyers trying to negotiate discounts of between 5% and 10% on already agreed prices, or foreign buyers simply pulling out of previously agreed deals.
To complicate matters, a lot of the pre-referendum increases in prices were due to landlords buying properties with the view to renting them out. But for the buy-to-let business model to continue there is need of a fresh supply of tenants. Pre-Brexit, this was partly assured by the migration of workers from the European Union.
It remains to be seen whether the vote will seriously affect the influx of people from the EU, but evidence is beginning to emerge that it has put some people off going to the U.K. Last week there were reports of potential students from Austria changing their mind about studying at U.K. universities, while this week it emerged that health workers from EU countries who had agreed to take positions in the U.K. have changed their mind. EU workers make up around 5% of employees in the U.K.'s health system.
With demand dwindling, supply of housing is also likely to fall. Recent data from Markitshow that construction PMI in the U.K. collapsed to 46 in June, the weakest performance in seven years, led by "a steep decline" in residential building.
The construction sector's contraction may help put a floor under house price declines, but at the same time it will
cut jobs, possibly sparking a recession. Brexit's negative effects on the economy are only just starting.
Editor's Note: This article was originally published at 8:30 a.m. EDT on Real Money on July 5.