By Elisabeth Troni, Head of Research & Insight EMEA
No doubt when Theresa May called for a snap election on her own leadership she wasn’t expecting to lose. But, if there is one thing the world seems to be producing in abundance it is uncertainty.
We take an early look at the key topics and any potential implications for UK real estate markets.
Politics: Who’s the boss?
One of the biggest effects of a hung parliament outcome is the uncertainty it can produce. As the Conservatives have remained the largest party they can form a government. An agreement with the DUP (Democratic Unionist Party) in Northern Ireland appears likely; whereby the Conservatives will – in theory – have enough members of Parliament to get votes through. However, without a majority in parliament there is no guarantee the Conservatives can pass laws on a consistent basis. Such uncertainty raises questions over their leadership position and its sustainability. As such, there is a distinct possibility of another general election, and sooner rather than later.
Brexit: What now?
Theresa May, arguably, called the election looking to bolster her mandate for a hard Brexit. By all accounts, she was expecting a sizeable majority which would make her less vulnerable to parliamentary rebellion from the euro-sceptic wing of her party. This has not happened. The DUP are firmly pro Brexit, leaving her similarly exposed and vulnerable. On other hand, Theresa May’s failed attempt to secure a ‘hard Brexit’ mandate may result in her pivoting to a softer stance. The possibility of a softer positioning with respect to how Britain approaches the EU could prove more business friendly. If the Conservatives stay in power, the role of the DUP will be critical here.
Although the Scottish National Party (SNP) remains the largest party in Scotland, it lost significant seats, draining it of political momentum, and significantly reducing the likelihood of a second independence referendum.
Economy: Lag effects?
Heightened political uncertainty has the risk of weakening the UK economic outlook via sentiment and confidence. Businesses don’t like uncertainty. They particularly don’t like uncertainty caused by political or trade agreement instability. If uncertainty continues, it is likely that investment decisions will be put into a holding pattern, or be diverted to more stable jurisdictions.
Financial markets: Denial?
A hung parliament leaves sterling once again at the mercy of events in Westminster, as has been the case since the Brexit vote almost a year ago. The election outcome caused the pound to fall against the dollar (2%), albeit marginal compared to the day following the EU Referendum (8%), reflecting expected deterioration in demand for British assets.
Equity markets have, so far, been largely unaffected by the outcome. The FTSE 100 has a large number of companies with earnings derived overseas, making them less exposed to UK specific concerns. The FTSE 250 is more domestically focused; but, similarly, has not registered a notable impact.
Bond markets have, likewise, been broadly unaffected. It will be interesting to watch if such a sanguine view by investors can be maintained. While heightened uncertainty may result in gilts trading as a ‘safe haven’ temporarily; a period of prolonged uncertainty would likely increase the risk premium for holding UK assets.
Real Estate: Go long!
We do not expect a material impact on real estate markets in the short term. The largest impact of heightened uncertainty due to the election outcome is likely to be reflected in deferred decision making. The longer there is significant political uncertainty, the longer firms may choose to delay leasing decisions.
Brexit-related uncertainty has already led to a weakening in demand for office space from banking and finance occupiers fearing the terms of a hard Brexit.
For the regional office markets, a risk is that public sector decisions are delayed. Almost all of the regional cities around the UK have large, active requirements for office space from the GPU (Government Property Unit).
For Scotland, the independence risk premium should unwind, and demand for real estate increase, with occupiers and investors more confident to make business decisions.
Unlike in the aftermath of the EU Referendum vote, there is little reason to expect distress or panic to emerge around open-ended property funds. Managers have deliberately increased their cash holdings (liquidity buffers), in part to mitigate against heightened uncertainty and a repeat of last year’s problems.
Our outlook for UK real estate reflects concerns over the impact of a hard Brexit. Our base case is that ‘hard Brexit’ consequences have not been priced in, nor taken into full consideration by investment markets; hence, we have a weak forecast for City of London offices. If the probability of a softer Brexit increases, the potential negative implications for employment and immigration are reduced; and, therefore our outlook for London office rents – in particular – should improve.
Despite heightened political uncertainty, we encourage occupiers and investors to maintain a focus on long-term fundamentals.
London has always been a cyclical market and its position as one of the world’s only two global financial centres remains unchanged. In London, a large proportion of jobs are high skilled and spread across a range of sectors. Since the EU Referendum vote, and despite the risk of jobs from financial services, demand for office space in London has been robust; reflecting a re-balancing of jobs into other business services, namely technology and creative sectors.
For the rest of the UK, regions with diverse and highly skilled employment bases should outperform. A key risk for markets with a low skills base is the automation of employment via robotic technologies. Therefore, a strategic focus on regional markets with flexible and high skilled labour markets is recommended.
Elisabeth Troni is Head of Research & Insight EMEA