17th February 2016
A British exit from the European Union could see commercial property values in the City of London fall by between 8 and 15% according to a report by Capital Economics commissioned by Woodford Investment Management.
The fund firm, founded by star investment manager Neil Woodford, also polled investors this week to test their view of the impact of an EU exit on the British economy. It found that 52% believe it would damage the economy, 28% said it would be positive and 20% said it would be neutral.
The Capital Economics report paints a rosier picture of the broader economy saying an exit could have a negative impact on growth and job creation but that it is slightly more plausible that the net impact would be broadly positive.
Indeed, it says that much depends on the negotiations. “Ultimately the issue is likely to hinge crucially on the terms that the United Kingdom can negotiate in the event that it does decide to leave. In turn, that may well depend on how the government’s attempts to negotiate European Union reform are received and how fearful leaders on the continent are that if Britain was to vote to leave that could set an unwelcome precedent for others.”
The report suggests that the biggest impact is on the City of London commercial property market. It says: “If Britain lost its free access to the single market, there is a worry that this could rapidly change the country’s status as a commercial gateway to the rest of Europe, with adverse consequences for both occupier and property investment markets. If demand from overseas buyers did drop following Brexit, the impact on the market could be significant. After all, by value, overseas buyers have accounted for roughly half of all transactions in the British commercial property market over the past few years.
“It seems likely that leaving the European Union would hit the health of the City and it is plausible that a number of overseas institutions would close or scale back their London operations, putting a dent in occupier demand. That drop in demand could come at an unfortunate point in the development cycle. Over the next few years, the office development pipeline in central London is likely to run ahead of recent rates of net absorption, with the bulk of that surplus space destined for the City. A sharp drop in demand could see vacancy rates spike higher and rental values start to fall. (See Figure 28.)
“If that was to happen it is possible that investors might begin to reassess the price premium commanded by City office space. A rolling 5-year average of the difference between City office yields and the yields for regional office markets shows that this premium has been growing steadily over the past 20 years – it has more than doubled over that period. (See Figure 29.)
“If investors felt that the City had been permanently damaged by the United Kingdom’s departure from the European Union, a jump of between 50 and 100 basis points in City office yields, knocking 8 to 15% off capital values, would not seem implausible. There is more reason for concern over the impact of Brexit on the City of London and, subsequently, the British property market. The argument here is that Brexit could damage the City, by forcing institutions to re-locate to the continent. In that scenario, vacancy rates could rise and the premium commanded by Central London office space could shrink.”
The economy – impact on consumption could be positive
On the economy more generally, the report says: “It is plausible that Brexit could have a modest negative impact on growth and job creation. However it is slightly more plausible that the net impact would be modestly positive. There are potential net benefits in the areas of a more tailored immigration policy, the freedom to make trade deals, moderately lower levels of regulation and savings to the public purse. In each of these areas, we do not believe that benefits of Brexit would be huge but they are likely to be positive. Meanwhile, costs in terms of financial services and foreign direct investment are more likely to be short-term and there are longer-term opportunities from Brexit even in these areas.
“Overall, the resultant effects on consumption could well be positive and are certainly not likely to be large. We continue to think that the United Kingdom’s economic prospects are good whether inside or outside the European Union. Britain has pulled ahead of the European Union in recent years, and we expect that gap to widen over the next few.”
Strong chance of a trade agreement
The report says there is a strong chance of trade agreement. It says: “Given the scale of trade interdependence between the United Kingdom and the European Union’s members, and the advantages of maintaining a close commercial arrangement, there would be little to be gained on either side from hostile trade relations after Brexit. Indeed, given that the European Union is currently negotiating free trade agreements with countries that are much less important to it from a trading point of view, it would be odd if it did not try to reach an agreement with the United Kingdom. Similarly, there is no reason to think that Britain would not be able to negotiate new trade deals with those countries that it currently has free trade agreements with via the European Union.
“What’s more, fears that exporters would be left high and dry the day after the Brexit vote are unfounded. Under Article 50 of the Treaty on European Union, a country leaving the European Union has 2 years in which to negotiate a withdrawal agreement, before the Treaties cease to apply to that country. During that two-year negotiation period, the United Kingdom would still effectively be in the European Union with unfettered access to the single market.”
“Brexit is only likely to have a limited impact on Britain’s productivity. The major potential for improvement comes from increased business investment which shows little connection with political developments. Estimates that axing European Union regulations would save Britain a lot of money exaggerate the true picture as the United Kingdom would still choose to implement many of them. It would also need to implement the union’s regulations to continue to export easily to the single market. Reduced regulation might give a small boost to productivity but wouldn’t be a game-changer.”
“Concerns about a drying up of foreign direct investment if Britain votes to leave the European Union are somewhat overblown. Access to the single market is not the only reason that firms invest in Britain. Other advantages to investing here should ensure that foreign firms continue to want a foothold in the country. It is likely Britain would remain a haven for foreign direct investment flows even if it was outside of the European Union. Of course, we could see a period of weak foreign direct investment inflows as the United Kingdom’s new relationship is renegotiated. However, if Britain is able to obtain favourable terms, then foreign direct investment would probably recoup this lost ground.”
“The British government could save about £10bn per year on its contributions to the European Union’s budget if the country left the bloc. This figure could be higher if either the British rebate was to be threatened in the years ahead or Brexit was to result in overall faster economic growth.
“On the other hand, a little economic disruption and lower migration as a result of Brexit could offset these savings. The government might also continue to make some contributions to the union if it wanted to preserve single market access, it might need to compensate sectors of the economy and specific regions that currently benefit from European Union handouts and it may have to sacrifice customs duties income to strike new trade deals with countries outside Europe. We expect that Brexit would benefit the public finances, but not to a huge degree.”
Immigration could be designed to British requirements
“Annual net migration from Europe has more than doubled since 2012, reaching 183,000 in March 2015. Immigration from the European Union is currently boosting the workforce by around 0.5% a year. This has helped support the economy’s ability to grow without pushing up wage growth and inflation, keeping interest rates lower for longer. Whether the United Kingdom gains any powers to restrict immigration from Europe will depend on its future relationship with the European Union. If Britain wanted to retain full access to the single market, it may have to keep the free movement of labour between the United Kingdom and the Union. But this is unlikely. Policy is far more likely to change to restrict the number of low skilled workers entering the country and shift towards attracting more highly skilled workers. This would be a potential headache for low-wage sectors heavily dependent on migrant labour, such as agriculture, but could benefit other sectors with a shortage of highly skilled labour. Overall, policy would shift to be more specifically designed for Britain’s migration requirements.”