Academics have long warned of the negative impacts of macroeconomic and political uncertainty on private investment. Amongst other detrimental impacts, uncertainty causes relatively risk averse behavior by investors resulting in delays in executing investment decisions. Recently, uncertainty regarding the UK economy is attributed to the Brexit referendum where Britain voted to leave the European Union. Questions on the policy stance of the government on whether it would be a 'hard' or a 'soft' Brexit, the likely change in the law and tax regimes and the overall likely course of the UK economy remains at best ambiguous in the minds of domestic and international businesses.
This uncertainty has already started to creep in the economy as witnessed by a decline in direct investment levels. Direct investment includes long term investments in limited partnerships that invest in energy exploration and development, leased equipment and real estate. Data from the Office for National Statistics reveals that direct investment under equity capital has significantly decreased in Q2 2016 relative to the past year. This article analyzes a component of direct investment- the real estate market and specifically explores the recent deterioration of overseas investment in the UK property market.
Property market after Brexit
The UK has been a fertile ground for overseas investment especially in the property market. Net international investment (foreign owned assets in the UK minus UK residents' holdings of overseas assets) is 14.4 per cent of GDP, a significant proportion of which is portfolio investment in debt securities. Just to get an idea of property ownership of overseas investors, records from October 2015 derived from UK government's land registry data shows that about 99,344 registered properties across the country are owned by overseas investors which is about 3.1 per cent of registered property title holders in England and Wales. 44 per cent of the properties of overseas investors are situated in Greater London.
More recently, like other sectors of the economy, the property market has also been affected by creeping inflation and a depreciated sterling. In the wake of the Brexit referendum, exchange rate volatility led some money transfer companies to suspend operations for 48 hours until the outcome of the referendum was clear. However, efforts were made to control this by the Financial Conduct Authority which remained in close contact with the firms they supervise including payment institutions.
Besides exchange rate instability, another factor ailing the property market is inflation. Inflationary trends have squeezed the real incomes of domestic workers resulting in a reduced likelihood that they would opt for homeownership. This has also been reiterated by Rebecca Harding, chief economist of the British Banker's Association. In a recent issue of the FT, she said that although mortgage approvals have slightly picked up in September after reaching a 19 month low in August, the housing market continues to show signs of weakness. Other analysts have also predicted that despite recovery in mortgage lending after exhibiting a deep plunge post Brexit, the revival will soon run out of steam as ordinary people feel pressures from depressed real wages.
This effect has actually already set in the UK property market with data from Nationwide demonstrating that quarterly growth of overall property prices have exhibited a decline with a considerable decrease of property prices in London. Luxury properties have already started to feel the heat with the sale of 'super-prime' properties worth £10 million in London collapsing by 86 per cent in August 2016 over the last year.
Depressed investment in UK real estate market is also visible from open ended property funds. Data from the Investment Association, a trade body that represents UK's investment managers reveals that property funds have been the worst performers with almost £3 billion pounds being pulled out from the sector since Jan-Aug 2016. The magnitude of this outflow can be judged from the fact that it is much higher relative to the 2008 financial crisis.
Until the negotiations for Brexit commence and a likely course of action is charted out, uncertainty will directly and indirectly through feedback loops affect various sectors of the UK economy including real estate. The government and the central bank face some serious challenges ahead.