As Chancellor George Osborne and Bank of England governor Mark Carney summoned all powers at their disposal last week to calm the markets, the suspension of withdrawals from at least six property funds did nothing to help their cause.
Investor confidence in the UK property market has clearly been shaken, and there have been echoes of 2007 when a similar domino effect from successive fund suspensions caused negative sentiment to spread. Back then it was just the start of a prolonged financial crisis, but experts say of today’s situation that it is too early to judge if history is repeating itself or markets are likely to settle as Britain gets to grips with the post-referendum reality.
With a Conservative Party leadership battle under way and many Remain campaigners calling for the referendum result to be overturned, a period of both political and financial turbulence is inevitable.
Speaking at the launch of the BoE’s latest six-monthly Financial Stability Report earlier this month, Carney said: “There is evidence that some risks have begun to crystallise. The current outlook for UK financial stability is challenging.”
The Bank has relaxed special capital requirements for banks, potentially freeing up to £150bn for lending purposes, and eight major banks have signed an agreement with the Chancellor to provide more funding to households and businesses. Barclays, HSBC, Lloyds, Metro Bank, Nationwide, RBS, Santander UK and Virgin Money all agreed “to make the extra capital available… in this challenging time”.
Carney called the easing of capital restrictions a “major change”, adding: “It means that three-quarters of UK banks, accounting for 90 per cent of the stock of UK lending, will immediately –immediately – have greater flexibility to supply credit to UK households and firms.”
Yet while encouraging banks to lend, Carney seemed to have a very different message for borrowers.
“We are advising people to be prudent,” he said. “If you are taking out a mortgage, at some stage during the life of that mortgage, conditions will be difficult. You want to ensure that you can service that mortgage even if times are tough, so think about where interest rates will go, where wages will go in the lifetime of that mortgage.”
Meanwhile, Osborne spotted an opportunity amid the post-Brexit vote chaos to announce that his plans to achieve a budget surplus by 2020 had been fatally flawed by the referendum fallout.
Addressing the Greater Manchester Chambers of Commerce, he said: “The referendum result is, as expected, likely to lead to a significant negative shock for the British economy. How we respond will determine the impact on people’s jobs and on economic growth.
“The Bank of England can support demand; the Government must provide fiscal credibility. So we will continue to be tough on the deficit but we must be realistic about achieving a surplus by the end of this decade. This is precisely the flexibility that our rules provide for.”
Osborne and Carney’s attempts to steady nerves were not helped by pessimism about the housing market from some quarters.
IHS Global Insight chief UK and European economist Howard Archer says: “Housing market activity and prices now look to be at very serious risk of an extended, marked downturn following the UK’s vote to leave the EU. This is likely to weigh down markedly on economic activity and consumer confidence, which is not good news for the housing market.
Unemployment could also rise over the coming months. Additionally, consumers’ purchasing power could increasingly be squeezed as inflation is lifted by a weaker pound and companies look to clamp down on pay as they strive to save costs in a more difficult environment.”
He adds: “We suspect house prices could fall by 5 per cent in the second half of 2016 and there could be another 5-7 per cent drop in 2017.”
In a further worrying sign of negative market sentiment towards UK real estate, at least six commercial property funds with holdings worth £15bn suspended trading last week, denying many thousands of investors access to their cash for the foreseeable future.
Meanwhile, rather than gating the fund, Aberdeen Property Trust wrote off 17 per cent of its portfolio value, leaving investors in no doubt over how much they would lose if they tried to withdraw money now.
Aberdeen chief executive Martin Gilbert said: “Reducing the share price of the fund reflects the changing market conditions over the past week or so and uncertainty around prices. Sellers requiring liquidity are having to market properties at sometimes significant discounts to their recent valuations.”
Standard Life was the first to block withdrawals on its property fund last week, followed swiftly by Aviva and then M&G. As large volumes of investors sought to sell out, Canada Life, Columbia Threadneedle and Henderson Investors also closed their funds to withdrawals.
Fidelity International investment director Tom Stevenson explains: “Unfortunately, Brexit has triggered a flight from property – both commercial and residential – as worries have grown that uncertainty over the UK economy will deter investors, especially from overseas. The share prices of property companies have been among the hardest hit in the UK market because of their domestic exposure.
“The shift in sentiment in the quoted property sector has, unsurprisingly, been reflected in increased nervousness about other investment vehicles, like open-ended property funds.”
On the prospects for the sector more generally, Stevenson says: “The case for investing in commercial real estate is undoubtedly worse than it was for two reasons. First, Brexit could lead to a reduction in jobs in, say, financial services in London; that would obviously be a negative for property demand. Second, Brexit could lead to a recession; that, too, would be bad news.”
However, he acknowledges that, with so many variables at play, it is impossible to predict the direction of property values.
“The reality is that no one really knows where property is headed over the next couple of years. If the pound remains weak, it is possible that foreign buyers will see UK property as a cheap safe haven. Admittedly, that prospect seems some way off.
“In the meantime, the yield attraction remains compelling.”
Nutmeg chief investment officer Shaun Port believes all the remaining open-ended property funds will soon block withdrawals.
“Investors tend to invest on the understanding that they can sell their investment at any time, but the underlying assets – large buildings – are themselves very hard to sell at short notice.They require weeks or months to sell. Worse, some properties under development cannot be sold until development work is completed,” he says.
“We share the Bank of England’s concern about this sector. Our fear is that this could be the beginning of a vicious cycle in commercial property, where the gating of withdrawals in one fund leads to higher withdrawals and further gating in other funds across the sector. As sentiment turns, funds could be forced into selling property assets at ever-falling valuations as more and more property comes on to the market, meaning the valuation of the fund also falls.”
But Castle Trust Capital executive director Matthew Wyles thinks the fund gatings should not be regarded as evidence that the underlying assets are doomed. He says: “I don’t think that’s an indication of distress. It’s more an illustration of the structural flaw in the concept of open-ended investment companies holding commercial property as an asset.
“It’s a highly illiquid asset and investors have this contractual right to withdraw their money within 24 hours. So, where you’ve got a lot of people who want to exit, you’ve got to have a mechanism to ensure that those exiting are not prejudicing the interests of those who are staying in. You end up with these artificial mechanisms where either they use big discounts to deter investors from withdrawing or they just say ‘I’m very sorry but you can’t’.
“The simple fact is that an illiquid asset like property should not be held in an open-ended structure; it should always be in a closed-ended structure like an investment trust, where the equity market provides liquidity and, if it trades at a huge discount, that’s your problem. That’s what the markets are pricing the security at.
“All I think this indicates is that short-term sentiment around commercial property is bearish.”
Wyles thinks pension funds holding property are unlikely to join the flight out of this asset.
“Pension funds by definition take a hugely long view. They are looking for yield because they need to pay pensioners every month and they can afford to hold assets through thick and thin.
“What they don’t like is yield volatility; they need certainty that whatever yield they’ve signed up for broadly is going to flow. Well, actually, property is pretty good. You may get volatility in net asset value but typically property is very good at delivering a stream of reliable, predictable income. So I don’t think this is an issue for pension funds.”
Boon for buy-to-let?
Wyles goes further in arguing that Brexit uncertainty may prove good news for landlords, with would-be homebuyers put off their purchases until the market settles.
He says: “There is a logical argument that, when people feel negative about house prices, that should be a net positive for the rental sector because, if you are thinking of buying and decide to put it off, you have still got to live somewhere.
“So the one area where I think Brexit may be a net positive is in rental values.”
However, any further boost to the buy-to-let market would conflict with the Chancellor’s attempts to cool the sector through stamp duty rises and cuts to mortgage interest relief.
Wyles says: “George Osborne is a bit like King Canute. The social tide is flowing in the direction of the rental sector and all he’s doing is interfering in a natural functioning of the market, which is very un-Conservative. He’s created some really serious tax distortions and at some stage those tax distortions have got to be unwound.
“Right now the Conservatives have a lot more to worry about than buy-to-let. But at some stage it will be worth the sector having another good go at lobbying because what Osborne did was bad tax and I think at some point it needs to be reversed.”
Investec mortgage business development director Peter Izard thinks a near-term reversal of the stamp duty changes may be wishful thinking on the part of landlords, but he says: “What you can’t afford to do post-Brexit is have a major slowdown in the property market because that will have massive implications. So watch this space: the Autumn Statement could be interesting. Will he take action to stimulate the market even further?
“Don’t rule anything out because, with the fast-moving political scene and new leadership, who is to say the Chancellor will continue to be in position? Things are changing so quickly.”
Are policymakers doing enough?
So the Bank is relaxing capital requirements; further cuts to base rate may be on the cards; the Chancellor has signed an agreement with banks to sustain lending; and he has suggested he may cut corporation tax to under 15 per cent in a bid to keep big business on UK shores. But will all these measures be enough to restore confidence in the British economy?
“Clearly, cutting corporation tax is a smart thing to do but pulling a single lever won’t be enough,” says Wyles. “The issues around Brexit are much more fundamental and structural than can be reversed by a tweak to corporation tax.”
However, he believes the housing market is underpinned by a number of important factors. He says: “Individuals thinking about making a big commitment will have regard to job security and their earnings, and clearly the sort of uncertainty that Brexit brings is not helpful to that. But we have got to keep remembering that interest rates are incredibly low and are going to stay low, and there is a structural shortage of housing in the UK. So I don’t think we are looking at any serious negative effect in the housing market.”
Nevertheless, there are pockets of high risk where the impact of Brexit may be felt more keenly, he adds.
“Everybody should tread carefully in high-value assets, particularly in London and the South-east; anything north of £1m. It’s already well off its highs as a result of stamp duty and other measures that the Government has taken, but this cannot be a net positive.
“High-value property is more than 10 per cent cheaper in dollar terms than it was two weeks ago but I don’t think that’s enough.
“For UK housing generally we are at hold, but in terms of high-value housing we are much more cautious because it’s far more exposed to international sentiment.
“Frankly, we are now seen as hostile to foreigners. If I was a Chinese, Malaysian or Brazilian investor thinking about buying in London, I might just hold off until 2017.”
Looking to the future
As the post-referendum story continues to unfold, the world will keep a watchful eye on the UK property market – as well as the FTSE – for a barometer on the health of the British economy.
Policymakers are taking a huge gamble that easing credit conditions for UK borrowers will be sufficient to encourage them to bet on the future of house prices and keep the market moving forwards.