The UK election and the property markets

The latest RICS (Royal Institution of Chartered Surveyors) UK residential survey of member firms – undertaken prior to the election – indicated a slow-down in activity in the residential market. The survey is based on a ‘balance of responses’, with negative/fall replies subtracted from positive/growth replies, so the survey is a good measure of breadth but not necessarily of depth. Enquiries, instructions and sales all registered declines over May, with the UK General Election cited as the most common factor generating caution amongst both buyers and vendors.

Although the survey was conducted in a period when a convincing Conservative majority was generally expected, the respondents' three-month forward expectation of demand was for little change. That might suggest that, even if the election uncertainty was a factor in causing the slow-down, it was probably not the only factor and more likely to have been a contributor to a trend that was already in place.

Nevertheless, the results were rather reminiscent of those of the May 2016 survey when uncertainty caused by the then upcoming referendum on the UK’s membership of the EU was, by far, the most prevalent reason given for falling demand. Post the results, investor sentiment dropped very significantly in the commercial property markets (again the result was generally unexpected), in anticipation of reduced tenant demand although, in the event, tenant demand generally remained remarkably unaffected (there was, however, a drop in central London). Subsequently, commercial market confidence actually recovered faster than that of the residential markets.

Although there are different sets of factors driving the residential and commercial markets, there is actually quite a strong correlation between the two. Some of this can be attributed to the factors which they have in common (interest rates, inflation, economic growth), but a substantial proportion reflects the shared sentiment between the two markets. The recent falls/stabilisations in values in parts of the London markets are a good example.  The RICS commercial property survey of Q1 2017 – which indicated that headline rental and capital value growth were expected to accelerate once again – may therefore be misleading, having been undertaken prior to the election being called.

Just as in the wake of the Brexit vote, when there were a number of collateral uncertainties, the formation of a Conservative government with support from the DUP party is likely to generate its own uncertainties. The key objective for the Conservatives will be to reformulate the party’s strategy to one which is more popular with voters (even if less honest about the financial consequences) and, at some time, call a new election.

The reality of the intention of the call for the June election was to increase the Conservative majority so as to avoid a dissident minority of the party undermining the UK’s Brexit negotiating position. That has not been achieved; indeed, the situation is likely to have become worse, even if Members of Parliament now might be more aware of the fragility of their own tenure. It is therefore almost inconceivable that the existing Parliament will last for the full five years; an election within the year seems almost certain.

The uncertainty over this period cannot be easily dismissed. The Labour party’s manifesto policies – which had previously not been taken very seriously by the investment markets – have a realistic possibility of being implemented if a new election does not return a Conservative government.

For the commercial property markets, key amongst these policies would be the intention to dramatically increase corporate tax rates. Although the Labour party’s proposed policy would only raise them to levels prevalent in 2010, this needs to be seen against a backdrop of global competition to reduce national rates, and an increase would certainly be seen as going in the wrong direction. The result for companies – of lower net profits – would likely mean that distributions to shareholders would be lower and capital available for reinvestment would be reduced. Given policies pursued by companies over the last few years, it is likely that the latter would bear the brunt of such tax increases. The collateral consequence is that the rate of job creation would likely slow, and this would have negative implications for growth in consumer spending, which has already been slowing. Foreign companies considering locating in the UK might see a tax rise as a significant risk. (A reduction in tax rates was one of the weapons that the government had ‘threatened’ the EU with if Brexit negotiations proved unproductive)

It is, of course, difficult to judge how this is going to pan out over, say, the next twelve months, but real estate investors will need to be conscious of the effect that this might have on tenant demand, particularly in those parts of the market low value-added activity might make expansion plans only marginally profitable.