Neil Prime | 30/03/2017
Today Prime Minister Theresa May triggered Article 50, formally starting the UK’s exit from the European Union. If all goes to plan, the UK should leave the EU by than April 2019. So, what does today’s Article 50 announcement mean for the commercial real estate market and London economy as a whole?
A lot depends on whether Article 50 is a marker for getting back on track to greater certainty, or if it signals the start of tumultuous negotiations, some of which will inevitably be played out in the public eye, creating even more uncertainty.
Uncertainty delays business decision-making The market hates uncertainty. In the run-up to last June’s referendum, we saw a slowdown in markets as the business community waited for what it believed would be a victory for Remain. When the vote went the other way, it caught everyone by surprise. It led to a hiatus of several months, with businesses putting off major decisions wherever they could, while talk continued about what kind of deal we might get from Europe.
The post-Brexit CityIt’s now nine months since the referendum and we’re still nowhere nearer to knowing what Brexit will look like, but time is moving on, so it’s no surprise that Goldman Sachs has just announced its plan to move hundreds of jobs to Europe. In the absence of any clarity about the full extent Brexit will have on passporting rights and therefore the scale and impact on their operations, Goldman Sachs is making a decision based on its best understanding of what Brexit could look like. The reason they, and others, are taking initial steps now is obviously to guard the loss of access to the European market. By the time we know what the position UK will be in in terms of passporting rights, there is unlikely to be enough time to put contingency measures in place before April 2019. They need time to set up the infrastructure and start moving people to new or expanded existing offices within the EU. They simply cannot wait until all the details of the future settlement with the EU are clear.
However, investment banks are not going to suddenly stop trading in London. Whilst access to Europe is an important part of having major operations here, they also undertake significant trading from London that is not affected by access to Europe. That coupled with the wealth of talent London offers, legal transparency and particularly London’s position as a mature market place still make it a vital part of their global operations. This is why the numbers we’ve heard reported recently have been more in the hundreds rather than the thousands implied immediately pre and post Brexit. However it’s only once the terms of Brexit are known that the implications particularly for financial services will be known.
This overall uncertainty has led occupiers to seek more flexible leasing arrangements during the Brexit process. For example, if a bank currently lease 200,000 square feet and they are moving, some are looking at core take of say170,000 square feet and ask for the option to expand back up to 200,000, or down to say 130,000 square feet depending on what unfolds during the Brexit process.
So, in the short term, sectors such as finance and banking could be ex-growth in London in the next couple of years. This will have some impact on those sectors that feed off the banks. This doesn’t mean that there will be a collapse in demand which will impact rents or values. We will still see leasing activity in financial services but in the short term net absorption is unlikely to be a positive. In addition the dynamics of the market are such that we don’t have a huge supply of offices in terms of vacancy, so you don’t need extraordinary take-up to sustain rental levels. We have also seen a broadening of the tenant mix in the City and across London generally, and the financial sector is not as dominant as it once was in leasing terms.
One thing that isn’t helping matters is the rise in business rates taking effect from this month. It couldn’t have come at a worse time, and is an extraordinary hike for start-ups and multinational corporations alike – a huge own goal from the Government.
Tech sector growth relies on EU talentThe tech sector has been the biggest driver of growth in London since the Global Financial Crisis but it in part relies on talent from around the world including the EU to power this growth. If tech firms are no longer able to hire the highly skilled people they need it will inevitably dampen their ability to grow and the investment needed to achieve it.
In-migration is important for the dynamic growth of London as a city. The Mayor Sadiq Khan and others talk about establishing a city state for London, with a visa type of deal. However, I can’t see that being achieved in the short term, or at least until we are further along the process for determining the new settlement with Europe at a national level. But London’s health is vital to national GDP and there is absolutely a case for it to have greater flexibility in this regard.
In my view, Government will need to start providing clear signals to business as we move through the Brexit process to help create a greater level of certainty and clarity. This will help occupiers and investors make decisions and potentially help create a more consistent and normalised market both in terms of capital and occupier activities.
Making the most of BrexitAs part of the European Union we are bound by the nature of the trade agreements that Europe negotiated with the Far East, the US and emerging markets. In the years following Brexit, if we have a decent arrangement with Europe and we’re trading more effectively with the emerging markets, London could potentially be in an even stronger position than it has been.
Brexit does open up the potential to enhance our trading relationships with the likes of China and India, and I think we could see more new entrants into our market establishing occupational footprint, inward investment and growing it rapidly. After all, London is already the largest offshore clearing centre for Renminbi (Chinese yuan), which is a huge opportunity to build on. There are high hopes that we could also further deepen our relationships with the United States and Canada. So, yes, I definitely think there must be upsides to being able to negotiate our own trade deals with partner countries.
One quick win would be to make the visa system for Chinese nationals less complicated. This will attract more inward investment and encourage more Chinese businesses to open offices in London and increase levels of tourism. We’re also seeing that the sterling depreciation has spurred increased investment in the UK from the Asia Pacific regions. Although currency movements have not had a strong historic correlation with overall international capital inflow into the UK, they are part of the reason why the market has experienced a recent surge in demand from buyers from the Middle East and the Asia Pacific region, headlined by Hong Kong and mainland China. We’re already seeing an upward trend of the presence of Chinese companies in London. If you take Bank of China for instance, it had 30,000 square feet five years ago and has grown to over 100,000 square feet. And, with the upcoming deregulation of other sectors in China we will see more firms from mainland China and Hong Kong trading here in the UK.
My prognosis for five to 10 years’ time is that we’ll have a much more settled, and even more internationally diverse set of high value businesses trading here in London. That said, before we get there, we need to navigate the next couple of years of Brexit negotiations. There is no doubting that this will create ongoing uncertainty and we can’t expect the market to be immune from that.