Brexit: A Worst Case Scenario

With less than ten days remaining to the fateful EU Referendum, the rhetoric from both sides is ratcheting up. Now that it appears that the Leave campaign is stepping ahead, the warnings about the consequences of Brexit are sounding increasingly dire – and property investment is said by some to be one of the sectors likely to be hardest hit.

Whatever your views on the Referendum, it would certainly be unwise to dismiss all warnings out of hand, so in this post we’ll look at the gloomiest of the predictions and the arguments that lie behind them.

On June 10th, the international economic research specialist Sandford C Bernstein surprised many pundits by issuing an almost apocalyptic picture of what a departure from the EU could mean. George Osborne had already suggested that Brexit could lead house prices to fall by between 10% and 18% but Mark Burrows – Bernstein’s Senior Research Associate – proposed a much higher figure. ¬†According to his team, Brexit could see 30% wiped off the value of property.

The usual Leave campaign response to such pronouncements is the accusation of scaremongering and, given the wide gulf between this 30% figure and other analysts’ predictions, one might well wonder whether it had been purposefully exaggerated. However, Bernstein argues that its figures are well founded.

The company writes that the property market is “propped up by foreign investors and given 1) Sterling is predicted to fall in the 20% range and 2) volatility is likely to remain for at least a year post-event, it’s unlikely that there will be a bid on an asset class that is already overheated.”

The argument goes that foreign investors and the international currency markets are both unhappy at the prospect of Britain leaving the EU. The more independent polls suggest that the Leave campaign is pushing ahead, the shakier investor confidence becomes. Certainly, the value of Sterling has fallen in response to recent polls, suggesting that the Pound could be worth considerably less in the event of a vote to leave. If so, then overseas property owners won’t want to take a big hit on their investments – so one possible reaction might be a rush to offload property before prices fall too far. The resulting increase in supply would then tend to push prices lower still.

The country’s economic recovery has looked increasingly fragile in recent months and if it were to falter, it would not have to fall too far to see it back in ‘recession’ territory. Market confidence underpins so much in the economy and house prices are no exception, so a return to recession, combined with at least a year of post-Referendum economic turbulence could see prices falling further than many commentators had expected.

The sentiment is echoed by the credit ratings agency Fitch. In May, the company made four forecasts based on four different scenarios. The first – a vote to remain – would see no change in the property market and values would go on rising at similar rates to the present. The other three scenarios all considered Leave votes, but with Britain trading on either favourable or unfavourable terms. In all three scenarios, Fitch expected property prices to be lower than they would if things were to continue as normal.

In its best-case Leave scenario, it said that restricted economic growth and investment would have a braking effect on house prices and that London properties would be particularly hard hit. However, in the scenario based on “unfavourable” trading conditions, it forecast much more severe problems for investors. (In scenario 4, the results would be equally bad but, in addition, they would prompt a new independence vote by Scotland.)

In an article last month, International Business Times described Fitch’s predictions as follows:

“Sterling would fall by as much as 30%. Demand for property, falling house prices and higher interest rates would cause banks heavily exposed to commercial real estate and buy-to-let lending to suffer, creating a credit crunch for small businesses akin to that of the 2008 financial crisis… Moreover, tighter controls on immigration – a desire of many Brexit supporters – would mean lower rental yields in the buy-to-let sector because migrants are three times more likely to rent than UK nationals.”

Fitch itself said: “UK homebuilders and residential property companies could be negatively affected by the lower demand for property caused by lower net immigration, higher funding and labour costs, lower available liquidity, and a weaker job market. The severity of the impact would depend on the final terms of exit and timing of the process, but the bubble-level prices in some areas could be at risk of dropping significantly.”

Not all sources agree on the severity of the likely problems, however. One final forecast worth considering was issued on 9th June by the Royal Institution of Chartered Surveyors. Its chief economist Simon Rubinsohn said that property prices were likely to fall for the first time since 2012 but, interestingly, he argued that this would be only a short term phenomenon, with London again taking the brunt of the damage, thanks to its highly inflated prices.

Currently, the market uncertainty caused by the Referendum appears to be causing both vendors and potential buyers to play a waiting game. The RICS figures show a marked decline in new vendor instructions in the last three months, and these will inevitably show in this summer’s market statistics as a short term flattening of prices. However, as Rubinsohn notes: “there is not at this point a sense that a fundamental shift is taking place in the market.”

Whilst there are some daunting forecasts being made, bear in mind that both Fitch’s and Bernstein’s figures place considerable emphasis on the London property market, which most investors would consider to be over-inflated anyway. Elsewhere, demand still far outstrips supply, so under normal conditions, prices should tend to keep on rising.

Some commentators appear to expect a kind of ‘reverse ripple- effect’, whereby falling prices in the capital begin to drag down those in the surrounding regions. However, the likely extent of that effect is difficult to estimate; if past experience has shown us anything, it’s that that the UK housing market never operates as a single homogenous entity.

It’s possible that Brexit could trigger a nationwide fall in house prices – particularly if it damages economic growth, employment and average earnings – but the effects will vary by region, county and neighbourhood. In regions not greatly influenced by foreign investment, there should be no reason to expect an immediate price hit, in which case, the factor that then matters most is how well the UK economy performs after the Referendum. That, of course, is the nub of the whole EU debate, and the results of that are anyone’s guess.