Brexit and the Future

The result of yesterday’s EU Referendum has been described as the single most significant European event since the end of the Second World War. In a vote that surprised both the financial markets and Britain’s European neighbours, the country voted to end its 43 year relationship with the EU.

The immediate results were unsurprising. On international currency markets, Sterling fell to its lowest levels since 1985. Stock markets also fell sharply, with the FTSE Futures index dropping 9% overnight. Bank stocks fell by as much as 7% and the shockwaves quickly hit overseas trading, with the Nikkei in Tokyo recording falls of around 7%.

The UK has not yet left the EU, of course. That process could take several years of hard negotiations, and some have suggested that Britain’s departure could be postponed for up to four years. Brexit will certainly not be immediate, although some of its consequences might be.

For investors, the prospect of years of uncertainty is not an appealing one. Not only are there many concerns associated with the Brexit process itself, but the vote has already led to calls for independence in Scotland and Northern Ireland, both of which voted to remain. Consequently, investors may now have to consider the additional possibility of the future break-up of the United Kingdom, and all the market turbulence that would follow from that.

This is, in truth, an unprecedented and highly complex situation. Nevertheless, some unscrupulous property investment companies have sought to capitalise on it with some questionable claims. For example, to encourage rapid investment decisions, they have pointed to the possibility that the Bank of England may reduce the base rate to zero – a move which could further cheapen the cost of borrowing and, thus, the price of buy to let mortgages.

There are certainly credible reasons why the Monetary Policy Committee might cut interest rates in the short term. If that were to happen, then mortgages could indeed get cheaper and BTL profits could improve accordingly. However, investors would be well advised not to rely on that as a long term foundation for their cashflow forecasts. If the value of Sterling were to fall too far on currency markets, the Bank of England might be pressured to intervene with a higher base rate. Similarly, if inflation were to rise too quickly – as a result of a falling exchange rate and the rising cost of imported raw materials – then it might do likewise.

The truth is that the UK economy is entering new and uncharted territory today and many of the assumptions that economists have relied upon no longer apply. Interest rates might fall but there are no guarantees that, in the turbulent times ahead, they might not rise again. There are so many unknowns that it makes little sense to speculate until the smoke has cleared.

Until then, the only reliable guides are the fundamentals of supply and demand. Fortunately, as we have commented before, the prevailing conditions still look strongly supportive of buy-to-let investment.

There are still very large numbers of people requiring rental accommodation – so demand remains exceptionally strong – and the supply of new housing is still extremely restricted. In fact, given the uncertainty following the Referendum, many expect house building to slow down. Reporting on the aftermath of the vote, the BBC noted: “As well as the banks, the housebuilding sector was also badly hit, with shares in Bovis Homes down more than 50%.”

International stock markets are often predisposed to overreaction so it is best not to be too swayed by their immediate responses. It will take time for the dust to settle, for heads to calm and for a clearer picture of Britain’s future to emerge. Actually, however, that might not take too long. No one in Britain wants to see uncertainty debilitate the country’s economy for long and, already, Mark Carney, the governor of the Bank of England has made a clear public statement designed to maintain confidence in the financial system.

At various points in a statement this morning, he said: “Some market and economic volatility can be expected as this process unfolds. But we are well prepared for this. The Treasury and the Bank of England have engaged in extensive contingency planning … The Bank will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward. These adjustments will be supported by a resilient UK financial system – one that the Bank of England has consistently strengthened over the last seven years…  The capital requirements of our largest banks are now ten times higher than before the crisis. The Bank of England has stress tested them against scenarios more severe than the country currently faces.”

In a similar vein, the CBI, the British Chambers of Commerce, the Institute of Directors and a raft of other business organisations have stressed the importance of making a smooth transition. With all minds focused on how to make the best of the new economic climate, it should not take too long for a clearer picture to emerge.

In the meantime, it is worth reflecting that property has always weathered economic storms before, and that its long term track record has outperformed virtually every other asset class. Whatever else might change, people will always need affordable places to live, and with a growing, ageing population, there is every likelihood that rental demand will remain strong.