The Phony War in London's Property Market

It's hard to shake feeling that real estate has further to fall.
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It's odd that Brexit's biggest American fan, Donald Trump, is a real-estate mogul. Since the referendum, real-estate stocks have been the worst performers on the MSCI UK index. While the economy has held up and there's no sign of panic selling, the fear of a future slump and finance jobs leaving London has seen banks retrench, land values fall and projects reviewed.

House of Blues

Real estate stocks have yet to recover from the U.K. vote to leave the EU

Source: Bloomberg

Property investors such as British Land Co. Plc and Land Securities Group Plc have proven pretty resilient operationally, though. Their latest six-month results show the value of their portfolios down by a fairly restrained 2 to 3 percent and rental income growing.

It's not just that Brexit hasn't actually happened yet. These firms also own malls and shops exposed to the U.K. consumer, who's kept on spending. Brits feel pretty upbeat about their personal finances and are forking out the most on food since 2013, according to KPMG. The tenant list for Land Securities' London development Nova, including Bone Daddies and the Riding House Cafe, reads like a Who's Who of millennial watering holes.

Summer Spending

Q3 U.K. retail sales growth year-on-year

Source: BRC-KPMG Retail Sales Monitor

But next year doesn't look so tasty. Inflation is predicted to surge, squeezing shoppers. Expectations of a slowing economy and rising unemployment won't help. Sure, landlords have ways to respond. They can sell under-performing assets and focus on popular shops. But that won't be easy when clothing sales aren't doing so well: Marks & Spencer alone is planning to shutter 60 stores even as it opens more food outlets.

It's hard to see the British banker helping much either. The Brexit process is nearing the end of its "phony" phase. A recent High Court ruling to let parliament have a say lifted U.K. property shares. But it's unlikely to derail the process. Meanwhile, the prospect of a U.S. rollback of financial regulation -- thanks to Trump -- might tempt people to shift from London to New York (the real threat to the City's pre-eminence).

Besides the possibility of more empire-building by Google and Apple Inc. in the U.K., the only thing that might cheer up the office market is if Theresa May takes Deloitte's advice and hires 30,000 civil servants to manage Brexit.

Okay, so investors have already priced in much of the gloom. British Land and Land Securities trade at below-average stock-market valuations that imply a big double-digit fall in property values. If all the dire predictions don't come true, that discount could narrow. These companies have cut debt and kept some spending powder dry. This isn't 2008 all over again.

But it's hard to shake the feeling that real-estate values have further to fall, considering the uncertainty about future demand, tenant take-up and the health of the U.K. economy. A sustained rise in bond yields -- from admittedly ultra-low levels -- would create more competition for real estate as a safe-haven asset.

Time to Yield?

Real-estate stocks are facing a squeeze just as bond yields pick up

Source: Bloomberg

Government support or fiscal stimulus might limit the pain, but even small declines in the value of a 15 billion-pound portfolio can wipe out half a year's rental profits. We're far from a meltdown. But no-one's willing to say the good times will keep rolling. Donald Trump once said real estate is "tangible, it's solid, it's beautiful." Brexit is none of those things.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at

    To contact the editor responsible for this story:
    James Boxell at

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