UK property – time to sell? [Article 2 of 2] 20220520

 

UK property – time to sell? [2 of 2]

In this second instalment discussing the property investment pros and cons for the UK, we will look more into the geopolitical and regulatory aspect of the investment environment:

4) Warfaring disrupts business, causes capital flight (to US/Asia)

The Ukraine conflict is perhaps just the beginning of a reversal of human war cycles, as we have bounced off the bottoms of more than one multi-millennial support lines in the early 1990s:

Chart 17: conflict fatalities may have hit long term bottoms and is turning up

As the peace dividend from the fall of the communist bloc in 1989 recede into distant memory, could a new war hungry political set up be now in place to drive conflicts going forward? Is the ascent of a new economic super-power posing enough challenge to the existing order to lead to more hostilities?

With no ideological strive a la Cold War style (ie between communism and capitalism), what might be the next bone of contention in conflicts? Could it be domestic politics driven where international wars are mere diversions to avoid power loss at home? Could the jaw dropping inflations in commodities prices and food/energy shortages lead to resource wars?

We are now certainly in need of preparing, investment-wise, for a new multi-polar world, and the upheavals the breakup of existing order ushers in. One way to avoid being caught is definitely diversifying capital away from the main players of such conflicts (eg Europe, or even parts of North Asia – e.g. Japan).

UK, sadly sits too close to one of the main theatres of hostilities, and taking profits on existing exposures may not seem too bad a thing to do! Further, without the resource back up that some of our new target markets – mostly commodities rich ones – are endowed with, UK is less well positioned to weather the storm ahead:

Figure 1: Europe + Asia heavily rely on energy imports (red) vs Americas + Oceania (yellow/green) net exporters of the same

5) Chasing out the rich – has the selling only just begun?

The fervent confiscation of private property owned by individuals (see: indiscriminate seizures), who are not state operators in the strict sense of the definition, could be a last straw for any international investor considering the UK, as the current govt embarks on a capital hostile regime only seen during wartimes. Seizing Russian wealth without due process could be very dangerous for the country’s image as a safe destination for investment, and harks back the harsh Japanese imprisonment camps on USA mainland in WW2, not to mention what communist regimes did after successful revolutions (eg in Russia in 1917, China in early 1950s).

Whilst the ‘totalitarian’ enemy are abstaining from similar tactics, despite easily in position to confiscate western assets many times larger in Russia, the fact that a now ideologically driven UK takes the lead within the international community in asset forfeitures, without official declarations of war (which must be authorised by parliament?), or due criminal court judgments, really bodes ill for the future of London’s ability to attract investment.

Is it any wonder then that Superman KS Li (Hong Kong’s richest man) has sold in Dec 2021 his London Broadgate investment after barely 4 years of ownership for £1.25bn (a mere gain of 25%)? The fact that Cheung Kong often leads the market in catching cycles has been legendary and was amply illustrated by its HK$40.2bn sale of The Center in HK in 2017 which was mocked at the time but today its buyers are licking the wounds of their 25+% losses. Perhaps Mr Li has similar assessments on the deteriorating investment construct that is UK? Not only that, CK has further ramped up its UK disposals by flipping the much larger £15bn rump that is its power assets in March 2022 to Macquarie and KKR (see here).

The investment and jobs that would otherwise have stayed in the UK in the years ahead will now go for places less mob like, and more even handed, like Dubai (see article here). As succinctly observed by another commentator:

while many cheer the asset forfeiture of the evil Russian oligarchs, other nations can and will use this new tactic of war in the future. ... How could anyone feel safe investing in a Western nation if their assets will not be protected?

Western governments have exposed themselves throughout this pandemic, especially by letting us0 know they are not above coercion and silencing free speech [eg curfew in Australia, bank acc seizure in Canada, big tech cancelling of dissenting medical evidence]. The wealthy citizens are always the first to flee when a city or nation is failing.

this will totally destroy the world economy as we know it. Foreign investment in Russia will be seized, and the prospect of this migrating to China is extremely high. A line has been crossed. You do not go after the assets of private individuals claiming they are holding personal money for Putin. That would be akin to saying someone was holding money for any politician simply because they live under that leader’s rule.

This is a symptom of a major trend shift, and could mean a structural loss for most of the traditional Western cities in their ability to attract wealth in future from the Arabs, Chinese, Indians, and of course Russians…

Just to show how significant foreign capital is to the London market, see how much they have multiplied over the 11 years to 2021:

Chart 18: Land Registry titles with individual overseas owners – London a magnet for foreign capital

The 100s of thousands of property owners that felt UK was a safe place to park money may now have doubts and start heading for the exits, especially when the hostile political sentiment towards foreign owners continues to escalate (e.g. in the fashion shown in Figure 2). Capital has no loyalty, and will head where it is treated best.

Figure 2: UK no longer a safe haven for foreign capital?

We suspect that as China sides with the opposite side of the UK political narrative in this Ukraine conflict, it could be sooner rather than later that Chinese money (eg including investors based out of HK) would also be targeted for sanction/confiscation in this new norm of attack on private property. What if Taiwan becomes the next geopolitical hotspot? Will it be too late to pull out then? May be this is what Mr Li saw that prompted his disposal of UK assets?

6) Regulations Overload is becoming unbearable – for property investors

The assault of regulations on property ownership has been quite relenting in the past decade, as we have outlined in detail before here. But this has not stopped since, as the multiplying demands for compliance keep mounting, examples include:

a) Property selling now requires AML declarations, what red tape rationale is this? Below is a form from our property agents:

Figure 3: onerous form filling and reluctant law enforcement is now daily chore for landlords

b) Our accountants wrote to us below as they are no longer able to pretend compliance costs are negligible and will charge extra for sharing the burden:

You will note that the letter includes reference to a Compliance Surcharge which is a new item. You will undoubtedly be aware that all professional firms face ever increasing regulation and scrutiny, requiring a significant amount of additional staff and 3rd party resource to deal with matters such as:
• Anti Money-laundering legislation in onboarding and monitoring our clients
• Anti-bribery and Facilitation of Tax Evasion legislation
• Data Protection and GDPR requirements
• Increased regulatory compliance visits from professional bodies
• IT & Cyber Security

For some time now, we have been looking at the basis upon which we charge our clients. It is no longer sustainable for us to absorb these costs, which outstrip inflation in terms of growth.

…and apply a 2.5% Compliance Surcharge to our fees, as a direct contribution to these costs.

c) Green costs – the new ambitious EPC requirements could set back £13k-27k depending on the work needed for Grade D/E buildings, for details see article here; Hamptons calculated that in the North East, necessary upgrades would be equivalent to 83pc of the region’s annual rental income, according to Telegraph;

d) Green costs for commercial property too – according to Savills, proposed Department for Business, Energy and Industrial Strategy (BEIS) framework would ensure that all non-domestic rented buildings achieve a [even more stringent] minimum ‘B’ rating by 2030… 87% of the office stock has an EPC rating of ‘C’ or below. This is why we have also started disposing our commercial property in London on behalf of a client syndicate.

e) tax compliance becoming cumbersome – a prelude to much harsher regime to come? Here is an example of a form that non-resident landlords have to file to the HMRC, which no doubt will continue to lengthen going forward:

OVERSEAS BUYERS OF UNITED KINGDOM PROPERTY
RESIDENCE INFORMATION

During the Year:

Did you have a home overseas? Y / N
How many days did you spend in the UK?
How many ties** to the UK did you have?
How many workdays did you spend in the UK?
How many workdays did you spend overseas?

** Ties to the UK are defined as follows (references to "tax year" mean the year ended 5 April 2022) :
    1 Your spouse / civil partner / cohabitee or minor child was resident in the UK
    2 You had accommodation available in the UK for 91 days or more in the tax year
and you spent at least one night there
    3 You worked (for 3 hours or more) in the UK on 40 or more days in the tax year
    4 You spent more than 90 days in the UK in either of the previous 2 tax years
    5 You spent more "midnights" in the UK than in any other country

This body of complex requirements sets a costly trap for anyone who enjoys the English summer too much, or having sent kids to study there, not to mention those going for business purposes…

7) Demographics less bullish

Post-Brexit, UK's population growth should significantly slow, meaning lower pressures on the otherwise very tight housing supply (Chart 19), with the impact of EU citizens returning home a yet to be quantified negative factor:

Chart 19: very tight supplies in UK may unexpectedly ease

Further, lockdowns also repelled a lot of international visitors (reduces demand for Airbnb / short stay), added to that student population drops from China (geopolitics), there may be more unexpected release of stock otherwise unavailable.

As a result of all of the above, we believe the UK market will face much stronger headwinds going forward, and better risk adjusted returns may be had in other jurisdictions. In any case for the optimists, we present another technically derived upside forecast as well, indicating possible rise of 14% (orange line) vs the most bearish case of 21% price drop (blue line):

Chart 20: technical forecast scenarios: -21% to +14% by end-25

Obviously, a lot of Hongkongers want to continue holding UK property for asset allocation reasons rather than return maximising trades. For all B&MM clients who feel action is needed as a result of this series of articles, we do provide such services.

Where to go next?

'Go East' is probably the answer, if you compare the world reality of barely two decades ago vs now (Figure 4); but if China risk is not your cup of tea, then derivatives thereon (including commodities jurisdictions that feed that growth) could well work... In the short term, however, capital flights from Europe (or even Asia) could mean USA might be the ‘least dirty of shirts’ in a world so screwed up with unparalleled amounts economic dislocations, political divisions, and military risks.

Figure 4: Asia and commodities are probably the lands of plenty in the long term

 

The author would like to thank Benson Kong Yu Chin of The Hong Kong Polytechnic University for assisting in data collection, analysis, and drafting of this article.