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Exodus? Look at Europe, but don't ignore London

London maintains its attractions and is unlikely to lose its crown as the hub of financial activity within the EU
July 22, 2016

Replacing London as the number one financial centre in Europe is not going to be a straightforward process, if, indeed, it happens at all. Early indications suggest that some migration of jobs in the financial sector is currently under consideration, motivated primarily by concerns over the potential loss of passporting rights that allow financial institutions based in London unfettered access to the rest of the EU.

If this were to occur, the two primary effects may be a reduction in demand for office space in London and increased demand for accommodation within the EU. For investors looking to exploit this migration, the obvious vehicle through which to do so would be in a UK-listed vehicle with euro-denominated assets such as Schroder European Real Estate Investment Trust (SERE). Launched in December 2015, the fund already invested €150m (£125m) of assets under management, with an emphasis on investing in the most established and, crucially, the most liquid markets, where one of the key components is operating in a market that already has an underlying domestic appetite.

For reasons such as language and a favourable timezone, Dublin has its attractions, along with flexible labour laws and strong economic ties with the UK and the US. However, the office market is relatively small, with very low vacancy rates. That said, new developments coming on stream could increase existing space of around 4.1m sq metres by about 10 per cent. Even so, extra demand could boost both capital values and rental income, especially if there were an inflow of demand from London.

Frankfurt’s attractions include good transport links (not Dublin’s strong point) and proximity to the European Central Bank, while vacancy rates, despite a recent fall, stand at 12 per cent. Other possibilities include Paris, although difficulties in finding space in the central area, language and less flexible labour laws weigh against Paris being the obvious default location, despite recent overtures to bankers by President Hollande, a notably policy U-turn.

So where does that leave London? Tony Smedley, manager of Schroder European Real Estate, maintains that investing in European property should be seen as an important addition to any investment portfolio rather than a replacement, and any migration away from London is likely to be a relatively drawn-out affair. Issues affecting timing include talent pool issues and accommodation, with banks in many cases locked into long-term leases. There are also emerging signs that UK banks have effectively pulled up the drawbridge on finance for purely speculative investments, although it’s fair to say that many property companies, such as Land Securities (LAND), have been generally drawing back anyway from developments that are not already largely pre-let. The net effect could see higher vacancy rates in the wake of a migration away from London tempered by a reduction in new supply coming on stream.

There is another element that could lead to a significant move in office workers not only from London but also from other traditional financial centres. More sophisticated communications and increased technology could see back-office operations shifted to more cost-efficient locations within the EU. Poland, for example, has an increased presence as a service hub, with Romania and Hungary moving in the same direction.

On valuation terms, the picture that paints non-EU investments as an attractive alternative is less clear. On a net asset value basis, UK property funds trade close to a 25 per cent discount, with an average dividend yield of 3.1 per cent. By comparison, mainland Europe looks expensive, trading at a 12 per cent premium, although dividend yields average nearer 4 per cent. Perhaps German residential offers the greatest attraction. Vacancy rates are low, demand exceeds supply, while current market values are around half replacement costs.

All in all, it’s still hard to make a clear judgment on how the potential shift away from London will crystallise into a real migration. It’s also much too early to decide where that migration could lead to. London maintains its attractions – especially, it is only half-joked, to the lifestyles of bankers’ wives and families – and is unlikely to lose its crown as the hub of financial activity within the EU. Exploring the potential investment opportunities in the EU makes good sense, but it’s probably unwise to make assumptions yet because, as events over the past month have shown, the only uncertainty that has been clearly defined is that we can rely on suppositions and imponderables that, when the dust has settled, still leaves London as an attractive place to invest funds in property.

Part 1: Resilient real estate

Part 2: Commercial property hotspots - the sub-sectors best positioned for Brexit