Is London immune from a UK property crash?

The Motley Fool
City of London office blocks
City of London office blocks

Following the EU referendum, the performance of the UK economy has generally been more resilient than most investors expected. With the exception of a falling pound, the UK's economic growth rate and employment performance has been surprisingly strong. However, today's results from commercial property owner and manager Shaftesbury (LSE: SHB) show that things could be about to worsen for London property prices.

In its update, the real estate investment trust (REIT) states that there is a background of growing caution in property markets. It is beginning to affect some portfolio values and while its own estate recorded underlying capital value growth of 4.9% for the year to 30 September, this is likely to have been weighted towards the first nine months of the year.

Furthermore, Brexit has not yet begun. The period from 23 June to today may have included greater uncertainty than prior to the vote, but caution among businesses and investors is likely to increase as negotiations between the UK and EU begin. In fact, the EU has stated this week that the UK will not be able to cherry-pick the rules and regulations it is seeking. As things stand, it appears as though the UK may fail to obtain access to the single market unless it concedes at least some control over its immigration policy.

Clearly, negotiations between the UK and EU are unlikely to progress smoothly. This could leave the UK and London in particular in a state of limbo. Businesses and investors may postpone investment decisions until after the negotiations have concluded in order to see whether the UK will have access to the single market. Arguably, this matters even more to London since it is a global financial centre. If it does not obtain a financial passport for the EU or access to the single market in some way, shape or form, then it is not difficult to see international financial institutions and other companies moving into the EU.

In such a scenario, London property prices could fall significantly. Shaftesbury's results may show that its net property income increased by 6.7%, while footfall and trading in the West End and across its locations remained buoyant. However, that could all change in 2017 if Brexit impacts negatively on the outlook for the London economy.

Due to this, it is crucial to seek out a wide margin of safety in case of short term challenges. In Shaftesbury's case, it trades on a price-to-earnings (P/E) ratio of 57, which indicates that it is overvalued given the uncertain outlook it faces. However, within the REIT sector, Tritax Big Box(LSE: BBOX) has a P/E ratio of 20.5 and when this is combined with its earnings growth forecast for next year of 10% it equates to a price-to-earnings growth (PEG) ratio of 2.

This indicates that Tritax Big Box could rise in the medium to long term, although its short term performance may be hampered by difficulties within the UK and London property markets. While Brexit may not yet have caused a deterioration in the UK's economic outlook, this could easily take place in 2017. London is unlikely to be immune from this, although Tritax Big Box's valuation shows that it could be a sound long term buy.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.