Brexit Uncertainty

Kingsley Thomas
Remain or leave, the debate continues but what effect will the result have on the construction industry?

The UK has been in the EU for 40 years. Most of us don't remember anything different. The end of the 2nd world war brought Western Europe together, and those relationships spawned the idealism of the EU, which some say has provided the foundation for the longest period of peacetime Western Europe has ever seen.

We know not to trust polls, and there have been contradictory results, but the trend is a converging vote share – it is expected to be close.

The 23rd June will see a referendum on whether the UK should REMAIN or LEAVE the EU. Although polls have typically shown the REMAIN vote with a majority, in recent months the polls have become closer. We know not to trust polls, and there have been contradictory results, but the trend is a converging vote share – it is expected to be close.

We Don't Know

Many authoritative forces have put forward their views; The International Monetary Fund (IMF), World Bank, Office for Budget Responsibility (OBR), Institute for Fiscal Studies, and the Bank of England are all warning against leaving – their views cannot be ignored. Political heavyweights such as Boris Johnson, Iain Duncan Smith and Michael Gove are spearheading the case to take the opportunity to break away from the EU. We have seen the splitting of traditional party politics in the UK with Labour and Conservative politicians standing together to make their shared case. Arguments are multifaceted, often politically motivated, sometimes esoteric and sometimes contradictory. There is no right or wrong answer – nobody really knows.

Undiscovered Country

What we do know is there is huge uncertainty and the world is changing. There is economic volatility, the migrant crisis, security concerns on Europe's borders, jihadist terrorism, and geopolitical tensions around the world. It is very possible in 12 months that the UK has voted LEAVE triggering David Cameron's resignation, allowing Boris Johnson to become Prime Minister, and Donald Trump is elected president of the USA. Europe is changing, and the world is changing – we are heading into undiscovered country. There is less and less certainty and the EU referendum is a high-impact event that adds to this uncertainty.

David Cameron has said voting to leave is the self-destruct option – LEAVE campaigners argue that this plays on fear and the REMAIN camp have to use negative arguments as they do not have anything positive to say about the EU. A LEAVE vote could be bad for the EU, the UK's largest trading partner, both politically and economically. This could have an impact on the global economy, further impacting the UK on a macroeconomic level. Looking at the arguments, both sides agree that there will be uncertainty continuing beyond 23rd June, more so if we vote LEAVE. The debate must be on the severity of the impact on a range of factors that we are uncertain about – will it be a severe jolt or a temporary blip?

The View of our Industry

There is equal uncertainty in our industry. There are a number of pre-vote issues we are experiencing, such as delays to investment decisions being taken. This is despite underlying economic fundamentals being supportive, but spending by clients is more cautious as they adopt a wait-and-see attitude. The counter argument is that London is still seen as a safe place to invest with those taking a global view - there are bigger risks on the global stage than Brexit.

Recently, both Building Magazine and Property Week have published survey results. The Building survey revealed that 63 percent of the 1300 construction professionals surveyed said remaining in the EU would have the best outcome for the construction sector. The Property week survey showed 60 percent in favour of remain.

Many companies in our industry will not speak out because Brexit is a political issue. But the impact on the construction and property industry may be dramatic. Companies in the construction industry have an enormous stake in the vote on 23rd June.

Worst Case Scenario

There are many forecasts of what would happen after a LEAVE vote. Pretty much all are negative in the short term, with some showing an overall better position in the medium to longer term, but most showing a deterioration and the UK never catching-up. Nobody can be certain. Some have predicted a sell-off of equities leading to a 25 percent reduction in the value of FTSE, a major increase in capital outflows, a 20 percent depreciation of Sterling, significant reduction in Foreign Direct Investment (FDI), a worsening of the Balance of Payments, a sustained increase in the Public Sector Net Cash Requirement, a reduction in built asset values, a higher cost of lending, high inflation, and increasing unemployment.

Political and legislative uncertainty will continue as the UK untangles from the EU. Parliament will be tied up with unravelling EU bills that, under the 2009 Lisbon Treaty, allows the government two years to make the amendments. The process is likely to take longer, drawing out the uncertainty, causing distraction to the normal business of government and from bills that may support infrastructure and investment that the industry benefits from.

All of these factors above will be impacted by the vote – the debate must be on the severity of the impact. Below we have looked at factors impacting on our industry.

The key issues and how our industry may be impacted

1. Increased Cost of Imports 

  • Sterling devaluation - Goldman Sachs says there may be a 20 percent fall in the value of Sterling. The currency has already fallen by 12.5 percent against the Euro and 6.8 percent against the US Dollar since the referendum debate began in December. The impact on our industry will be an increase in the cost of imported products and materials, therefore causing construction inflation. A possible upside is the lower cost of our exported construction and property related products and services.
  • Trade tariffs – a key benefit of the EU is free trade, therefore with the removal of free trade, tariffs may be imposed on imports of products and materials used in construction, causing inflation. In the medium to long term, however, it is argued that over time the UK will agree beneficial trading arrangements with the EU, but also pursue beneficial arrangements with the US and others.

2. Reduced business confidence - business confidence and risk appetite is extremely important for our industry as it impacts on investment decisions. For projects to progress, whether commercial property development or FDI in infrastructure, investment is required to fund projects.

3. Higher cost of finance - the availability and cost of finance is fundamental to the viability of projects. The availability and cost of finance is determined by a range of factors and risk profiling. In the worst case scenario set about above, funding would be more expensive and difficult to secure.

4. Viability of development - as costs rise and asset values decrease, business cases for development will be challenged, and this will slow development. Fewer projects will enjoy a viable business case leading to reduced workloads in the industry.

5. Mergers & Acquisitions (M&A) – the recession following the financial crisis in 2007 saw consolidation in the industry, and the outcome of a LEAVE vote may present M&A opportunities, whether distressed acquisitions, or strategic M&A activity as companies adjust their footprint, capacity and capability to accommodate the new environment.

6. Multinationals relocating - UK occupiers may look to relocate their operations to within the EU, e.g HSBC considering moving their 1000 investment bankers to Paris. These projects require investment, which is a potential short-term upside, but it is unlikely to occur in the short and medium term as companies are in lease agreements, there is a large cost to relocation, and other rivals such as Frankfurt or Paris do not have the office space available.

7. Pursuit of opportunities beyond the EU – a possible positive side effect of a LEAVE vote is that businesses will be more driven to find new markets beyond the EU. A vast majority of UK construction companies do not operate outside the UK, however, so this is not likely to change particularly if there is limited investment available and a low risk appetite.

8. Weak FDI - investment sentiment would be more negative, and according to the Bank of England, there would be a significant reduction in FDI, which funds projects across the UK.

9. No European funding – The funding from the European Investment Bank (EIB) will stop. Recently the EIB announced £280m of investment for the expansion of facilities at University College London, and £700m for the Thames Tideway Tunnel. The EIB is an important investor, providing £16bn of investment for projects in the UK over the past three years.

10. No requirement to fund our EU contribution – the UK is a positive net contributor to the EU, and the net benefit to the UK would be £8bn, according to the Institute of Fiscal Studies. This could be invested directly in the UK, although it is argued that the negative impact on the economy may eliminate any upside.

11. Wage inflation – if there is no free movement of people from the EU it will deepen the issue of skills shortages in the UK, and this will push up wages. Currently 10 percent of the construction workforce in the UK is from the EU.

In relation to infrastructure growth, Construction Products Association (CPA) economist Noble Francis said the UK's "most pressing issue" was whether the wider construction industry was capable of up-skilling to deal with demand. "By 2019, total construction output is expected to be £20bn higher than in 2015, yet employment in the industry remains 324,000 lower than it was over seven years ago. If the growth we have forecast is to be achieved then the serious issue of skills shortages needs to be addressed." Regardless of Brexit, there will be pressure on wages, but Brexit will add to it significantly.

The upside is the opportunity to adopt a different system that allows the UK to bring skills and talent in from anywhere in the world, including the EU but not just the EU.

12. Housebuilding stimulus - the stimulus on housebuilding brought about by the increase in house prices may be offset by sharp increases in labour costs and material prices causing construction inflation. It has been forecast that house prices will fall making developments unviable, and a reduction in net EU migration will reduce pressure on demand, therefore reducing pressure on house prices. However the UK must attract skilled labour who need somewhere to live, offsetting a reduction in demand in the medium term. There is the supply-side issue of a shortage of homes in many parts of the UK, and a fall in housing development will compound that issue.

13. Buy British – being outside the EU makes a Buy-British policy possible. Public sector contracts would not be subject to OJEU procurement, allowing a preference for UK suppliers. However, it is argued that this would have a limited impact as currently only 1.3 percent of public contracts go to companies not providing the goods or services from a UK base, even if it is a foreign company.

Conclusion

What this summary tells us is there are many issues and factors to consider, all of which are interrelated – it is highly complex. The impact of a LEAVE vote is unknown, and the uncertainty is already having an impact. In the event of a LEAVE vote the uncertainty will continue, and the impact on all the factors set out above will become apparent over time.

A personal observation is that on balance, there appears to be more risk of downside if the UK were to vote LEAVE. I'll be listening keenly to the debate up to 23rd June.

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