Blog 2 - Scottish Independence and Property

Following the Brexit vote, the prospect of a second Scottish independence referendum has surfaced. The nature of the result of the EU referendum (with Scotland voting by a majority for the UK to Remain but the UK as a whole voting to Leave) has provided the ‘material change of circumstances’ for another referendum outlined in the SNP’s Holyrood election manifesto; namely, Scotland ‘being dragged out of the EU against its will’.

So if Scotland were to have another referendum, and did vote for independence, what would that mean for Scottish property?

There are a number of issues to consider.

Currency

It is still unclear which currency and independent Scotland would adopt. Keeping the pound in a currency union is likely to be ruled out, as is sterlingisation. Both these options are even less likely if Scotland is in the EU and the rest of the UK isn’t. There is the potential for Scotland to join the Euro or issue its own currency via a new Scottish central bank. There are some other, perhaps less satisfactory and/or less likely options too. No option is without its cost and therefore its potential to negatively impact upon Scotland’s property industry.

What this entails for property is not entirely clear. Transitioning to a new currency could be very costly and challenging, and the uncertainty involved could lead to capital flight[1] from Scotland. Particularly from Scotland’s prominent financial sector. The requirement to defend the new currency against speculators and to make Scotland ‘creditworthy’ will most likely mean that there will be a period of higher taxes and lower public spending.

With this ‘fiscal consolidation’[2], there could be a slowdown in economic growth which would have a knock-on negative impact on the property sector. More broadly, a change in currency could have major implications for the valuation of, and demand for property, not to mention the impact on interest rates set in Scotland.

With the currency impact alone, the could be a downward pressure on both the residential and commercial investment and development sectors, low capital appreciation and low rental returns as business sentiment waned and take home salaries were lowered.

Beyond the short to medium term, it would be hard to predict the impact on the property sector of a change in currency following independence and would be dependent on the economic/fiscal circumstances prevailing at the time.

Government Finances

Given a clear recurrent deficit[3] in terms of the amount of tax revenue Scotland on its own currently generates and its current rate of public expenditure, as an independent country, it would have to increase taxes, cut public spending or borrow to cover the deficit; or a combination of all three.

With a new currency and no track record in managing and paying back sovereign debt (or at least not for over 300 years) as an independent country, the cost of Scotland’s government borrowing is likely to be higher than the UK enjoys at present.

Given the tough choices it would face in these early years, a period of public sector austerity seems almost inevitable. There is no apparent route to quick economic growth following independence (in fact, many would suggest the opposite). These conditions are unlikely to boost commercial or residential property investment or development in the short to medium term and could lead to yet more capital flight or at least, a capital diversion away from Scotland. They would likely hinder any public sector driven growth in the economy which would have a resultant impact on the property sector.

In these circumstances, it might be envisaged that there would be a period of retrenchment in investment into both the commercial and residential sectors, with lower rents and declining or static capital values. Development in both sectors would likely be impeded in the years immediately following a vote to become independent.

North Sea Oil and Gas

The global oil price has taken a dramatic fall since the last referendum took place in 2014. With a long term oil price of $113 a barrel quoted in the White Paper: Scotland’s Future now widely discredited, and with oil prices now hovering at a range of figures roughly below half that level, the ability of Scotland to pay for its current level of public services without a UK fiscal transfer is severely hampered.

And the dollar price of oil – which could, of course, bounce back to higher levels in future - is only one part of the North Sea story going forward. Profits – from which taxes are generated – are in long term decline as oil becomes more costly to extract from mature fields, and fields in more geographically and geologically challenging locations. Thus revenues from the North Sea are unlikely to plug this gap over the long term. This would have an impact upon the fiscal position of an independent Scotland, which, in turn, would likely impact upon the property sector, as discussed above.

The North Sea oil and gas industry is widely seen as still being very much a viable source of jobs and revenues and will continue to be in the decades to come. With the prospect of industry diversification and decommissioning of oil rigs and fields (which, again, may come at significant cost to the Scottish Government upon independence due to the tax incentives required), there will be additional high-skilled employment in the North East of Scotland for years to come.

With viable tax incentives, this type of work should allow for continued commercial development and investment in Aberdeen and the wider North East region, whether Scotland is independent or not. It will also support continued investment and development in the residential sector. The question is, could Scotland, on its own, afford to make the most of what is left of the industry? Would the industry be better served within the UK constitutional framework, or outside of it? And how might any changes that might take place in the industry on account of Scotland becoming independent affect the consequent impact upon local commercial and residential property?

At this stage, there is no clear answer or consensus.

European Union

The majority preference of the governing SNP’s political hierarchy is for an independent Scotland to be an EU member state. However, notwithstanding the various hurdles to overcome to actually obtain EU membership (chief among these being a prospective independent Scotland’s budget deficit concerns[4]), if Scotland were to become an independent member of the EU, what would the consequences be for the property industry?

First of all, there would be the currency implications. These have been addressed earlier but it is suffice to say that Scotland could not share the pound in a currency union with the rest of the UK if it joined the EU as a separate member state. The Acquis to European Union requires, in effect, a member state to have its own central bank and issue its own currency prior to joining the Euro. And for new member states, there is a requirement that they commit to joining the Euro at some point in the future.[5] So there would be further currency uncertainty with all that this would entail for the Scottish property sector.

The nature of the trading relationship with the rest of the UK would change too if Scotland were to be an independent EU member state. The EU is, for one thing, a customs union and trades externally as one bloc; any rules applying to the other member states would also apply to Scotland. As Scotland does four times more trade by value with the rest of the UK as it does with the rest of the EU[6][7], it is crucial that close trading links are maintained (or otherwise quickly replaced by other markets), and barriers to trade minimised between the EU and the rest of the UK, in the event of independence, to avoid economic damage[8]. This, of course, is likely to depend on the outcome of the post-Brexit negotiations.

If close ties are maintained, there could, in fact, be minimal impact on the economy arising out of a situation in which Scotland is in the EU, and the rest of the UK is out of it, and therefore less of an impact on the property sector. Questions remain over whether there would be a shift in the location of operations between Scotland and the rest of the UK in this scenario with companies potentially seeking to base themselves in their most important market (eg those financial services businesses who trade proportionately far more with the rest of the UK than the EU). Until the outcome of the negotiations is clear, it is hard to predict what will happen. What we can say, however, is that any change which means companies have to move some or all of their key operations out of Scotland on account of any new trading status/relationship is likely to have a significant impact on the property investment and development sectors, both in commercial and residential property.

If Brexit, as is expected, brings some restrictions on free movement of EU citizens to the (rest of the) UK, and an independent Scotland joins the EU and is thus committed to free movement of people (and possibly inclusion in the Schengen passport-free zone), some have argued that it would be hard to reconcile this without some form of border control between Scotland and England, particularly if the two countries have widely different immigration policies post-independence.

A ‘hard’ border may restrict movement of goods and people between Scotland and England somewhat which could stymie trade between the two countries and could indeed damage their economies. This would be felt in the property market and could, again, lead to relocations of people and businesses between England and Scotland to abrogate the need to go through a border, thereby affecting the demand for residential and commercial property in some parts of Scotland.

Additionally, there would be the matter of contributions to the EU budget which would affect the Scottish Government’s fiscal position. Contributions from member states mainly come in the form of a percentage of gross national income, VAT income and customs duties from non-EU countries[9]. There is every chance, if Scotland’s economy were to perform well once within the EU, that it would become a net contributor to the EU, according to analysis from 2011[10] and, indeed, the words of the then Deputy and now First Minster, Nicola Sturgeon in 2013[11].

However, some of the monies contributed would be recouped in the form of transfer payments to its ‘transition’ regions[12] (a term used for the purpose of assessment for EU funding primarily), for example, the Highlands & Islands[13][14], through European Regional Development Fund (ERDF) and other monies[15] and other financial assistance with infrastructure and other pan-EU projects. The distribution of these (which, some argue, may not be fully replaced by the UK government in the long run, following Brexit) could have a major impact on local residential and commercial property markets across Scotland if it were to become an independent EU member state[16].

To reiterate, until we know the terms of any possible EU membership for an independent Scotland, as well as the terms of a post-Brexit trade deal between the EU and UK, it is not possible to make any accurate predictions as to how membership, or otherwise, of the EU would affect an independent Scotland’s commercial and residential property sectors.

Setting up a new state

The cost of setting up a new Scottish state was a controversial and contentious point of debate in the run up to the 2014 referendum. The amount of money available to provide the necessary government infrastructure would, of course, depend on the state of the public finances, the cost of borrowing, and so on; these were discussed above.

As a devolved administration, a lot of the ‘apparatus’ for operating as an independent country is arguably in place. And with a number of foreign consulates already set up in Edinburgh, a raft of newly-constructed foreign embassies may not necessarily be on the cards. However, as an independent country, there would be a requirement for new ministries and a ‘support network’ of consultancies, think tanks, political advisory firms and lobbying bodies, to augment the network already there. This would undoubtedly spur demand for both residential and commercial property in Edinburgh and elsewhere.

There is, of course, the potential for more international delegations to Edinburgh as an international capital – which would impact upon the leisure property market there - but it is arguable whether there would be a huge boom in this area; it is already a well-known destination.

Miscellaneous

There are many other areas to cover with regards to how things may change (or stay the same) in a hypothetical independent Scotland – and how these might affect the residential and commercial property markets in Scotland - but given that this is a blog, and not an in-depth study, I feel it best to mention them in passing, and accept also that there is much I have missed out. There is far more analysis to be done, for example, on the impact on financial services of a vote for independence. Similarly, on legal and professional services which are part of the ‘supply chain’ for financial services. This could have massive impacts on the residential and commercial scenes in Edinburgh and Glasgow, in particular.

There are the potential changes in defence capability and spending which could affect the economies of areas with large shipbuilding and engineering facilities, or those with large military barracks, naval bases or airforce bases.

There is the NHS and how it would operate, and be funded, in an independent Scotland. It is fully devolved now but consideration as to how it would be funded following independence may alter its expenditure patterns which may have effects on local property markets.

There are many, many other areas in which changes brought on by Scotland becoming an independent country could affect its property market.

Summary

There is much more to discuss on this issue and I will re-visit it, and cover it in more detail in subsequent blogs. I will also be covering the whole issue and its impact on the residential and commercial property markets, with much fuller and more specific analysis, in a report to follow, which I will publish on this blog and my website - www.thefifthestateagent.co.uk - in due course.

Conclusion

Whilst independence would no doubt throw up potential opportunities in the commercial and residential property sectors, a cursory glance at the issues raised during the last independence referendum campaign, allied to some of the issues raised by the ‘Brexit’ vote (which may, in fact, arguably make independence an even riskier prospect now) serve to demonstrate that there would be huge challenges and risks for these sectors if Scotland decided to go it alone, either in the EU or outside it. The complications wrought by the Brexit vote, and the lack of clarity on what the UK’s future outside the EU will look like, inevitably make the new independence debate more opaque, and even more open to question and unsubstantiated conjecture, on some key issues than perhaps it was in 2014.

No new blueprint for independence has entered the public domain in the wake of ‘Brexit’ so we must wait and see if the signals for a renewed independence push amount to anything, and what the new plan for independence may be, before conducting full and rigorous analysis. I will come back to this issue in due course.

[1] http://www.bankofengland.co.uk/publications/Documents/records/fpc/pdf/2014/record1410.pdf

[2] http://stv.tv/news/politics/1361133-snp-mp-criticised-for-fiscal-consolidation-comments/

[3] http://www.gov.scot/Publications/2016/08/2132

[4] http://ec.europa.eu/economy_finance/economic_governance/sgp/index_en.htm

[5] http://ec.europa.eu/enlargement/policy/conditions-membership/chapters-of-the-acquis/index_en.htm

[6] http://www.gov.scot/Topics/Statistics/Browse/Economy/Exports/ESSPublication

[7] https://uk.news.yahoo.com/independence-greater-threat-scotlands-economy-103313863.html

[8] https://www.politicshome.com/news/uk/economy/economic-growth/news/77960/rbs-scottish-independence-would-make-brexit-worse

[9] https://europa.eu/european-union/about-eu/money/revenue-income_en

[10] http://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN06110

[11]http://www.heraldscotland.com/news/13093818.Sturgeon__independent_Scotland_would_have_to_apply_for_EU_membership/

[12] http://ec.europa.eu/regional_policy/en/funding/erdf/

[13] http://www.euclidnetwork.eu/files/get_file.pdf

[14] http://ec.europa.eu/regional_policy/en/policy/how/is-my-region-covered/

[15] http://ec.europa.eu/regional_policy/en/

[16] http://www.telegraph.co.uk/news/2016/08/06/rbs-warns-scottish-independence-would-make-brexit-upheaval-worse/ ; http://uk.businessinsider.com/univeristy-of-strathclyde-economic-scottish-independence-brexit-2016-10?r=US&IR=T