Blog 3 - The ‘Single Market’, how it affects UK property and the impact of the UK leaving it

The issue of the importance of the EU’s ‘Single Market’ for UK businesses has come sharply into focus in the wake of Britain’s majority vote to leave the European Union. To be clear, whilst EU membership guarantees unfettered access to the Single Market, the absence of EU membership does not necessarily, of itself, mean a restriction of access. Norway’s EEA membership, for example, has afforded it unrestricted access to the Single Market in return for a budget contribution and adherence to the four principles, or ‘Four Freedoms’ of EU membership, namely the Free Movement of People, the Free Movement of Goods, the Free Movement of Capital and the Free Movement of Services. It has little in the way of a direct say in EU rules but it does have the purported ‘advantage’ of having its own agricultural and fisheries policies and a seat at the World Trade Organisation (The EU is represented as a single entity, and customs union at the WTO, and EU member states do not have their own WTO seats.)[1]

Article 50

It is, as yet, unclear what the UK’s exact negotiating strategy will be following the triggering of Article 50, that is, the notification of intent to negotiate exit from the European Union. We are only privy to a broad outline strategy. The nature of the UK’s post-EU membership and trading relationship with the remaining 27 member states is therefore also unclear. However, we have been informed that the UK is aiming for a ‘comprehensive free trade agreement’ between the UK and the EU, and as such, it will be leaving the Single Market. But to inform this process and perhaps also to shed a light upon why a number of property commentators have expressed deep concerns about any situation in which the UK left the Single Market, the intention in this blog is to summarise what the Single Market is, how it works in practice and how it impacts upon the UK property market (both residential and commercial).

The Single Market – What is it?

The Single Market[2][3] is a creation of the European Union (and its predecessors/forerunners) that expanded upon what had initially been the ‘Common Market’ (which arose from the original EEC Treaty – The Treaty of Rome - of 1957). The Single European Act[4] built upon and amended the original EEC Treaty. The Maastricht Treaty[5], Lisbon Treaty[6][7], Amsterdam Treaty[8], Nice Treaty[9][10] and others paved the way for transformation from a commercial trading arrangement between European nations to a form of political union – all of these treaties can be seen as a deliberate process of deeper European integration through both commercial/trade/regulatory and political alignment, otherwise known as ‘ever closer union’. The European Economic Area (EEA) encompasses the full extent of the Single Market and includes both EU (all EU member states are part of the EEA) and a small number of non-EU states who agree to comply with a number of conditions, and, crucially, full commitment to the ‘Four Freedoms’ (see earlier and below).

Single Market[11] v Common Market[12]

As alluded to above, the Single Market has evolved, to a certain extent, from the Common Market, and is arguably incomplete in its current form, particularly with regard to Services. The European Economic Community, or EEC, was the forerunner to the European Union and was colloquially known as the ‘Common Market’. In fact, the UK had a referendum in 1975 on whether to stay in the Common Market, two years after PM Edward Heath and his Conservative Government had taken it in. Of course, it was a fairly convincing ‘Remain’ vote back then!

Four Freedoms – how do they impact upon the property market?

The Single Market provides for the ‘Four Freedoms’.

Free Movement of People[13]

This movement is tied to the efficient operation of the Single Market and means that anyone wishing to work or do business in any part of the EU/EEA can do so without restriction. It does not afford full citizenship rights in another member state but allows them a permanent right of residence, amongst other rights. When there is demand for labour from a member state within the EU, citizens from other EU/EEA member state countries can ‘fill the gap’ and apply for roles without the need for any form of visa or work permit. This can lead to high levels of immigration from some parts of the EU/EEA to growing, successful economies, eg the UK.

This generates demand for residential property as, of course, these ‘freely moving’ people need somewhere to live once they move to the new member state. Conversely, if free movement is restricted (and not replaced by immigration from elsewhere), this can serve to dampen demand for residential property, either for sale or for rent, thereby applying downward pressure on sale prices and rents. In theory, at least.

The commercial property market follows a similar pattern. If the economy is growing and businesses are expanding, then all things being equal, they are likely to take on more employees and eventually may expand their premises to accommodate them. On this basis, demand for commercial property will outstrip supply, and rents and capital values will increase. And the converse, of course, is true. If the UK left the Single Market, it would have greater control over who could and could not enter this country as migrant workers. If this happened and the numbers of migrants came down as a result, businesses, provided they were growing at the same rate as before, would have to rely on those already living in the UK (if this were possible), or the smaller number of new migrants from both the EU and from elsewhere, to pick up the slack and fill the necessary roles. This could have implications for occupier demand and, ultimately, affect the commercial property investment outlook.

Commercial property may or may not see similar impacts to residential property, provided the economic outlook remained the same. However, a reduction in overall housing demand due to a slowdown in population growth ultimately would have an impact on the housing market, the size of which would obviously depend on the UK’s new immigration policy.

Free Movement of Goods[14]

Naturally, this ‘freedom’ impacts upon the manufacturing, distribution and transport industries more so than any other. Being in the Single Market provides, along with tariff-free cross-border trading, a body of regulation and product standardisation that all manufacturers within it must comply with, which then allows, to all intents and purposes, unrestricted sales of goods to other countries in the EU/EEA. The intention being that manufacturers and distributors in one state benefit from increased exports to other member states. Conversely, if access is restricted and the slack not picked up from domestic or other international consumers, this could be detrimental to manufacturers and distributors.

We might look, as an example, at industrial property investment in major manufacturing towns and cities. The North and Midlands, for instance, are home to some of Europe’s most productive car manufacturing plants, exporting hundreds of thousands of vehicles each year to the rest of the EU[15]. If single market access is restricted, and demand is not delivered domestically or from elsewhere to make up the shortfall, the future viability of such plants could be in doubt. The impact on local property markets, industrial, residential and perhaps others, could be severe. Detrimental impacts could also be felt in other manufacturing centres (South Wales, the Scottish Central Belt, even the Highlands & Islands, amongst a number of locales). Local commercial property investment for firms that provide support services to these massive industrial/primary production bases could also suffer.

If local employment suffers, and new industries are not found to provide employees in these areas with equally well-paid work, the impact on the local residential market could be profound. The same phenomenon could apply to industrial ports that serve EU destinations. The recent steep fall in house prices in Aberdeen and the surrounding region following the oil price crash shows what can happen when an industry is hit by financial losses[16].

Free Movement of Capital[17]

Free movement of capital means, for EU citizens, the ability to carry out financial transactions and operations abroad, such as opening bank accounts, buying shares in non-domestic companies, investing where the best return is, and purchasing real estate. For companies it principally means being able to invest in and own other European companies and take an active part in their management.

So, for example, a German real estate fund could invest in UK property on a similar basis to a UK company. Without formal legal restrictions, an EU-based fund could, for example, buy a central London office block to drive safe returns for its investors. Post-Brexit, it may not have the same access and therefore a potential blockage in investment (and competition) would exist in the market, with the potential to drive down capital values. In theory, restricting the free movement of capital could undermine the efficient operation of aspects of the other three ‘freedoms’, in particular, the UK financial services sector.

Again, restrictions in the free movement of capital could act as a drag on the UK economy and hurt local commercial and residential property markets, particularly those most exposed to intra-EU trade and investment flows.

Free Movement of Services[18]

This freedom is the one whose jeopardy most worries the City[19]. Without full access to the Single Market, and, in particular, financial ‘passporting’ rights[20][21][22][23][24][25][26] being afforded to UK-based financial institutions, the City is under the threat of losing its hitherto unassailable position as Europe’s (and in some areas, the world’s) pre-eminent financial centre. Already, cities in the remaining EU member states which boast strong financial centres are touting for London’s business and trying to persuade London-headquartered institutions to consider moving some if not all of their operations there once Article 50 is triggered.

One method by which the UK could counter such moves is to become a low regulation, low tax offshore haven for financial services[27], a ‘Singapore on Steroids’ as both advocates and critics have, at times, likened it. This could be a successful approach but it would almost certainly be seen as an aggressive trading stance with the EU and not assist in good trading relations between the UK and EU initially. Furthermore, it would undoubtedly lead to a complete loss of financial passporting rights for UK/London-based institutions. This would be part of a ‘hard Brexit’ approach. London’s growing strength in the ‘Fintech’ or financial technology sector may escape unharmed and might even benefit if it has room to grow, and a favourable tax and regulation environment. Less competition for office space in London’s key financial districts may indeed help it grow.

Some leading ‘Brexiteers’ have argued that merely adopting an equivalent regulatory regime for financial services may suffice to maintain the UK financial services industry’s ability to effectively ‘passport’ the trade in financial instruments via MIFID/MIFID II[28], ‘back to back’ trading[29] ‘currency swaps’[30][31] or some other such ‘equivalence’ in financial regulations between the UK and EU. If that turned out to be the case and an agreement on this basis can be successfully negotiated, it would represent a massive boost and relief for London’s main financial centres in the City/Canary Wharf/West End, and big regional financial centres with large EU trade, which have collectively fretted since the decision to even hold a referendum was made. Office investment in these, and related, sectors should hold up if some form of passporting continues. The residential market that financial and professional services (and countless ancillary business sectors) underpins in the various UK cities would also be insulated from losses if there was a smooth transition along these lines.

‘Selling into the Single Market’[32]

This is a phrase used by prominent Leave politicians and campaigners to distinguish – but simultaneously imply equivalent or similar status - between Single Market membership (with its associated costs and perceived downsides) and mere access or entitlement to sell ‘into’ it by either a free trade agreement or relying upon default World Trade Organisation (WTO) ‘Most Favoured Nation’ rules[33].

It is quite clear that anything less than Single Market membership raises the prospect of both tariff and non-tariff barriers between the EU and UK. The level and nature of these will be the subject of the negotiations following the triggering of Article 50 by the UK Government.

The Institute for Fiscal Studies (IFS) made clear in a statement on 10 August 2016 that ‘access’ to the Single Market is not comparable/similar to membership of the Single Market[34]. Thus any inferior free trade agreement – if one can indeed be agreed – has the potential to impact upon trade, the economy and the residential and commercial property markets in the UK.

Alternative Trading Models

Various trading models have been discussed before, during and after the referendum. The Canada Model[35][36] (essentially a formal bilateral free trade agreement with the EU), the Norway Model[37] (this represents the closest possible trading relationship with the EU that it is possible to have whilst not actually being in the EU, and in an economic/trading sense, mimics much of what EU membership entails), the Switzerland Model[38] (this involves hundreds of separate free trade agreements covering various elements of trade. In return for access to the Single Market via these trade agreements, the Swiss make ‘concessions’ on various EU Single Market rules and regulations, and some concessions on the Four Freedoms) and even the Albania Model![39] (perhaps slightly tongue-in-cheek!)

However, the UK government has made it clear that it is approaching the negotiations looking for a bespoke ‘British’ Model[40][41][42],not an ‘off the shelf’ one. They intend to tailor it for the UK with prioritisation for certain industries and specific trade-offs to secure concessions on free movement and the scope of EU regulations. The intention on the UK’s part is to secure a ‘comprehensive free trade agreement’[43].

Conclusion

Without Single Market access, there could be a number of impacts on the UK property sector. There are so many myriad potential outcomes, and so much bargaining and tough negotiation ahead of us, that it is almost impossible to predict what will happen. There might be tariffs, there might be restrictions on the movement of people, capital and goods and there might be other costs. There might also be great opportunities! And if there are exchange rate impacts, these may end up having a bigger impact on the property market than the legal/regulatory changes in the UK/EU trade relationship.

Investment to UK property may slow down but if advantageous free trade deals with growing markets around the world are secured quickly, then it may speed up and increase. Confidence in a market is among a number of facets which dictates the level of inward investment into it. It may be that confidence in the Single Market/EU/Eurozone[44] project will wane (some see it breaking up[45] in future and that Brexit is just the start of its unravelling) – this could make the UK a perceived safe haven for international capital.

But, should this not be seen as likely, inward investment may decline on account of a lack of access to larger markets, the basing of European/EMEA HQs in London[46]/the South East of England in particular. Expansion of premises and investment into HQs could stop or slow down, with impacts on property investment and the construction sector.[47][48][49]

The UK has been, for decades, a significant recipient of non-European FDI[50] – will this continue in a post-Brexit UK? What will the impact on confidence and inward investment of abandoning a so-called ‘soft Brexit’[51] in favour of a ‘hard Brexit’?[52][53] Should we even be using such terms?

Will the UK no longer considered ‘launchpad’ for EU market for global businesses? If this is less certain, how will this impact on other areas, eg on the new Heathrow/Gatwick runway decision?[54] What will the OVERALL impacts[55] on the residential[56] and commercial[57] property markets[58] be? What will the broader impacts on property development[59] be?

There are far more questions than there are, as yet, answers. There are also so many facets of the decision to leave the EU which will have major impacts on the UK property market and that have not been covered in this blog.

What we can say, with some certainty, is that the trade relationship we have with the EU now is not going to be enhanced by our leaving the EU. The best anyone can hope for, in terms of a trade relationship, is something ‘as good as’ being in the Single Market, with any perceived trade upsides being felt in new trading relationships with other economies. But there is reason for optimism if both sides act in their own economic interests, and do not seek to hurt or punish the other side. If there is a favourable trade deal at the end of the negotiations, the commercial and residential property sectors, in investment terms, should continue to be a Great British success story.

For the next two years, at least, everyone in the property industry needs to keep their fingers crossed!

[1] http://www.efta.int/eea/eea-agreement

[2] https://ukandeu.ac.uk/multimedia/bbc-world-at-one-the-eu-and-the-single-market/

[3] https://fullfact.org/europe/what-single-market/

[4] http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=URISERV:xy0027

[5] http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=URISERV:xy0026

[6] http://ec.europa.eu/archives/lisbon_treaty/take/index_en.htm

[7] http://www.lisbon-treaty.org/wcm/the-lisbon-treaty.html

[8] http://news.bbc.co.uk/1/hi/in_depth/europe/euro-glossary/1216210.stm

[9] http://europa.eu/rapid/press-release_MEMO-03-23_en.htm

[10] https://ukandeu.ac.uk/fact-figures/what-is-the-nice-treaty/

[11] https://singlemarket.blog.gov.uk/

[12] http://www.parliament.uk/about/living-heritage/evolutionofparliament/legislativescrutiny/parliament-and-europe/overview/britain-and-eec-to-single-european-act/

[13] https://www.weforum.org/agenda/2016/09/free-movement-of-people-explainer

[14] http://www.europarl.europa.eu/atyourservice/en/displayFtu.html?ftuId=FTU_3.1.2.html

[15] https://www.smmt.co.uk/2016/01/best-year-in-a-decade-for-british-car-manufacturing-as-exports-reach-record-high/

[16] https://www.eveningexpress.co.uk/fp/uncategorized/city-suffers-biggest-drop-in-house-price-and-sales-in-scotland/

[17] http://www.europarl.europa.eu/atyourservice/en/displayFtu.html?ftuId=FTU_3.1.6.html

[18] http://www.europarl.europa.eu/atyourservice/en/displayFtu.html?ftuId=FTU_3.1.4.html

[19] http://www.egi.co.uk/news/financial-services-exodus-with-brexit/

[20] http://www.parliament.uk/business/committees/committees-a-z/lords-select/eu-financial-affairs-subcommittee/inquiries/parliament-2015/brexit-financial-services-inquiry/

[21] https://www.bloomberg.com/professional/blog/financial-services-sector-implications-of-brexit/

[22] http://www.nortonrosefulbright.com/knowledge/publications/136980/impact-of-brexit-on-financial-institutions

[23] https://corpgov.law.harvard.edu/2016/07/12/the-law-and-brexit/

[24] http://www.msn.com/en-gb/money/topstories/london-stock-exchange-boss-warns-100000-jobs-at-risk-from-brexit-vote/ar-BBwy657?li=AA54rU&ocid=spartanntp

[25] http://www.msn.com/en-gb/money/news/brexit-5000-financial-services-firms-at-risk-if-uk-leaves-single-market/ar-BBwo4Fz?ocid=spartanntp

[26] http://www.msn.com/en-gb/money/news/brexit-banks-begin-moving-jobs-outside-uk/ar-BBwH4mV?li=AA54rU&ocid=spartanntp

[27] http://blogs.wsj.com/moneybeat/2016/09/15/wsj-citys-brexit-briefing-boe-keeps-rates-steady-for-now-hollande-and-merkel-plan-eu-priorities-uk-retail-sales-resilient/?mod=e2tw

[28] https://www.fca.org.uk/markets/mifid-ii

[29] https://www.ft.com/content/5ceb8606-e8af-11e6-967b-c88452263daf

[30] https://www.fxcm.com/insights/how-do-currency-swaps-work/

[31] http://www.bbc.co.uk/news/business-23020718

[32]https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/278490/Bruges_Group_sayingnotothesinglemarket.pdf

[33] https://www.wto.org/english/thewto_e/whatis_e/tif_e/fact2_e.htm

[34] http://citywire.co.uk/money/brexit-ifs-brands-single-market-access-meaningless/a941462

[35] http://ukandeu.ac.uk/oh-canada-an-alternative-for-the-uk-after-brexit/

[36] https://theconversation.com/what-is-the-canada-trade-model-and-could-it-work-for-a-post-brexit-uk-58098

[37] http://blogs.wsj.com/briefly/2016/06/30/brexit-and-the-norway-model-at-a-glance/

[38] http://ukandeu.ac.uk/is-the-swiss-model-a-brexit-solution/

[39] https://www.ft.com/content/56a33c8a-7b50-33f8-bd0e-a9149fe1df5a

[40] http://www.bbc.co.uk/news/uk-politics-eu-referendum-36639261

[41] http://www.scotsman.com/business/markets-economy/between-the-lines-flexibility-is-key-to-brexit-survival-1-4227415

[42] https://www.gov.uk/government/speeches/pm-speech-to-the-lord-mayors-banquet-14-november-2016

[43] http://www.bbc.co.uk/news/uk-politics-38641207

[44] http://www.cityam.com/249132/italy-just-three-plausible-steps-away-crashing-out-eurozone

[45] http://www.msn.com/en-gb/money/news/the-deutsche-bank-crisis-could-take-angela-merkel-down-%E2%80%93-and-the-euro/ar-BBwERG1?li=AA54rU&ocid=spartanntp

[46] http://www2.deloitte.com/uk/en/pages/growth/articles/london-crowned-business-capital-of-europe.html

[47] http://www.constructionenquirer.com/2016/09/06/building-services-specialists-see-brexit-as-a-boost-for-business/

[48] http://www.constructionenquirer.com/2016/09/14/contractors-face-construction-price-falls-of-6-by-2018/

[49] http://www.rics.org/uk/news/news-insight/comment/eureferendum-construction/

[50] https://www.gov.uk/government/news/uk-confirmed-as-leading-european-destination-for-foreign-direct-investment

[51] http://www.bbc.co.uk/news/uk-politics-37507129

[52] http://www.bbc.co.uk/news/uk-politics-36723220

[53] http://uk.businessinsider.com/hsbc-table-explains-difference-between-hard-and-soft-brexit-2016-10?

[54] http://uk.reuters.com/article/uk-britain-airport-idUKKCN0ZG0QI?feedType=RSS&feedName=topNews

[55] http://www.egi.co.uk/news/what-impact-will-article-50-have-on-the-property-industry/

[56] http://www.rics.org/uk/news/news-insight/comment/eu-referendum-residential/

[57] http://www.rics.org/uk/news/news-insight/comment/eu-referendum-commercial/

[58] http://www.rics.org/uk/news/news-insight/press-releases/rics-responds-to-the-eu-referendum/

[59] http://www.egi.co.uk/news/development-not-dented-by-brexit/