Will Brexit be a red herring for UK house prices?

Today’s full-year results from the UK’s largest listed landlord Grainger (LSE: GRI) show that Brexit hasn’t yet had a negative impact on the UK property market. The company’s net rental income has risen by 15% to £37.4m and its overall performance has been encouraging.

And the company says the private rented sector growth opportunity is very compelling. Could it be the case that Brexit won’t hurt the UK property market, or will it do so once leaving the EU becomes a reality?

Clearly, Grainger’s results are somewhat behind the curve when it comes to Brexit. Prior to the EU referendum, the outlook for the UK economy was very bright and relatively stable. However, this has now changed and the UK is likely to experience a level of uncertainty it hasn’t seen since the end of the credit crunch. This could cause delays in investment, weak economic growth and reduced demand for property.

The property market reacts relatively slowly to poor economic performance. In rentals, for example, most tenants are locked into minimum periods and it’s only when they come to renew that the impact of a deteriorating economy begins to be felt. Finding new tenants could become more difficult for Grainger and other landlords, who may have to reduce their rents in order to fill voids.

Wider uncertainty

Similarly, property sales also react relatively slowly to wider economic uncertainty. The process of buying a house is still relatively slow, so it may not be until next year when the full impact of Brexit and its uncertainty begins to be felt. This is likely to be exacerbated by the fact that Article 50 is due to be invoked by the end of March. Once negotiations begin, it may become clear that the EU won’t compromise on access to the single market, and the UK won’t compromise on free movement.

As such, the chances of a hard Brexit are likely to increase and cause more uncertainty. So the UK property market could endure a rough period, where low confidence leads to falling rents and falling house prices. However, this doesn’t mean property stocks should be completely avoided. But it does make sense for investors to seek out wide margins of safety in case of difficulties for the wider sector.

In Grainger’s case, it has a price-to-earnings (P/E) ratio of 12.3, but is forecast to record a fall in earnings of 45% this year. As such, it seems to be a stock to avoid. Meanwhile, housebuilder Persimmon (LSE: PSN) has a P/E ratio of just 8.8 and while its earnings are due to fall by 4% next year, it still offers high upward re-rating potential. In addition, Persimmon has a sound balance sheet and strong cash flow, which should help it survive challenges that may lie ahead for the sector. And with a diverse land bank, its long-term growth opportunities remain high.

While Brexit may not yet have hurt UK house prices, there’s a good chance that it will do so in 2017. As such, it’s unlikely to be a red herring, with wide margins of safety being required in order to make it a worthwhile place to invest.

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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.