Brexit Implications for French Property

Since the Brexit vote, a lot of our clients have been very concerned as to the Brexit implications for French property. I believe that the implications will be near identical for Italian property.

No two cases are identical, but I will try to summarise the position as it will affect most of you. If your specific case isn’t covered please contact me directly and I’ll do what I can to help.

Because this is a wide topic, let me summarise how the content is structured to make it easier for you to get to the sections of this rather long document that are relevant to you.

1. General points covering all cases.
2. The consequences in France or Italy affecting UK passport holders with a principal residence in France or Italy.
3. The consequences in the UK affecting UK passport holders with a principal residence in France or Italy.
4. The consequences in France or Italy affecting UK passport holders with a second home in France or Italy.
5. The consequences in the UK affecting UK passport holders with a second home in France or Italy.
6. The consequences in France or Italy affecting UK passport holders considering the purchase of property in France or Italy.
7. The consequences in the UK affecting UK passport holders considering the purchase of property in France or Italy.
8. The property investment implications of Brexit.

As George Soros said, forecasting is hard and forecasts almost always turn out to be wrong! However, looking at the range of possible scenarios may help you to take a realistic view of what faces you in a post Brexit world regarding property in France and Italy.

Before you read further, please bear in mind that what follows is my personal judgement on these very unclear evolving circumstances. What will actually happen will be unknowable for some years to come. These notes have evolved from conversations with clients who fall into the above categories and from discussions with university research departments, notably Strathclyde University in Glasgow (my old department), colleagues in European and UK banks and contacts from the relevant Central Banks.

My comments are not offered as advice, financial or otherwise, as to what any reader should do and I accordingly decline any responsibility for any action you make take or not take as a result of your reading of this research note. However, I can affirm that as a direct result of the research underlying this paper I have taken my own advice and implemented a strategy directly in accord with this paper.

General Points Covering All Cases

These points are relevant to all cases and so can be considered as a global macro enveloping all the specific cases that follow.

Though Brexit has a very large press and political exposure in the UK it is, by and large, considered to be of relative unimportance to most of France and Italy. You need to guard against taking the whole process too seriously because, in the wider scheme of things, it will probably not be of as such enormous historical significance as the Roman and Norman invasions! Equally, if Trump bombs North Korea no one may remember Brexit in 3 months’ time.

The UK is now a “service economy” and you will be beset by chargeable advice and briefing papers from a plethora of financial and legal advisors offering you neatly packaged answers. The situation is not, in my opinion, amenable to any neatly packaged answer – it’s too complex and multi-faceted. The best you can hope for is that by the application of basic common sense you may come out in a stronger rather than a weaker position.

George Soros made around USD 1 billion shorting GBP in 1992 not by taking paid advice, reading the press and listening to politicians. All he did was apply common sense and basic macroeconomics to the situation – what he was being told just did not add up. I suggest that you use the same sceptical approach to all you hear about Brexit, especially in the UK.

In the context of the UK service industry, press and political establishment the first question you should ask yourself about any advice or opinion is Cui Bono – For Whose Benefit – yours or the advisor. If in doubt as to how this works, I suggest you read one of John Kay’s books on the UK financial services industry.

Academic research into Brexit voting patterns strongly suggest that the explanation of Brexit offered by the UK press and political establishment is wrong, though the explanation of immigration as the cause does play well to the English conservative party’s right wing agenda.

 

Brexit was more probably the result of a relatively straightforward causal chain starting with the neoliberal free market ideology that led to globalisation and the free movement of capital. Simply put the causal chain was probably something like:

Neoliberal Ideology > Globalisation > Movement of Lower Skill Jobs to Lower Cost Locations >Impoverishment of the “Left Behinds” > Collapse of Employment Sectors > Populism >Search of a Simple Solution > Politicians Seizing the Main Chance.

In support of this we see two very convincing pieces of evidence:

The clear dichotomy between the pro and anti-Brexit constituencies with the pro being generally being wealthier and better educated than the anti.

A similar dynamic appearing across a wide range of countries subject to the same macroeconomic and social forces – think Trump and Marine Le Pen.

It is doubtful that what these people voted for can be delivered by any government because the problem has its roots in technology. Sadly, expelling immigrants will not make it any more feasible for the unskilled and less well educated to design and manufacture the next generation of iPhones!

Brexit is not a one size fits all problem and many of those who wish to will be able to circumvent the issue entirely.

A number of European countries apply the principle of Jus Sanguinis to nationality. Under this concept if you have qualifying decadency it is possible to apply for automatic dual nationality, for example Ireland and Italy.

This may be the simplest way to defuse the Brexit issue if you are able.

Brexit, though a cause celebre of the English political right, may ultimately prove to be something that affect the United Kingdom differentially.

In Scotland, Brexit may well be the catalyst that propels Scottish independence and leads to a totally different outcome vis a vis Europe.

Though I’m not going to publicly take a side in this debate (Italian decent with Scottish education!) I was very struck at the time of Indyref 1 that the members of the Scottish social media platform Kilter voted (from memory – I was sailing on Loch Ness) around 80% for and 20% against independence.

In Northern Ireland, Brexit may well lead to some very unexpected consequences because the political settlement of 1998 may not survive a hard Brexit.

It is entirely feasible to imagine a situation in which England Brexits, Scotland chooses independence in Europe and Northern Ireland is unable to go forward as part of the UK with a hard border.

Looked at from the standpoint of the English right this is an unimaginable consequence, but looked at in an historical context it is no more unimaginable than the collapse of Yugoslavia, the unwinding of the USSR and even the ending of the British Empire.

Specific Cases

The remaining sections cover what we expect to be the realistically possible worst case scenarios. The realistically best case scenarios will be no change from today’s situation. The actual outcome will probably lie between the two extremes but, given the English governments ideological bias, we are planning for the outcome to be much closer to the worst case than the best-case scenario.

The consequences in France or Italy affecting UK passport holders with a principal residence in France or Italy.

We think that the situation for these people will largely be similar to what it was under the pre-single market rules. Continued residence would require a residence permit and would be likely to require proof of forward financial independence.

Under the previous regulation, it was not difficult to obtain a residence permit in retirement provided proof of adequate pension entitlement was available. It was harder to obtain a residence permit for those wishing to work because there were additional requirements pertaining to a work permit.

The consequences in the UK affecting UK passport holders with a principal residence in France or Italy.

We expect that the situation will be very similar to that of UK nationals living abroad but outside the EU.

What is a particular risk is that a UK government would seek to reduce the cost of benefits and other entitlements (e.g. pensions) through arbitrary restrictions such as the removal of inflation indexation.

The macroeconomic background, despite the political protestations, is that the UK economy is in long term decline and has overall (though not for very small specific groups) been very unsuccessful when compared internationally. For example, in USD terms GBP is worth around half what it was worth in 1970. Looking further back to my father’s generation in London the 5s (25p in decimal coinage) was called a dollar because that was what it was worth in USD.

 

A cursory study of UK economic and political history suggests that this trend will continue for the foreseeable future and the UK government will seek to minimise expense and maximise tax where it can. UK non-residents in Europe may well be a prime target because they will get little sympathy “back home”.

The consequences in France or Italy affecting UK passport holders with a second home in France or Italy.

We expect these people to be very little affected, subject only to the possible requirements of visitor’s visas and the extension of the second home tax.

It is possible that there may be differential treatment accorded depending on location with the poorer and more backward rural areas being able to offer different conditions to the more prosperous and popular areas.

There will likely be significant investment related considerations which are covered in the investment section below.

The consequences in the UK affecting UK passport holders with a second home in France or Italy.

We do not expect this group to be significantly affected beyond the currency implications of the EUR GBP cross rate.

If GBP was to weaken further and if the worst-case Brexit economic scenario came about one could imagine that an English government might be forced to reintroduce, possibly on a temporary basis, some form of exchange control. We believe this to be very unlikely, but there is the precedent of the UK bailout by the IMF in 1976 and the Lamont collapse of sterling in 1992. Ultimately the effects may well depend on the nature and extent of effects of post Brexit economic fallout. Clearly any consequences such as this would have dramatic financial consequences for property owners.

The consequences in France or Italy affecting UK passport holders considering the purchase of property in France or Italy.

We do not expect these to be substantially different from those affecting people in point 8 above.

We do however see a difference in terms of investment strategy and positioning because those covered by point 8 have already placed their bet and sunk capital in the market. Those in this category have not yet committed themselves in the market and should read the investment section below.

The consequences in the UK affecting UK passport holders considering the purchase of property in France or Italy.

We expect these people will be subject to some combination of the effects described in points 7 and 9.

In straight political terms this group will have potential political exposure arising from three specific dimensions.

Firstly, an English government strapped for cash will seek all revenue it can amass and especially from groups who will not lead to collateral political damage for the government. I remember, as a schoolboy on virtually no pocket money but owning a ramshackle 40-year-old and leaking 12’ sailing dinghy, suffering when the chancellor Denis Healy decided to “squeeze the rich until the pips squeak” and I could no longer afford to replace a broken shackle after the tax hike on luxury boats owned by the rich. Owners of second homes in Europe beware, you may not get much sympathy from a hard Brexit government.

Secondly, should the economic and social results of Brexit not live up to the hopes of and promises made to those who voted for Brexit, it is conceivable that any tax increase that might be applied would be viewed as “politically just” and thus not limited by rationality or reason.

Thirdly, the status of UK passport holders in Europe may not become clear for some time so there is an implicit risk deriving from this uncertainty.

The property investment implications of Brexit.

Unsurprisingly a great many of the discussions we’ve had with clients over the last few months can be rendered down to their concern as to their sunk or proposed property investment.

Clearly, as we are unable to give a point forecast as to the consequences of Brexit, we can give no forecast as to its effect on the French and Italian property market. However, that does not mean that it is impossible to derive a shrewd trading strategy for the property market.

We know with 100% certainty that Brexit will cause some degree of market instability and that, following the Soros concept of “reflexivity”, the instability will swing either side of true value to far from equilibrium positions.

This is how we assess the investment implications of Brexit on the basis of what we know today.

1. We expect a differential effect across France and Italy depending on location and the profile of purchasers in the location.For desirable locations where there is a strong market composed of national and international buyers we expect there to be no effect. There may even be an inverse effect in locations such as Paris 16e driven by the transfer of high income finance sector jobs out of London.In the lower cost rural areas, often the destination of choice for the English, we expect to see prices hit quite hard and for liquidity to fall even further.The fall in price and liquidity will be driven by three factors:
   1. The cumulative effect of the fall in GBP against the EUR plus the experience of maximum exchange rate swings will lead many people, especially the retired or those on a UK income, to consider the EUR to be beyond their reach. At the limit, a buyer in 2000 who planned their finances at the then rate of GBP 1 to EUR 1.67 has seen the rate move as low as GBP 1 to EUR 1.04 over the period. If they believe the risk to be on the downside, as many of our clients do, the logic is to bail out now and take the loss before it gets any bigger.
   2. In many of these areas the national population has become skewed to the elderly and those on benefits because those with good employment prospects continue to move into the towns in areas where jobs are available. There thus remains virtually no local market of potential buyers with purchasing power able to raise a mortgage.
   3. The market in these areas has historically tended to be driven by incoming UK nationals seeking cheap rural housing to renovate. These people are no longer arriving in any number and so liquidity has virtually disappeared in many areas.
2. From our client base, we can see that many property owners are under pressure to sell, either financially or psychologically, and this is having a significant and negative impact on price and liquidity in some areas because it compounds aggregate existing weakness.
3. From George Soros’s work, we can see the principle of reflexivity at work in the property market. The pressure to exit is in the process of driving the market price below the long-term market price to a point far from equilibrium. It is not possible to predict when market sentiment may turn, but it is likely to be years rather than months.
4. If prices are being driven to a far from equilibrium position below the long-term trend then a buying opportunity develops. Forced sellers have no choice if there is only one buyer.
5. Buying at a far from equilibrium price below the long-term trend is generally good business.
6. As Soros showed with the Quantum Fund, intelligent use of leverage, in this case mortgage funds, can amplify gains.
7. Using mortgage funds permits the currency mark to market point to be deferred until a better exchange rate can be obtained whilst allowing for the benefit of pound / cost averaging.
8. If you are a more sophisticated investor who already owns a French or Italian property it is possible to use mortgage funds to short the FX and property market. You achieve this in 4 steps:
   1. Release the maximum equity from the French or Italian property.
   2. Convert the EUR released into GBP to take the exchange rate gain.
   3. Drip feed GBP back into EUR via the mortgage benefiting from pound cost averaging.
   4. Benefit from a long-term capital gain by holding the property until the market has recovered to trend or oscillated back above trend.

Conclusions On Brexit

The key determinant on Brexit will be medium term (5-10 years) economic performance. We’re being offered everything from Nirvana and the Slithey Gove uplands to Dante’s Ninth Circle of Hell. In every country, including the UK, the left behinds, unsatisfied and unappeased, risk driving a populism that will be more destructive than constructive.

The second determinant may well be your country. Brexit may end up being very different in England, Scotland and Northern Ireland.

Finally remember that all markets pass through cycles, periods of comparable stability and periods of great instability. In the former the best response is often trend following, whilst in the latter the profits are usually made by the contrarians. If in doubt look at how Norman Lamont, the free market conservative chancellor, lost his shirt (and much more) betting against George Soros. There will be money to be made!