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The UK EU membership referendum is now 1 year 9 months old and arguably, despite currency fluctuations and resultant higher inflation, the economic consequences remain muted. Brexiters have consistently pointed to the failure of 'project fear' - stark economic forecasts of the repercussions of a leave vote - to materialise. Well slowly but surely, it appears that this honeymoon period is coming to an end.

If anything is a bellwether of the UK economy, it is housing - hence industry concern around a growing media consensus that the London market, particularly the high end, is grinding to a halt. This is far from a national picture – regions of the North are still showing strong price growth – but it is a cautionary truth that where London leads, other regions generally follow.

London property has long been a safe-haven for foreign investment. The reasons are multiple, and not simply focused on strong capital growth trends. The UK has historically held a reputation for political stability, with a cross-party consensus to support (however indirectly) property prices via quantitative easing, low interest rates, stamp duty reform and schemes such as Help to Buy. Eurozone financial integration has also provided a free flow of investment funds.

Post the Brexit vote all of these market pillars are showing signs of strain. UK politics are chaotic; financially there is a risk that the Bank of England may become a follower, rather than a setter, of interest rates and there are clear signs that those disenfranchised by high house prices and rents, via successive Government housing policies, are becoming a target voting block. The UK Government has finally admitted to the loss of bank passporting rights post Brexit. This fact, and the upcoming EU Anti Tax Avoidance Directive, could further reduce flows of funds into the UK. In short, most of the factors that made London property attractive as a destination for off-shore investment have been damaged by the Brexit vote.

This has particular implications for the leasehold property sector. The voter block principally affected by rising house prices are also at the sharp end of unfair leasehold practices. The Government is aware of the negative sentiment associated with market abuse and has consequently targeted the leasehold sector for reform. New-build leasehold houses are banned, with legislation to be retrospective to the decision date. Ground rents on new-build leasehold flats are also to be reduced to zero. This leaves, however, significant numbers of existing leasehold properties. How will these be affected by the perfect parallel storms of Brexit and sector reforms?

The principal concern for both leaseholders and freeholders is freehold value and, if relevant, the potential costsof lease extension. It is important to differentiate between leasehold houses and flats. Freehold values for leasehold houses are determined by the Landlord and Tenant Act 1987 (as amended) whilst for flats, the relevant Act is the Leasehold Reform Housing & Urban Development Act 1993 (as amended). Of the two, it is the 1987 Act which is most likely to be heavily affected by reforms as the valuation methodology is complex, and determined by historical domestic rateable values (discontinued in 1990) which are often no longer available. Consequently, new investors are now likely to wait to see the shape of reforms before investing in either the freehold or leasehold components of these properties. This could provide a significant drag on the sector.

With regards to flats, there is a real risk that owners of existing leasehold properties may be disadvantaged. Given institutional investment in freehold assets the Government has, in our view, relatively little wriggle room in terms of legislative devaluation. For flats with leases of less than 80 years remaining, the critical determinant of lease-extension or freehold-share premiums is ‘relativity’ – the difference in value between the property with current lease and the value with freehold-share. Following dismissal of the Sloane Stanley Estate vs. Mundy appeal, the principal determinant of relativity when valuing freeholds or lease extensions should be comparable local sales of short vs. long-lease properties.

In a falling London market one could readily envisage a scenario where short-lease properties become much less attractive to informed external investors – hence requiring heavier relative discounting than long-lease equivalents. This in turn would push up premiums payable for lease-extension or freehold purchase in surrounding properties – a vicious cycle further reducing attractiveness of the asset class. Banks facing rising interest rates and financial uncertainty caused by Brexit may also be much less willing to loan against short-lease properties – further reducing their value. The Government, distracted by Brexit, hence faces a significant challenge in providing effective reforms.

The risks are not all on the leaseholder side of the equation, however. One could also see a scenario where a weakened Government attempts to court popularity through clumsy reforms, which hit the values of existing freehold assets.

Whilst confirmation of a transition arrangement for the departure of the UK from the EU may calm some nerves, it certainly seems like 2018/2019 is a period of high risk for the UK leasehold property sector – and a period in which many freeholders may see real benefits to divesting their assets.