As the independence referendum approaches, the implications of independence for the property market and vice versa has not received any attention. The real estate sector is a major component of the Scottish economy, from new construction through to investment finance.

Perhaps more importantly, having the necessary modern offices, warehouses and industrial units is essential for a growing economy.  Mortgage finance, too, oils the housing market, and supports new house building and the need to refurbish the existing stock.

Current Position

The trend over the last thirty years has been for UK financial institutions to be consolidated in larger and larger entities. The Royal Bank of Scotland swallowing up NatWest, and Halifax and Bank of Scotland combining are examples of this trend. The number of Scottish building societies in 1970 was in double figures, now it is just one: The Scottish Building Society.

This has contributed to an integrated UK property capital market. Residential mortgage funding now primarily happens through national institutions, most of which are based in England.  The largest funder, Bank of Scotland, is now owned by Lloyds Bank.  Traditional Scottish funding institutions are disappearing. For example the Dunfermline, once the largest independent building society in Scotland, was bought over by the Nationwide BS in 2009.  The Scottish Building Society is the last remaining independent building society but with 30,000 members and six branches it is dwarfed by the 15m members of

the Nationwide Building Society.  Lending on commercial property is also provided almost entirely by national banks.

Currently Scotland represents approximately 6 per cent of commercial and industrial property investment by UK financial institutions, although such investment is currently dominated by the South East of England.  Scotland clearly represents a small percentage of the national institutional property portfolio. Even so, most prime real estate, whether it be in the central business districts of Scottish cities, shopping centres, etc., are owned by London based investors.  Virtually of the recent large developments in Scotland are undertaken by property companies based in London and the South East.

There is a school of thought that, as a result of the concentration of decision makers in London and the south east that areas outside are underfunded and this acts as a constraint on property development and economic activity.  Of the large financial institutions only Standard Life is independently owned and based in Scotland.  Scottish Widows, while based in Edinburgh, is owned by Lloyds Bank.   However, the investment strategies of these institutions are global, so a Scottish location is unlikely to bias decision-making that aims for diversification as well as returns. Terrace Hill, probably the largest Scottish property company, is based in Glasgow but has virtually all of its development activity south of the border.

Independence

Investment and property development are dependent on expected occupier demand.  Demand for commercial and industrial property can be seen as a derived demand from economic activity.  This means that levels of investment/development in these sectors will at least partly but not completely be dependent on how the Scottish economy responds to independence.

Investment by financial institutions could potentially increase, as they match their investments to the location of their liabilities.  As a potential target for foreign investment Scotland will have the attraction of not being that different from England. There are some differences in the law relating to property transactions, leases etc between Scotland and the rest of the UK, but the move toward short commercial leases is reducing these distinctions? Planning policies have a common thread although residential development planning has been dismantled in England by the “localism” agenda.  Both sides of the border seek to minimise out of town development.  There could be differences in property taxation, sooner rather than later.

Arguably to be truly independent with its own distinctive fiscal policies Scotland needs to promote its own identity and stimulate economic growth; it needs to break away from the shackles of monetary union with the rest of the UK.  It may not have any choice, there is no certainty that the rest of the UK will agree to the continuation of currency union.  Unfortunately, this brings another set of issues linked to currency risk.  At its most basic, virtually all house buyers with a mortgage from a UK institution would potentially face monthly variations in payments (and extra conversion costs) as the Scottish pound (or Euro) varied with sterling.  This will potentially affect all borrowers including credit card balances and pensioners from UK companies.

Commercial property investors will take account of the uncertainty created by currency risk through adding an additional risk premium to their required returns which will deflate property values.  A key issue is the volatility of oil prices and the apparently inevitable equivalent consequences for the currency (Norway has a fund accumulated over decades to address this problem). This might only be a marginal effect but it is likely to have some deterrence effect to new development by reducing viability, although it could be counterbalanced if the Scottish economy was very successful.

Scotland will be only a small country with few of its own institutions to support its real estate needs.  New institutions will eventually emerge but scale will inevitably be a concern especially in supporting and covering the risks associated with major commercial developments. In this regard it is interesting to note that a string of high profile Scottish property companies like Kenmore, Kilmartin, Retail Property Holdings Ltd (RPH) and Elphinstone were victims of the credit crunch and all funded primarily by the Bank of Scotland.  Collectively they cost probably the bank over a billion pounds.

Conclusions

After centuries as one country, the UK real estate sector is highly integrated, in the sense that an independent Scottish sector is miniscule. An independent Scotland may struggle in the short term to come to terms with the pains of change.  However, with the industry currently controlled/ dominated by London-based decision makers, this has arguably been to the disadvantage of Scottish cities (and indeed other provincial cities).  In the long term it is possible to argue that independence could relax these investment constraints, especially if you believe Scotland will flourish. The alternative scenario sees Scotland’s relative decline making these constraints ever more severe.

An independent Scotland with its own currency will impose additional costs on home buyers with mortgages, and perhaps more importantly, uncertainty about future commitments over a twenty five year mortgage.  This uncertainty will also feed through to commercial investment and development, having some impact on values although these could be assuaged if the economy lifts off.

Overall there is increased uncertainty with all the benefits entirely dependent on the need for growth in the Scottish economy relative to the UK.  However, it seems likely that the institutional structures in the real estate sector could hinder such a scenario in the short term.  Whatever the constraints of the present system, Scotland will be almost entirely dependent on foreign investors and capital for its commercial property infrastructure for the foreseeable future.  With most of these investors based in the UK, the degree of the independence will be questionable.