(Bloomberg) — London’s real estate market is gearing up for a pivotal 2023, following years of turbulence which slowed the torrent of foreign money that once flowed to the capital.

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Cross-border investment flows to properties in London totaled £12.4 billion ($15 billion) in 2022, according to data compiled by MSCI Inc. That’s a big drop-off from the £30.5 billion of foreign dealmaking in 2015, which preceded the twin blows of Brexit and the Covid-19 pandemic.

London, which has long attracted huge swathes of foreign investment and drew in the most capital inflows of any global city in the first half of the year, faces uncertainty over property valuations as interest rates rise and in the wake of political chaos triggered by September’s mini-budget. Foreign dealmakers accounted for 57% of London real estate investment in 2022, compared with 65% in 2015, MSCI data show.

“Market liquidity is currently severely affected by a wide spread between buyer and seller pricing caused by uncertainty of how the rise in interest rates will crunch property values,” said Sue Munden, a senior analyst at Bloomberg Intelligence. “Transaction volumes may be weak until inflation has been controlled and interest rates settle.”

Britain’s 2016 Brexit vote briefly diverted a chunk of investment to Paris, before attention switched back to London in 2021. That mini-boom was quickly derailed by Russia’s invasion of Ukraine earlier this year, according to Munden. Still, London’s appeal as a destination for global investors and a weaker pound should keep overseas investment afloat in 2023, she said.

“While this plays out, the percentage of international buyers may stay above the 50% mark, especially given the weak pound,” Munden said. “The long-term confidence in London as a global city continues to make it a preferred investment market internationally.”

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China Retreats

China’s once firm grip on the London property market is loosening more than most nations as tight capital controls and a cooling of relations with the UK stemmed the flow of money coming from the Asian nation.

China accounted for less than 1.5% of all cross-border investment in London properties in 2022, or about £185 million, MSCI data show. That’s a stark drop from the nation’s 11% share in 2013 that totaled around £2.2 billion when Chinese investors were pouring cash into the capital city as then-Prime Minister David Cameron and then-Mayor Boris Johnson courted their investment.

Changing sentiment toward China may also be deterring investment. The Chinese government’s plan to build a new embassy near the Tower of London was rejected this month. Tower Hamlets Council unanimously refused to grant planning permission, citing concerns about residents’ safety, including that the area will become a target for terrorists and a hotspot for surveillance.

In a sign showing how negative relations have become, UK Prime Minister Rishi Sunak used his first major foreign policy speech this year to warn that the so-called “golden-era” of UK-China relations was over.

While Sunak backed away from prior government plans to label the country a “threat” to Britain, the tone is in stark contrast to the approach of Cameron’s government, whose efforts to boost relations between the countries included a UK visit in 2015 where Chinese President Xi Jinping joined him for a pint of beer.

Still, Chinese policies at home have had the greatest impact. It’s no coincidence that dealmaking dropped dramatically after Xi introduced tighter capital controls in 2016.

“The drop in investment is almost entirely driven by capital controls in China,” said Rasheed Hassan, head of global cross-border investment at broker Savills Plc. “That’s absolutely the dominating reason for the change in volumes.”

Dollar Rules

In 2022, more than a quarter of the £12.4 billion of cross-border real estate flows to London came from US investors, who capitalized on a strong dollar.

American buyers made up 14.5% of all overseas prime London residential property purchases in the first half of 2022, according to data compiled by Knight Frank. That’s up from 6.2% in the previous six months and the greatest proportion in data going back to the start of 2018.

London real estate broker Charles McDowell said five of the six properties he sold between July and November were to American buyers, with prices ranging from £25 million to almost £50 million.

“This year we have seen the emergence of a market dominated to a large extent by dollar-denominated buyers, as well more Middle East and Far East buyers, particularly in Hong Kong,” McDowell said. “We expect this to continue into 2023.”

–With assistance from Jack Sidders and Sue Munden.

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