BREXIT Comment

Following the Brexit referendum, we are facing a 2-3 year period of political and economic turmoil, which could have major implications for the UK real estate market.

Falling house prices?

Nobody can say for sure what will happen, other than that uncertainty and risk have spiked. This is already affecting the capital market and the occupier market, the two drivers of real estate values. Given the increased risk in both markets, property values will fall. This will not be apparent immediately in the less liquid and less transparent private markets, but the value of houses has undoubtedly fallen.

However, the share prices of the most liquid and transparent property vehicles - listed Real Estate Investment Trusts (REITs) and house builders - are already well down. They could bounce back, and prices are volatile, but these companies are trading at large (sometimes 30%+) discounts to their reported net asset value (historic property values plus cash less debt). So the markets believe that property values have fallen. If property companies can sell assets at reported book value, or small discounts, they should do so, as this would be good for shareholders (if all assets were realised as cash close to Net Asset Value (NAV), then the discount to NAV would disappear). So we may see selling at discounts, which will provide the valuation evidence the market needs to fall.

Worried funds and cancelled deals

Next to tumble are the values of units in open ended property funds. On the Monday following the vote, investment manager TH Real Estate cut the price of its own fund by 5%, meaning it believes that Brexit has knocked the average value of UK commercial real estate by 5%. This is already being used as evidence for re-pricing deals. In addition, funds may have to sell at discounted prices to fund redemptions. This means that our banks, which have large real estate loan books, are less solvent. It is no surprise that the share prices of RBS, Barclays and Lloyds have tumbled. Some post-vote deals have already gone through at 5-10% price reductions while many more deals, which were conditional on an EU Remain vote, have been cancelled.

London hard hit, UK provinces could be even harder

London-focussed property companies have been particularly hard hit as investors appear to believe that Brexit means that London will be less popular as a haven for capital. But less well diversified cities may be hit harder – if any multinationals pull out of regional cities that will have a major impact on employment and property prices. Office lettings under negotiation in the provincial market have been summarily terminated this week and office vacancy will increase as new developments complete without tenants prepared to sign long leases at high rents in uncertain conditions. This will simply be indicative of the economic slowdown already underway.

And the good news?

Like all commodities, real estate prices are driven by supply and demand. Demand will fall, but the good news for investors (albeit bad for builders) is that supply will fall too. There will be a likely slowdown in development as some large schemes will get deferred or switched off. With generally low vacancy rates, rental values may be protected.

The cheaper pound is good news for some, too. Exports will be cheaper for foreign buyers, so some companies and industries will be positively affected, supporting industrial and warehouse rents. And of course property prices for foreign investors are now lower, so the UK may remain attractive as it becomes cheap compared to other European markets such as Germany. There is also positive news for student accommodation, as UK university fees for overseas students have fallen, as have rents, with the vast majority of foreign students coming from outside the EU. Edinburgh and possibly Dublin are likely to attract more capital as they are potential beneficiaries of a UK breakup.

The grey areas

We may see lower interest rates. While this may be popular with some, it is not enough to counteract the likely increase in risk premiums and uncertainty over exit prices.  In addition, the UK’s weakened UK credit rating may wipe out the gains of reduced base rates.

Real estate in Continental Europe may now be more attractive than in the UK, but increased fears of a Euro break up (reflected in a fall in the Euro/dollar exchange rate) may give investors reason to pause.

Markets usually over-react, so we may see a rally in REIT share prices, which will reduce the downward pressure on property values. Some investors clearly see Brexit as a buying opportunity. That is, of course, not much comfort to those property owners who are about to see a good percentage knocked off the value of their balance sheets.