Bracing for Brexit
- Sep 23, 2016
By Steven Bandolik & Kenny Smith
In this new post-Brexit era, questions abound for the world’s financial institutions. Yet at least one thing is certain. U.S. commercial real estate firms that operate globally, with meaningful presences in the United Kingdom and Europe, face heightened challenges in conducting crossborder business. And the situation could become still more complicated if Brexit triggers a domino effect that prompts other European Union member nations to go their own way.
Though this uncertainty should not preclude U.S. CRE firms from investing overseas, let’s evaluate some of the important implications of Brexit that investors should keep in mind.
Implications for U.S. CRE Investors
Any U.S.-based investor with exposure in the U.K. or continental Europe will be impacted at some level by Brexit in the coming months and years. The nature and degree of that impact will start to become clear only as the two-year separation under Article 50 of the Lisbon Treaty begins to unfold. In the meantime, investors should already be thinking about a variety of financial, regulatory, operational and strategic issues:
- Currency conversion risks. CRE investors with currency exposure to the U.K. will likely face volatility due to the weaker pound sterling and its impact on capital values and earnings. Lower asset values—resulting from perceived risks that will increase cap rates and decrease rental rates—can be very damaging for large institutional investors with exposure to the U.K. The result could be significant mark-to-market losses on their portfolios in the short to medium term. Moving forward, it will thus be paramount for investors to reassess short- and long-term currency hedging positions in the face of exchange rate fluctuations.
- Structuring strategy and tax regime shifts. A reassessment of legal entities and investment structures—and the tax regimes that govern them—will be necessary for U.S. CRE investors, especially once Brexit negotiations get underway. Many investors with U.K. subsidiaries may need to rethink corporate location strategy and evaluate their options. For example, corporates with offshore headquarters in Jersey, a mostly autonomous U.K. crown dependency and tax haven, will likely need to consider the possibility of relocating to other popular European headquarters sites, such as Luxembourg.
- Rule changes. U.S. CRE investors will need to navigate regulatory uncertainty, even though existing U.K. requirements will remain in effect until the U.K. and E.U. reach an agreement. Once that milestone is achieved, firms will need to maintain E.U. regulatory compliance while preparing for U.K. regulatory scrutiny. This, in turn, could lead to other issues, including cost increases stemming from compliance with differing country-level agreements and renegotiated leases and rates. Basel III could even pose challenges to investors as increased portfolio volatility makes it harder to secure bank loans or refinance.
As the situation unfolds over the next few years, it will be intriguing to track the relative attractiveness of the U.K. to real estate investors. To learn more about how Brexit could affect CRE investment in the short to long term, check out our brief, “Brexit: What Now for U.S. Commercial Real Estate?”
Steven Bandolik is a director with Deloitte Services LP and a senior leader in Deloitte’s real estate services practice. A three-decade industry veteran, Bandolik provides advisory services in a wide range of areas, including capital markets, corporate finance, mergers and acquisitions, investments, restructuring and reorganization, workouts and asset recovery.
Kenny Smith is Deloitte’s Financial Services Industry leader, overseeing a team that works with 90 percent of the largest financial institutions across Deloitte’s audit, tax, consulting and advisory businesses. He has a 32-year track record in client service and practice management.
Originally appearing in our September 2016 issue of CPE.