The Brexit Impact: What’s Ahead for CRE?
- Jul 06, 2016
New York and London—The United Kingdom’s stunning vote last month to leave the European Union shook financial markets around the world and raised questions about the prospects for commercial real estate investment. Though the Brexit vote’s impact will take time to unfold, industry veterans suggest a complex outlook marked by both significant opportunities and potential challenges.
“Initially, we saw credit spreads widen significantly, but they have since come back to almost pre-Brexit levels. We think that the response is mild currently, but the jury is still out,” David Rifkind, managing partner at George Smith Partners, told Commercial Property Executive.
In the immediate aftermath of the Brexit referendum, volatility characterized global stock markets, and REITs with strong links to Europe sustained significant declines in value. “The immediate stock market reaction was negative for the companies that have meaningful exposure to the EU,” Steven Marks, senior REIT analyst at Fitch Ratings, told CPE. However, values quickly recovered to pre-Brexit levels.
Risk vs. Opportunity
The turmoil over Brexit divided investors into two major categories: those who saw numerous reasons for concern and looked for a safer zone to deploy capital and those who saw opportunity in the U.K.’s uncertain status.
The first group includes investors that are new to the British market and did not account for potential risks created by Brexit, as well as longtime investors who need to place debt on existing assets.
“Doing that in the existing environment is going to be more difficult,” contended Andrew Angeli, head of U.K. research at CBRE Global Investors. “There will be fewer lenders in the market. We expect margins to drift out a bit.” Where property values slip, investors will have to borrow at lower levels, he noted. And for North American private equity value-add investors, it may be the perfect time to look into the U.K. market, he added.
Angeli says that the attitude of the investors who spot opportunity in the U.K. distinguishes the current climate from that of the financial market meltdown of 2007-2008. Broadly speaking, fundamentals remain sound, and since the factors that influence performance rarely change overnight, the U.K.’s real estate markets appear poised to withstand Brexit’s short-term shocks. “Vacancy rates are cyclically low level. That’s definitely true in the London office market; construction supply outside of London is actually quite limited. Rents are still growing on our monthly (and) quarterly indices. So from a fundamentals perspective we’re doing well, and we actually incurred the Brexit disruption at a favorable point,” Angeli said.
Discussions leading up to the Brexit vote produced a kind of gentlemen’s agreement that second-quarter valuations in the U.K. will not take the referendum into account. When third-quarter results roll around, however, investors will definitely be keeping an eye on the fluctuations of the equity and REIT markets.
“The U.K. has a very large REIT market, and pricing has been volatile there,” Angeli said. “The big names—Land Securities, British Land, Hammerson—are trading at discounts well below their long-run trend. That would suggest that capital value declines are probably going to happen in the direct space in the coming six to nine months.” Reports indicate net outflows of retail and institutional funds in the U.K., which translates into a decline in capital value.
Also of note, Brexit’s impact on Eurozone members is likely to vary widely. Ireland, the Netherlands and Belgium could be particularly vulnerable; Germany, widely regarded as the EU’s economic anchor, will be far less affected, given the size of its economy and the scale of its ties to global giants like China and North America. The same can be said of Spain, which enjoys close links to Latin America, and the Nordic countries. So while a broad recession in the Eurozone seems relatively unlikely, the stability of the market now depends on other EU members.
“If Brexit turns out to be a one-time event and the EU is able to move past it and continue to have a parallel relationship with the United Kingdom as an independent entity, then I don’t think there’s really going to be a long-term negative,” Rifkind said. “The long-term negative would be if this was the start of a trend. If we start to see the EU as an economic cooperative or economic bloc begin to unravel and we see a lot more dislocation in those markets. That would affect the U.S. negatively.”
U.S. Magnet Markets
Potential market shifts in the U.K., and possible mid-term instability in the EU, may push foreign investors to look for an environment that appears to offer more stability. “I think the U.S. has always been attractive, especially with European investors looking at negative interest rates,” said Ken McCarthy, principal economist & applied research lead with Cushman & Wakefield Inc. “I would say yes, the current uncertainty will likely lead investors to look to a more stable and more certain environment, and that would be the United States.”
In the U.S., interest will focus on gateway cities such as New York, Washington, Boston, San Francisco, Chicago and Los Angeles. “The major metropolitan areas are likely to be the ones the investors will look to as the best opportunities in an uncertain environment. What this will do is it will push up pricing in some markets and push down yields, but overall, we think investors will accept somewhat lower returns as payment for the safety of these markets,” McCarthy told CPE.
The Brexit vote happened in a time of general market caution, and while it’s too early to make a final call, the effects this year will likely be less than far reaching. “We’ll probably see lower investment volumes globally,” Angeli said. Last year was historically strong, he noted, “and Brexit, in conjunction with a lot of other events like the U.S. presidential election, may cause investors to take stock and deploy less (capital) than they have in the last couple of years.”
All things considered, the chances of an immediate, drastic change in the European strategies of U.S.-based real estate investors seems remote. While most investors will initially react by pausing to observe how the process unfolds, many will keep their eyes open for potential opportunities. So far, the prospect of another Great Recession seems unlikely, but that may depend on how EU countries respond. The way business will be done in and with the U.K. will also depend on the changes in regulations negotiated with the EU, once the U.K. gets its exit procedure in motion.