Put the panic on hold: bricks and mortar can bounce more than investors think
8th August 2016
The commercial property market has had ups and downs over the past few years, but even those with the strongest constitutions must have wondered what on earth was happening on Friday June 24.
With stocks in freefall and the pound plunging to lows not seen in decades, commercial property investors watched as millions of pounds were wiped off their portfolios overnight after the vote to quit the EU.
In the days that followed, property-based retail funds pulled up the drawbridges, closing themselves to redemptions, as investors scrabbled to get their money out amid concerns about plummeting values.
But, gradually, things are appearing to stabilise. Many of the retail funds have been reopened. Some significant investment transactions have been signed off at prices that haven’t made agents wince.
So was the turmoil in the commercial property world simply a hiccup? Or is a much wider downward trend inevitable?
“Before the referendum, London was cited as the market that had the most to lose out on from an exit vote,” explains Zachary Gauge, European real-estate analyst at UBS, pointing to the impact of a potential change in passporting rights for financial institutions as something that could hit the City particularly hard.
“But, although it’s early days, we’ve almost seen the flipside to that as [the property market] has retained its attractiveness to international capital.”
International investors, who in the early days after the vote were spooked by the political and economic uncertainty in the UK, are now sniffing around UK assets hoping the fluctuation in currency prices could work to their advantage.
US bank Wells Fargo last month agreed a deal to buy new headquarters in the City, in what was one of the biggest deals for a single office building this year – and although the bank has not commented on whether a more favourable exchange rate swayed its decision, it has benefited from it.
“You get more bricks and mortar for your dollars so for overseas investors it looks like good value,” explains Charles Weeks, chief executive of real-estate investment adviser Cornerstone Europe. The pound was worth $1.49 immediately before the vote. Last week it was worth around $1.33, a drop of 10.7pc.
Gauge says opportunistic buyers are also hoping that a drop in confidence will lower the price investors are willing to sell at, meaning they will be able to grab a bargain: “There are lots of buyers hoping to come in and achieve some sort of discount,” he says, “although so far that’s been relatively limited.
“US private equity funds, for example, would look for much higher returns that we’ve seen yet, and it’s definitely not as bad as 2007 or 2008.”
Weeks estimates that values have dropped around 3-5pc, although adds that there are too few test cases to really prove anything. Once more buildings are sold, there will be a better sense of what the London property market is worth, he explains.
Rob Wilkinson, chief executive at AEW, says there have been a number of below-market-price transactions but not as many as expected, and some of that was driven by retail funds, such as Aberdeen Asset Management, needing to sell quickly to raise cash.
“There is an argument that if you want to trade in an extremely short period, you might have to take the discount you’re offered, regardless of the market,” he says.
Agents believe enthusiasm in the UK commercial property market had dipped long before June 24. Alastair Graham-Campbell, who heads the team at Knight Frank that buys and sells major property portfolios, said there were very few deals worth more than £20m in the run-up to the vote. He estimated sales of porfolios in the first half of the year were down 68pc.
But he remains optimistic, adding that he estimates 50 deals have been already completed since the vote.
“[The vote to leave] caught people out and that’s why it’s had a big effect, but real estate is still very attractive,” he says.
Despite the market wobbles, property still provides a good income for funds compared with bonds and equities. And with interest rates cut by the Bank of England this week, putting money into bricks and mortar seems more compelling than ever. “Interest rates are going to be lower for longer, certainly in the UK but probably in Europe as well, which will be positive for property,” Weeks says.
“The referendum result has effectively given us an extension to the investment cycle,” he explains. “Where investors were probably sensing that the UK market was fully valued, I think a lot of that has dissipated. Brexit accentuated that and means the market is potentially more interesting for longer.”
But the strong fundamentals of the market need protecting, explains Melanie Leech, chief executive of the British Property Federation, which represents the industry to the Government.
“Policymakers must think very carefully before introducing new taxes or measures that could deter investment in the sector, and must also consider how to proactively encourage its growth,” she warns.
She wants the Government to defer some tax changes from next April to April 2017, as well as consider a stamp duty “holiday” for commercial development.
“Local government has a role to play as well, and must be encouraged and incentivised to release public- sector land, and work with the private sector to ensure that the development pipeline, and its associated benefits, does not see a drop in activity,” she says.
The underlying concern, especially in the City of London, is that the demand for office space will weaken as financial institutions look to move staff to new bases in the EU.
“There’s a lot coming through in terms of supply in 2016 and 2017,” says Gauge, adding that that could cause excess office space to become available in London if companies stop expanding.
But he adds: “No schemes which are currently under construction are being stopped. Many of them have been pre-let so they have to finish.”
Gerald Kaye, who is chief executive of developer Helical, says he is confident that the buildings the company has under construction will attract occupiers.
“It’s not as if we’re going into a slowdown with any huge oversupply,” he points out. Vacancy rates across London offices are currently around 3pc – close to the all-time low.
But Kaye acknowledges that the longer-term outlook is perhaps less certain. “The problem won’t be oversupply, it will be underdemand,” he believes.
“It might be the last quarter of this year or the first quarter of next year before we see delays in decisions from occupiers,” says Wilkinson, adding that as there is more clarity on the exact terms of Britain’s exit from the bloc, firms will be a better position to make a decision about where staff need to be.
So has the property industry got problems? Yes and no. There is plenty to be thankful for, not least the swathe of foreign investors who find themselves drawn to the relative good value and safety of real-estate assets when the rest of the world – politically and economically – is looking a bit shaky.
But until the market picks up and valuations stabilise, there is still a lot to be uncertain about.
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