U.K. Property Firms’ Stocks Survive Brexit Fallout

7th September 2016

Some London office, residential property owners still struggling, as shakeout continues

Shares in most listed U.K. property companies have recovered much of the ground they lost after Britain’s vote in late June to leave the European Union pounded the real-estate sector.

But a few laggards remain particularly among companies that own London office and residential property. Investors are now poring over sales and leasing transactions that have taken place in the city since the Brexit vote to figure out whether it will have the impact on values that the stock market is predicting.

Derwent London PLC, a real-estate investment trust with a portfolio of central London office buildings is down 20% since the June 23 referendum at 2,758 pence ($37) on Tuesday. Shares of Capital & Counties Properties PLC, a property company with exposure to London residential and retail and leisure markets, are down 18% at £2.972 ($4) since the referendum.

Immediately after Brexit, U.K. property companies saw shares fall as much as 40%, leaving it one of the hardest-hit sectors after the vote. But most have rebounded strongly.

For example, shares of Land Securities PLC, the U.K.’s largest commercial real-estate company, fell 16% the day after the referendum, and are down 8.7% since the vote. Shares of British Land PLC, which owns commercial real estate throughout the U.K., were off 13% Tuesday from what they were on the day of the vote.

Post-Brexit investor concern is focused on London largely because many expect the city to become a less attractive place for businesses to locate when the U.K. is no longer part of the European Union. Companies might move employees to other European capitals such as Paris, Frankfurt or Dublin if they face limitations on selling services from London, the thinking goes.

Financial-services companies, which analysts say are most at risk from a change to the rules, take up 20% of central-London office space, according to Barclays real-estate analyst  David Prescott. If they relocate operations elsewhere demand for London office space and residences would likely decline.

Central London offices lost 4.1% in value during July, according to property broker CBRE. Offices in the City of London fell the most—by 6.1%.

The fall in residential values is reflected in the value of Capital & Counties’ investment in Earls Court, a planned development with 7,500 homes. Its market value slipped 14.3% in the first half of 2016 due “to the weakened sentiment in the central London residential market following the EU referendum,” the company said.

On the surface, Derwent appears to have limited vulnerability to Brexit’s impact. The company has little exposure to financial services and multinational corporations, said Mr. Prescott from Barclays.

Only 2.3% of Derwent’s June rental income came from tenants in the financial sector, said Chief Executive John Burns in an interview. And just 2% of Derwent’s commercial space was empty at the end of June, the company said.

However, analysts and investors find other sources of concern. For example, Derwent currently has four major office developments under way. The value of some of these may decline if the office leasing market softens and costs start to rise.

The risk is Derwent “might have to back out development profits already booked,” said Jefferies’ real-estate analyst Mike Prew.

These developments include one in London’s Fitzrovia neighborhood and the Brunel Building in Paddington. Both projects are due to be delivered in 2019. Valuers have already cut the combined value of the two projects by 2.5% to £264 million. The company said “the valuers increased development margins.”

The value of some other Derwent projects has increased. But Mr. Burns warned in the company’s half-year earnings statement last month that the rising political and economic uncertainty will weaken demand. Mr. Burns said he now sees Derwent’s rents growing between 1% and 5% in 2016. Earlier the company projected that rents would rise 5% to 8% this year.

Even before Brexit, analysts were warning that real-estate values in London were due to fall. High-end residential real-estate values hit peak levels in the summer of 2014.

REITs in the U.K. booked either a loss or a much smaller gain on the revaluation of their properties in the first half of the year, which drove down their pretax profits or even made them swing to a pretax loss.

Analysts and real-estate brokers say the slowdown was largely the result of the real-estate cycle maturing after more than five years of steady gains.  Values have been looking stretched, said Mr. Prew. “We think the real-estate market needed Brexit to happen,” he said.

“Capital value growth was always expected to falter at some point during 2016...The Brexit vote has now crystallized that expectation, though it is not the only driver of it,” CBRE said in its July monthly index.

The good news in the office market is that tenants are still signing leases at respectable rent levels. Three weeks after the vote, British Land said it had rented out the remaining three floors of its Leadenhall Building, a skyscraper in the City of London also known as the Cheesegrater.

A month later, Land Securities said it had let three floors of its 20 Eastbourne Terrace in Paddington, an 18-story office building.

“The volume of letting transactions is quite good because the lettings market is less driven by sentiment than the investment market,” said Mat Oakley, Savills’ head of European commercial research. The July takeup for west end London office space was “the highest July total on record.”

Kames Capital was one of the companies that took the 43rd floor in British Land’s Cheesegrater and they are paying £107 a square foot, Mr. Oakley said. However he added: “There are still questions about the market going forward. We don’t really expect a downside till next year.”

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