Financial markets have entered a period of volatility following the UK’s decision to leave the European Union. Political and economic uncertainty has led not only to a rapid fall in sterling, but also a mixed response to valuations across asset classes. We focus in this client update on the current status of the real estate market in Europe, our medium to long term view for this asset class and a suggested approach for those risk-on investors who wish to take advantage of current market conditions.
GCC investors are very familiar with the real estate sector in the UK, many of them with substantial holdings of commercial property in the range GBP20 million to GBP50 million. Investors in such assets are likely to focus on the risk of adjustment to net initial yields if office space becomes available in the event that large multinational companies occupying such buildings seek to relocate staff and core functions. In the short time since the result of the UK referendum was announced, there has been little anecdotal evidence so far of such a trend or of any formal announcements in this regard.
There has also been speculation that the base rate could be cut with a consequent downward effect on the value of sterling, potentially favouring those UK companies selling goods and services overseas. A further potential consequence may be that investor funds would migrate away from bank deposits into income producing assets such as real estate.
However in recent days several fund managers have either suspended redemptions for investors in illiquid UK commercial property funds or marked down net asset values by as much as 15%. Whilst on the surface this may appear only to impact property funds, many investment companies also operate separate investment products that allocate a proportion of their investment in UK property funds. As a result such multi-asset products may also become subject to “gates” imposed on investors withdrawing cash. It is worth noting the relatively high proportion of retail investors in these funds in the UK and hence the tendency to seek to redeem at early signs of volatility.
The number of counter-balancing economic variables and post-Brexit political uncertainty have combined to create a significant level of uncertainty in the financial markets. There is a fear that Brexit may mean large financial institutions will consider moving jobs out of London and consequently affect the London residential property market as well as the commercial office market. However most of the factors that have driven real estate over the past three years remain in place. The UK economy remains fundamentally robust, interest rates remain low and gilt prices high. We believe long term investors in UK commercial property would be best served by continuing to show tolerance to a period of weakness. European commercial property and property funds have yet to respond in a meaningful and material way to UK political uncertainty.
For those UK commercial property funds with a high proportion of retail investors looking to redeem at short notice, a forced sale of an asset creates a potential opportunity for the buyer in the short term. We are beginning to see such assets being offered into the market by large funds. Dollar-denominated buyers may realise even greater value in the strength of their currency, and thus potentially be presented with a “perfect storm” of opportunity for the risk-on buyer.
It is too early to assess the full impact of Brexit on UK and European commercial property prices. As we begin to see transaction activity in the months following the referendum result, we will develop a clearer picture of a fair market price for these assets. Certainly, we have seen in recent days strong support for bank financing of the commercial property market as we continue to receive offers of lending from local commercial banks, funds and European banks. Commercial terms currently being offered remain largely as they were in the months pre-referendum. Levels of asset gearing also remain well below levels seen during the 2007-2009 financial crisis.
Our Plan for 2016/2017
Rasmala has made three acquisitions valued at over GBP60 million in the 6 months leading up to the referendum. Each of these assets has strong fundamentals such as location, tenant profiles and length of the remaining lease. We believe our portfolio is sufficiently robust to withstand short term uncertainty and we continue to actively originate new UK and European opportunities. Our due diligence process continues to place emphasis on asset relet-ability, covenant strength and core business activities at the site. One of the primary aspects of our due diligence remains the corporate profile of the tenant and whether the UK (or European market in the case of European deals) is key to the tenant’s business. We also continue to assess what, if any, risks there are for the tenant scaling back its real estate requirements.
We remain confident in the fundamental strength of the UK economy underpinned by its legislative robustness. Although Brexit may put pressure on the retail sector, the light industrial sector (warehouses) will remain a strong defensive play given the move away from the high street towards the internet. There are significant pools of money waiting to be deployed in this area.
Stabilized markets in Western Europe – particularly Germany – also remain attractive. We continue to work on UK and European transactions in the second half of 2016 and are presently also in the final stages of completing a significant UAE transaction where we believe there to be some excellent opportunities for the diligent buyer.
We have no doubt that investment activity will regain pace and whilst it may not catch up with volumes recorded in 2014/2015, we are confident that the strength of the dollar versus sterling combined with a short-term widening of yields creates an attractive opportunity for the risk-on investor with a 3-5 year time horizon.
Co-Head, Investment Banking
Tel: + 44 20 7847 9919
Head of Real Estate
Tel: +971 4 424 2996