ULI Brexit Capital Markets Forum 2016 

Brexit Roundtable

Investment allocation:

In light of recent events, international investors have become increasingly demanding when allocating investment capital.  Whilst investment yields have been tightening, there has been a renewed emphasis on investment geographies across the globe.  The political and financial uncertainty resulting from Brexit has become a major influential factor when determining how to allocate investment capital.

Within the current environment, investors have become extremely cautious, as many are inclined to hold off and take a “wait and see” approach as to where to allocate their funds, until more sensible and safe opportunities arise. Value investing has a certain margin of safety, but it is increasingly challenging to both measure and determine what that margin should be today.

Now that the risk of a UK exit from the EU has become a reality, a lot of thought has been given as to what Brexit actually means and what impact it will ultimately have.  Many investment professionals now believe the markets are heading into a recession which will inevitably have a negative impact on growth in the United Kingdom with a corresponding knock-on effect on Continental Europe.  “We have essentially voted ourselves into a recession”.  However, there is a perception that “buying through recession” has historically achieved above average returns.

Public’s perception:

The public’s perception of the current situation has also had a major effect on investment decisions across the United Kingdom.  Over the past twelve months, markets have been extremely fragile with this trend set to continue going forward.  Institutional investors seeking long-term investment strategies are targeting long-dated, credit-oriented assets offering stability and an attractive yield on a risk adjusted basis.  Risk protection and long-income security have become high priorities.

In particular, the residential market in London has been negatively affected by recent events, not least the imposition of up to 15% SDLT on purchases over £1.5m.  However, the shift in pricing “cannot only be pinned down to Brexit”.  According to many, “the Market was cooling off anyway.  Brexit was only a major psychological event that accelerated the process.”  Several examples including a large amount of residential speculation, excess supply and overpricing as well as political uncertainty have led to a shift thereof.  Clearly, political events such as the Russian/Ukraine conflict, Brexit, immigration, terrorism and recent events in Turkey have led to a huge amount of uncertainty.

Limitations of who one can trade with due to embargos, e.g. with Russia and Ukraine, are putting constraints on trophy assets, especially as London is an expat market.  Additionally, there has been significant excess supply in London, with more high-end residential being built than can be absorbed today.   “Too many units are being built at the wrong price points”. 

Foreign capital:

In 2015, Europe and especially the United Kingdom experienced a strong demand from institutional investors around the globe. The United Kingdom was a magnet for overseas capital and was a safe haven for investors from Asia, Russia and the Middle East.  In 2016, the UK remains a global marketplace for investment, yet there has been a noticeable change in sentiment.

Since the referendum, several large transactions have taken place, even though yields have widened.  Sellers are making a trade-off between tighter yields and transactions certainty.  Investors as well as sellers are taking into account the speed and certainty of the processes and are accepting slightly lower pricing levels.

Pricing shift:

Regardless of the changing environment, institutional investors have always seen major markets such as London and Paris as core and will continue to do so.  Nonetheless, the pressure on these major markets, in particular London, will lead to the regions and B-Cities enjoying more interest over the coming months.  Already last year, the regions have attracted global capital and with government programs that are aiming to decentralize departments, it can be expected that there will be an increase in occupancy and rental growth. Additionally, excessive pricing in London and the shortage of supply outside of London is making institutions follow the capital shortage and chase higher yields.  With significant declines in bond yields, real estate’s risk premia has improved disregarding any movements in real estate pricing.

The sweeping reductions of values are having implications on the debt landscape too. The credit markets have shifted dramatically and covenant packages are tightening.  In particular, developments sites are negatively impacted by the recent events.  “Development financing has tightened considerably which will further contract supply”.  The upside is that this is in return will lead to a reduction of excess supply which may finally lead to a correction in the market.

Return to stability:

“I am not worried about the debt and equity capital in the United Kingdom. Pricing is slightly making more sense now”.  The impact of Brexit is still to be determined and has left a lot of uncertainty, including the impact on passporting and immigration, in particular.  The market is subject to change and with the recent events it is expected that speculative developments will slow down, at least in the short term.  This in turn will lead to an adjustment in pricing which should make investments more feasible for investors.  Disregarding that, London has always been seen as a safe haven and with the pound devaluation should stay attractive for overseas investors.  “In the long-term, the UK and the USA are anchor markets and will always get a majority of the capital.” 

On a positive note, several opportunities have arisen as a result of recent events.  With land prices being the first to decrease in value, it offers the opportunity on the development side.  “The continent is hot” and with recent events, investors have a strong alternative in investing into European countries.  However, in an era of more economic and political risk and with 50% of the European GDP being located in only two countries (France and Germany) that are having elections next year, it is deemed necessary to “see Brexit as a wake-up call”.  That being said, uncertainty clearly breeds opportunity for those nimble enough to assess the shifting political landscape to execute sound and opportunistic investment decisions.

Words by Jesse Trost

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