ANALYSIS: rating cut won't dent ‘wall of capital’ for UK property

Moody’s downgrade of the UK last month is unlikely to dent the ‘wall of capital’ available for UK property, Graham Barnes, a senior director in CBRE’s corporate and development finance team in London, has told PropertyEU.

By Sara Seddon Kilbinger

Moody’s downgrade of the UK last month is unlikely to dent the ‘wall of capital’ available for UK property, Graham Barnes, a senior director in CBRE’s corporate and development finance team in London, has told PropertyEU.

‘I don’t think that the effect will be dramatic because of the wall of capital out there,’ he said. ‘The potential downgrade had been telegraphed for a while, although it did come earlier than expected. The deal cycle is too long to know precisely what the effect will be but if you look at France, it hasn’t ceased to be on the investment radar since it was downgraded.’

NEGATIVE OUTLOOK
Credit rating agency Moody’s cut the UK’s ‘gold-plated’ AAA credit rating in February by one notch to Aa1. The ratings agency cited ‘sluggish economic growth over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy from the ongoing domestic public and private sector deleveraging process’ as the reason behind the downgrade.

According to Ross Walker, a senior UK economist at bank RBS in London, Moody’s downgrade was surprising ‘only in its timing’. ‘A downgrade had been expected to follow the Budget on 20 March as all three rating agencies had the UK on "negative outlook", he said.

However, one investor who is undeterred by the UK’s downgrade is global asset manager Aviva Investors, which improved its medium-term outlook for the UK last week. It is now forecasting an average annual return on property of 8% between 2013 and 2017, up from a five-year forecast of 6% in 2012.

‘The downgrade implies that investors could be more cautious about investing in the UK,’ said David Skinner, chief investment officer of real estate at Aviva in London. ‘However, given that there is no improvement in the medium-term outlook for the economy, our view is that property still looks like good value compared to other asset classes.’

SECONDARY ASSETS
Prime assets in the UK will perform well in most locations, according to Aviva, with investors likely to be increasingly attracted to higher-yielding sectors with the focus shifting from the prime assets in London to secondary and regional markets. As a result, sectors such as industrial and offices outside central London are expected to outperform on a risk-adjusted basis. ‘The time is right, therefore, for selective secondary strategies,’ Skinner added.

Nonetheless, the downgrade could push up the rate that the government has to pay to borrow which, in turn, could filter through to banks’ borrowing costs, putting a further dampener on the market, analysts say. For now, the market will have to wait and see whether this happens because, after all, downgrades can have surprising knock-on effects: for example, since the US lost its AAA credit rating, the cost of borrowing has actually fallen there by 50 bps.

‘In the long term, it should increase rates a bit - but the dominant factors for the pricing of real estate debt are underlying rates and supply and demand for debt. And there is lots of supply in the pipeline,’ said Barnes of CBRE.

Still, there are signs that currency markets are losing faith in the UK economy. The pound fell to a two-year low in late February as markets signalled frustration at the UK’s inability to pull out of the longest depression in 80 years. The pound has also fallen by 8% in recent weeks to $1.51, down from $1.63 in December. Forecasts for slow growth this year of just 0.2%, coupled with the UK’s bigger debt mountain, which smashed through the £1 tln barrier last year, is also adding to the gloom, economists say.

EUROZONE
As such, the UK’s plight marks a strong contrast to the eurozone, which has enjoyed relative stability in the past six months since ECB president Mario Draghi announced last summer that policy makers would do ‘whatever it takes’ to save the euro. Eurostat, which provides statistical data for the European Union, is predicting GDP growth of around 1% in the eurozone this year.

Moody’s has downgraded a number of countries and funds in recent months. In December, it downgraded two of the eurozone’s bailout funds, just days after it cut the credit rating for France. Moody's cut the European Stability Mechanism's (ESM) long-term debt rating by one notch from Aaa to Aa1 in December, maintaining a negative outlook for the bailout fund. Other countries, including Hungary, Poland and Italy were also downgraded by Moody’s last year.

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