The surprise decision by the British electorate on June 23 to vote to leave the European Union (EU) is a potentially game-changing development for both the United Kingdom (UK) and Europe, writes columnist Nicholas Spiro in a commentary for PropertyEU.
I say potentially because, if one thing is patently clear amid the political upheaval, volatile financial markets and deep uncertainty about the timing and consequences of a British exit from the EU (or 'Brexit'), nobody knows what is in store for the UK in the coming weeks and months.
To paraphrase former US Defence Secretary Donald Rumsfeld, there is enough confusion about the 'known knowns' of a Brexit, never mind the 'known unknowns' and the 'unknown unknowns'.
For Europe’s commercial real estate market, the post-referendum investment landscape has suddenly become a lot more perilous and uncertain. Britain’s decision to leave the EU will have a major bearing on investment strategies and will throw the vulnerabilities and opportunities in the market into sharp relief.
Investors and developers must now contend with a number of risks that have been amplified by the result of the referendum.
Political risks
The first, and the most difficult to quantify, is the growing importance of politics in assessing and pricing assets. The markets got Brexit wrong - and dramatically wrong at that. What other political risks that threaten Europe’s commercial real estate sector are being poorly gauged or underpriced? Are investors paying enough attention to US political risk in the run-up to November’s presidential election? What is clear is that politics now has a much stronger bearing on investor sentiment - and at a time when confidence in central banks’ ability to stabilise financial markets has waned.
The second risk is the threat to the status of the UK - and particularly that of London - as a 'safe haven'. Although the assessments of credit rating agencies should be treated with caution, Standard & Poor’s, which stripped the UK of its last triple-A rating on June 27, is right to view Britons’ decision to leave the EU as a 'seminal event' that endangers the country’s institutional framework and policy regime.
Still, while many development and construction projects will be put on hold and transaction volumes - which in central London already fell nearly 45% year-on-year in the first-half of this year, according to Cushman & Wakefield - will decline further, London’s haven appeal will prove resilient to a Brexit-voting UK. Indeed the sharp fall in sterling and growing caution among investors could create buying opportunities. Uncertainty - as opposed to irreparable damage - is the watchword for London’s commercial property market.
Collatoral damage
The third risk is the collateral damage in the rest of the EU, particularly in Italy where the country’s creaking banking sector, with its dangerously high share of non-performing loans (NPLs) and notoriously weak profitability, is now the most likely conduit for contagion. The fallout from a sharper Brexit-induced deterioration in financial market conditions could be significant, turning what is now a UK-centric vulnerability into a broader eurozone-wide one.
The fourth risk is the worrying disconnect between overpriced assets and weak fundamentals in a number of European commercial real estate markets, leaving developers and investors little room for error if the spillover effects from the Brexit vote prove a lot more damaging in the coming months. As BNP Paribas Real Estate notes, net yields for prime offices in Europe’s major capitals and cities have already plumbed historic lows. Madrid is now more or less on a par with Frankfurt and Brussels in the face of persistent political uncertainty after last month’s inconclusive parliamentary election and, in the words of the IMF, “deep structural problems” in Spain.
To say that the Brexit vote raises the stakes for Europe’s property investment market would be an understatement.
Yet it is not all doom and gloom.
The eurozone could end up benefiting from Britons’ decision to leave the EU if the financial and economic fallout weakens support for populist and eurosceptic parties across the bloc.
More importantly, a legally non-binding referendum is one thing. The UK parliament’s decision to invoke Article 50 - the so-called EU “exit clause” that can only be triggered by the member state seeking to withdraw from the bloc - is quite another.
It is still not clear if and when a Brexit will occur. Indeed even if the next UK government decides to leave the EU, it is unlikely to go as far as pulling Britain out of the European Single Market.
Europe’s commercial property investors face three possible outcomes: no Brexit, a 'soft' Brexit and a 'hard' Brexit. The second one is the most likely scenario.
Nicholas Spiro is a partner at Lauressa Advisory
