Investors are watching the UK market closely and preparing for the worst as the chances of Britain crashing out of the EU without a deal increase.
Brexit, like beauty, is in the eye of the beholder. The prospect of the UK leaving the European Union next March is seen as an unmitigated disaster by some, as a great opportunity by others and as a non-event by many. For real estate investors, geography seems to determine the point of view.
Asian capital tends to focus on the positives, zooming in on London and the City in particular. Investment from China, South Korea, Singapore and Malaysia has been soaring to record highs this year. This flurry of activity has been due mainly to the weak pound, which has made assets look cheap from an Asian perspective, but also partly to a belief that the UK will thrive after Brexit and the City will remain one of the world’s leading financial centres.
Europeans, on the other hand, tend to be more wary. On the Continent the prevailing sentiment is that Brexit will have a negative impact on the UK, at least in the short term, and many investors have taken a wait-and-see attitude. Some, fearing a hard Brexit, have gone further and sold UK assets or announced they will no longer invest in the UK market.
The level of uncertainty is increasing as the deadline for a deal between the EU and the UK draws nearer. Crunch talks take place at the European Council meeting on 18 October, but the omens look unpromising after Europe told British prime minister Theresa May in Salzburg last month that her ‘Chequers’ plan was unworkable.
The rough and the smooth
The uncertainty over Brexit has led to a slowdown in investments and economic growth. House prices have either stalled or fallen, especially in prime central London. Yet London is booming as an investment destination. The weakness of the pound against the dollar and many Asian currencies is making UK assets look cheap by comparison. In the office sector, the prospect of rental growth and yields over 4% outweighs the threat of a post-Brexit exodus of banks and companies from the City.
This year London has regained its place as the most desirable destination for foreign investors, according to Knight Frank research. In the first six months of 2018, they poured £5.6 bn (€6.3 bn) into London offices, ahead of Hong Kong with £5.06 bn and Paris CBD a distant third with £1.97 bn. In the UK, investment volumes have gone over the £27 bn mark so far this year, with Knight Frank predicting a full-year figure of £55 bn.
‘Counter-intuitively, the Brexit vote looks to have boosted the UK investment market through its impact on sterling,’ says Walter Boettcher, head of research and forecasting at Colliers International. ‘Despite Brexit uncertainty, demand for UK commercial property is stable and is supporting prices.’ Commercial property prices are now at their highest since the referendum.
Occupational demand for offices has also been strong. In H1 take-up for the major UK markets increased by 11% on H1 2017, according to UBS data, while take-up in Central London rose by an above-trend 7.1%. Vacancy rates are low: 5% in the City and 3.6% in the West End. Annual total returns in Q2 were 9.4%.
What lies ahead
UK offices are likely to end a good year on a high, but a big question mark hangs over the sector, as it would be the hardest hit by a messy Brexit. ‘The main impact is focused on financial services, and from a commercial property point of view the epicentre of impact is clearly London,’ says Boettcher. The risks are not just immediate, linked to the relocation of existing companies, but also long-term, with the possible loss of new business expansion and greater competition from other financial centres. Real estate investors are worried about possible rental growth damage, valuation downgrades of their portfolios and a less liquid market.
Marc Gilbard, CEO of Moorfield Group, told PropertyEU he believes in some circumstances valuers are building in a Brexit writedown, and in others they are not. In his Q2 2018 CEO letter to investors, he writes: ‘If we stripped out the sterling impact and what could be described as exceptional items, I think it would be much clearer that we moved into a recessionary environment and real estate market slowdown some months ago. We can certainly see weakness in many corporate trading statements, profit warnings and the rise in CVAs even if some other headlines can at times paint a more buoyant picture. Interest rates may stay low but nonetheless they are going to rise and this will impact on many areas of business and personal wealth. However, as the UK currently stands I don’t see a major economic downturn around the corner. It’s going to be a slow few years of correction followed by a gentle recovery to acceptable growth, and as such I would not rush to invest nor would I be looking for a hasty exit.’
UK REIT share price movements since the referendum give some idea of the negative effect on investor sentiment. British REITs have underperformed their European counterparts by more than 20% since the referendum. The collective UK REITs (EPRA UK) have recovered to pre-vote level, while Central London offices remain down by 5%. ‘Of all sectors, only London office performance (Derwent) looks to be linked unequivocally to Brexit-related issues,’ says Boettcher.
The industrial and logistics sector, which has played a big role in foreign investors’ attraction to the UK, is the most insulated from Brexit-related risk. The risks of disruption to existing supply chains, problems with customs clearing and tailbacks at the port of Dover are outweighed by the forecast of continued demand for industrial/logistics space and the opportunities to develop new distribution facilities to handle customs clearing and new distribution technologies.
Hard Brexit risk
European investors have taken different views of the Brexit risk. Some, like French asset manager Amundi, have opted out. ‘We prefer to disengage from the UK for now,’ said Jean-Marc Coly, CEO of Amundi Real Estate. ‘We made no acquisition in the UK in 2017 and we will not make any in 2018.’
Others, like Norges, the giant Norwegian sovereign wealth fund, continue to buy. Norges has invested over £1 bn (€1.1 bn) in the country since the referendum and is still adding to what is now a £5 bn UK portfolio, having just bought an offi ce building in Holborn for £325 mln, above the offer price.
‘European investors are closer to the Brexit issue, they have followed it every step of the way,’ says Marcus Lemli, CEO of Savills Germany and head of investment Europe. ‘My advice is to watch the market closely and look for opportunities which will emerge, undoubtedly. The real risks are unforeseen events, but even a hard Brexit would not be a surprise.’
The data up to the end of August suggest that European investors are still investing at levels similar to 2017, which was a good year, and that European occupier demand for leases in Central London is above the 10-year take-up average. Most investors are waiting to see where the negotiations will lead and are ready to leave the UK if it crashes out of the EU without a deal. They are also aware that, regardless of Brexit, the UK is close to the end of the cycle.
The UK has attracted a disproportionate share of global investment and ‘a rebalancing is overdue,’ says Simon Martin, head of research and strategy at Tristan Capital Partners. ‘We expect investors to do less in the UK and more on the Continent. The UK is falling away as people worry over the end state of the EU relationship. At Tristan we are very cautious and the UK has been a much smaller share of what we are doing.’
The short-term disruption of a hard Brexit would cut off capital fl ows and lead to sterling and market volatility. This could open up opportunities but ‘only for people with capital and a stomach for risk’, says Martin. ‘For many European investors, due to tactical reasons, the UK is currently not the market they like to invest in, because if something goes wrong they will have to take the blame and justify their actions,’ says Marcus Cieleback, group head of research at Patrizia.
Home team to the rescue?
The dynamics in the UK market are changing. The weak pound has attracted foreign investors to UK assets, but it has also made it very expensive for UK investors to buy assets in Europe or overseas. This fact, combined with a patriotic sense of duty, has led UK institutions to dip their toes back into the water. ‘The most notable change in the market in recent months has been the return of domestic investors to the field,’ says Mat Oakley, head of commercial research at Savills.
They have accounted for 59% of all acquisitions this year, the highest proportion since 2011. In volume terms this marks an increase of 12.9%, compared to a 21% fall in non-domestic investor activity. ‘The new dynamic is that UK institutions are back in the market and are beginning to challenge overseas investors,’ says Colliers’ Boettcher. ‘So far in 2018, net exposure by UK institutions has increased by £1.6 bn, while overseas exposure increased by £1.9 bn. It looks like it may become a story in its own right, should they overtake foreign investors by year-end.’
Impact on Europe
Brexit is certainly having an impact on European real estate. A positive impact in some obvious ways, and a negative impact in a more insidious way. On the plus side is the relocation of banks and companies from the UK to the EU and the transfer of thousands of jobs to European cities. It has not been the exodus once anticipated, but a steady trickle that could yet become a stream in the event of a hard Brexit.
Frankfurt has been the main – but by no means the only – beneficiary of this trend, which has also boosted Paris, Amsterdam, Dublin, Berlin, Luxembourg, Brussels and to a lesser extent Madrid and Milan, says Larry Young, head of BNP Paribas Real Estate’s International Investment Group. ‘Our teams have carried out some high-profile deals in these markets with investors such as CapitaLand, Vestas and Samsung.’
On the minus side, the UK choosing to leave Europe has shaken confidence in the EU itself. Alarm bells have been ringing as the well-known problems of the Eurozone such as excessive bureaucracy and costs have combined with worries about populist, right-wing and anti-immigrant sentiment in Hungary, Poland, Germany, Italy and most recently, Sweden. Some investors, paradoxically, see the UK as a safer destination for their capital than the EU, and the well-known liquidity of the UK property market is an added bonus.
‘The EU has been sufficiently destabilised that the UK is benefiting from safe haven investment flows from European investors that are worried about the Eurozone and the EU in general,’ says Boettcher. ‘This could lead to further falls in EU confidence and drive further investment flows towards the UK. My own view is that the UK will be okay, provided that the UK government does not mismanage the exit.’
Asian capital drives London market
The wave of Asian money looking for somewhere to go seems to have found a home in London. So far this year more money has been spent on London offices than on central Paris, Manhattan, Munich and Frankfurt combined, according to Knight Frank data, and this is largely due to Asian investors’ continued appetite for these assets.
The weak pound has played a big part in their interest, along with a strong employment market, sustained demand, a low vacancy rate and attractive yields of 4% plus. The liquidity and transparency of the market have also been a factor. ‘Asian investors like landmark properties and from this perspective London is the place to be,’ said Patrizia's Cieleback.
Capital has come into London from China, Hong Kong and, to a lesser extent, Malaysia and Singapore. Hong Kong’s CK Asset Holdings spent £1 bn to buy 5 Broadgate in the City, while Singapore’s Ho Bee Land paid £650 mln to acquire Ropemaker Place. This year, however, the South Koreans seem to be the most active, making the most of the strength of the Korean won versus the pound. Last month they landed the second-largest deal ever for an office building. Korea’s National Pension Service beat its compatriot Hanwha Group, Norwegian sovereign wealth fund Norges and other suitors to buy Goldman Sachs’ new headquarters in the City for £1.2 bn. It was the fifth acquisition of a large office building in the City by Korean capital in 2018, after four £300 mln-plus acquisitions by Mirae Asset Daewoo (two deals), Korea Investment Securities and Samsung SRA.
According to Cushman & Wakefield, total Korean investment could reach £4 bn by year-end. ‘Far Eastern investors account for over 50% of cross border investment by value,’ said Colliers' Boettcher. ‘I think it is fair to say that Asian investors are driving the market.’
