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21/12/2016

Brexit cracks remain for property

Property is only now coming to terms with the referendum result

With no likelihood of a ‘remain’ outcome unless the queen challenges the decision (which would be a constitutional landmark), the UK Supreme Court is debating who can trigger Brexit. However, the UK commercial property market is only now starting to come to terms with the referendum outcome. 

Immediately after the referendum result the sector suffered a loss of confidence, with a number of property funds suspending redemptions or imposing withdrawal penalties. This was the biggest jolt to real estate investment since the financial crisis, although the current climate is very different from 2008/9 as it is without the same concerns about lack of liquidity. 

Property analysts regard the recent ‘gating’ of funds as being more about the relative illiquidity of the asset class than a warning about future sector performance. Despite this, some UK property funds continue to see outflows. 

Capital values 

In terms of market impact, values in the real estate investment trust (REIT) sector and capital values have fallen since the Brexit vote with UK REITs trading 12% lower than pre-Brexit and capital values, as measured by the Investment Property Databank (IPD), down 3% (Figure 1).

The Investment Property Forum’s (IPF) consensus review in November 2016 forecast that average UK commercial values will fall 4% in 2016, 3.6% in 2017 and remain flat in 2018. Despite the negative outlook, given lower levels of debt compared with 2008/9, substantial numbers of property loans are unlikely to breach lending covenants. 

Given ongoing expectations of low interest, low growth and low gilt rates, property yields are likely to remain attractive to income investors. The depreciation of sterling to its lowest level against the US dollar for more than 30 years provides an entry point into the UK for new overseas investors. However, while investment may appear attractive for non-sterling investors, the asset class will be perceived as linked both to sterling volatility, threats from Article 50 and Brexit. Additionally, with bond yields spiking up, property yields look less attractive.

Weak lettings 

Property professionals have reported weak commercial lettings activity as occupiers weigh up the pros and cons of the UK market post-referendum. There remain concerns that this will impact vacancy and rental levels over the longer term, with up to 30% of the London office market having exposure to non-domestic tenants. Weaker economic growth forecasts also mean that rental growth is likely to be lower than expected.

Recent research published by MSCI, based on analysis of the difference in transactional prices versus prior property valuations, has provided some insight into recent property transactions. The hardest hit sector identified by MSCI was offices (down 4.5%) followed by industrial and then retail properties. 

Since exiting our position earlier in 2016, we remain content to continue to monitor the UK commercial property market until we have conviction that an opportunity exists to re-enter.

Figure 1. Feeling the impact of Brexit

Capital values and prices in the REIT sector have fallen since the Brexit vote.

Source: Factset, Kleinwort Benson. IPD denotes Investment Property Databank.

Past performance does not guarantee future performance.

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