Rain Check

It has been a few weeks since the UK referendum result and conversations have quickly moved from the initial shock and surprise to what effect it will really have on the economy, and in particular, the property market.

We have seen a few glimpses of the vote’s impact through the closure of some of the retail funds and the sharp mark down in quoted REIT prices, but even here many funds have reopened, net inflows are again being experienced and share prices are recovering.

Any evidence to guide sentiment will take some time to appear. So rather than dwelling on what might be, perhaps it is better to re-focus our attention on the fundamentals that underpin the market over the longer term, where there is plenty of evidence to show that we are well positioned to weather any short term influences that might impact the market.

One consequence of the vote has been for boards and owners of companies to hastily review their capital structures to check they have sufficient liquidity during what might become more challenging times.  We talk to many investors, as well as to over 100 lenders to property, and what we’ve been hearing in the last few weeks about the quantum of available debt and overseas equity is encouraging.

Lenders are of course more cautious. They have been stress testing their existing portfolios, and in terms of putting out new senior debt they will be more conservative. The 60-65 percent leverage common 12 months ago is more like 50-55 percent today. Debt margins are rising to take account of the perceived heightened risk, but only modestly, and there is no reason at all to believe that sources of debt capital will dry up.

Quite the contrary. Banks are generally in a healthier position with lower levels of exposure to real estate than in previous cycles–a crucial factor as strong relationships with lenders and access to liquidity will sustain the current position and help drive any recovery, when it occurs.  Evidence also suggests that the quantum of existing loans due for maturity in the next couple of years is lower–a product of the desire over recent years for borrowers to take advantage of lower longer term funding costs.  Borrowers won’t even necessarily have to pay more for senior debt, since a 25-50 basis points rise in pricing is netted out by the fall in the 5-year swap rate since the vote.  It is easy to forget as well that in this sustained lower interest rate environment overall borrowing costs remain at historical lows.

Alternative sources of debt financing have additionally expanded considerably over the last few years.  As the last De Montfort report showed, there are many new lenders, including debt funds, with money to place. The UK property market isn’t reliant on the clearing banks any more, with this group accounting for a more comfortable 34 percent of new originations last year compared to the near-fatal 72 percent peak in 2008.

Furthermore, international investor interest in the fundamentals of the UK property market remains encouraging, particularly from Asia, with the 12 percent fall in the value of sterling since the referendum making UK real estate look relatively good value to overseas buyers. Opportunistic investors also seem to be gathering interest again in the UK market. According to the 2016 Prequin Global Real Estate Report, private equity funds raised $202 billion of cash as of June 2015, when previously there was a feeling among them that parts of the UK property market were fully priced and they would likely deploy elsewhere. Several firms (such as Benson Elliot and Patron Capital which have just held final closings for new European funds) have said that they anticipate investing substantial capital here.

Now the banks and investors are generally in a healthier position than 2008, with lower levels of debt, there will not be large numbers of forced sales. Indeed, even after the financial crisis, when owners were under far greater pressure from high levels of debt and a credit squeeze, there were fewer forced sellers than anticipated so there is no reason to suggest supply issues from that source.

There are other supportive economic and property fundamentals to point to. Not least that the British economy is expected to continue growing; on 19 July the International Monetary Fund released a revised forecast for 2017 UK GDP of 1.3 percent, predicting faster growth in the UK than in Germany, France and Italy, and higher than CBRE’s own forecast of 1.1 percent. Vacancy rates in most UK markets remain low, and while occupiers may be more cautious, construction activity is likely to fall, which will support the supply/demand balance and consequently rental levels over time. Good quality real estate with long, secure income streams is likely to remain attractive to investors looking for yield, and property’s yield spread over other assets remains strongly positive. This is all quite different to the peak of the last cycle when there was a negative yield spread.

The industry consensus is that whatever happens in the short term, property values will recover in the medium term. With so many differences from the situation during the last downturn, it is difficult not to agree.

By Richard Dakin, Managing Director, UK Capital Advisors, CBRE.

This article first appeared in Estates Gazette.