Brexit Blog from the Back of a Boat
I wrote my initial draft of this blog from Yarmouth on leg one of our summer cruise – just post the ‘Brexit’ vote. It wasn’t great weather and there were stormy times in the Financial Markets … so snug in harbour seemed a good place to be!
I have been contacted by a few of our partners, gauging our views on the outlook for the property markets as a consequence of the wider economic impact of Brexit. There are many heavyweight and rather inconclusive research papers appearing, but in truth nobody really knows what is ahead because no one has been here before. But here are a few musings:
1. Property fundamentals are unchanged. There is a lack of supply of occupational space following little new development in recent years. New development and refurbishment projects will be further stalled due to market uncertainties. Market rents in the provinces are still historically quite low, competitive and attractive to those occupiers who still require space.
2. There remains a clear logic to invest selectively in property. There has been excessive yield compression in Central London and the prime markets - mainly driven by weight of money chasing limited product. Those markets aside capital values are still only about half way back to where they were at the top of the last cycle. We are still seeing office and industrial buildings available to buy at or around today’s new build cost. Good secondary property yields are still attractive in comparison with the other asset classes and debt costs are now at an historic low – five year fixed rate money is only about half a point ahead of three month Libor – the closest differential I have ever seen in my career. There remains a vast quantum of investor cash that I believe will seek to come into the property market once there are signs of stability – and possibly quite quickly.
What has changed dramatically is both investor and occupier confidence. There is huge uncertainty about what lies ahead.
The larger institutions have written down their retail fund values between 5-10%. Cynics would say this is to protect the value of the fund from excessive redemptions because there is as yet no transactional evidence to support that mark down - indeed valuers are instigating uncertainty clauses in the Red Book to caveat any figures being produced. This becomes a self-filling prophecy because a lot of transactions in hand are now being re-negotiated to follow, with 5% price knock being the norm! In fairness, it is the prime end buyers that have driven the yield compression over the last couple of years - consequently it is their portfolios that will suffer the biggest correction as they have often turned a blind eye to value fundamentals due pressure to invest.
In the Craigard portfolio things are less volatile because we are not at the prime end – mostly good secondary stock. We have not overpaid for assets - seeking discounted buys with quirks and warts to subsequently add value. What is vulnerable (if the uncertainties actually cause values to fall) is prospects for the added value. We expect the market for the next few months to be quite stalled – at institutional level Investment Committees will be sitting on their hands. Private prop cos and High Net Worth Investors are more likely to take an opportunist stance, but will still be wary.
I see tenant demand as a more important issue than investor confidence. There will be many tenant companies who interact with the European Markets, and until such times as Theresa May and her team conclude a new trading structure with Europe, they will be uncertain of their future business prospects. Relocation/expansion to new offices/warehouses/factories is therefore more likely to be put on hold and we expect the occupier markets to be fairly quiet over the next few months. That said, feedback from front line agents is that deals are still progressing with companies who are not so dependent on Europe or have a compelling need to move. This may play in our favour in some instances – tenants we might have lost will remain in situ. A consequence of shallower demand is that rental growth may now be delayed - at least until we all know the new rules with Europe and business can move forward.
All of this has an impact on tenants. There are many reports of contracts being cancelled or delayed – cash flow issues could cause tenant defaults. Therefore, reviewing the vulnerability of tenants is something we are considering.
So what is the Craigard conclusion…
1. Don’t panic, tighten up funding arrangements in some syndicates, work through voids and be, as ever, very realistic on letting deals. Moderate expectations…. and tidy up the office!
2. Be watchful for sound opportunities – solid purchases at the right price might be vulnerable to value shifts in the first year or two, but in the medium term we feel they will be robust. Britain is unlikely to be a basket case economy as a result of all this and demand for commercial property will remain sustainable in the longer term.
Property is still a sound bet with a lot going for it. At the moment it’s all about Britain’s long-term economic prospects and how quickly (or not) business and investor confidence recovers. We can expect lower performance than we were hoping pre-Brexit, but a well-considered property play overall is still a much better bet than cash or bonds and less volatile than equities – my IFA is telling me that shares are like property and historically well priced. But I need a steely nerve for that call with headline equity markets back to pre-Brexit levels!