Last week’s majority vote in favour of extracting the United Kingdom (UK) from the European Union (EU) is expected to reverberate in real estate markets on both sides of the English Channel, with the potential for some Brexit ripple effects to reach Canada. Over the longer term, London’s office sector, industrial facilities in manufacturing regions and warehouse space in logistics hubs are deemed most vulnerable, while several alternative locations in other EU countries are poised for increased demand. More immediately, uncertainty in the capital markets is the larger concern.
“Regardless of where interest rates or bond yields move to and for how long, it is likely that a higher risk, illiquid asset class such as property will see some kind of negative yield impact, at least in the short term,” LaSalle Investment Management cautioned its clients in an analysis of potential eventualities released just prior to the June 23 referendum.
In a follow-up June 24 memo, LaSalle’s leading UK and EU executives warned clients “real estate performance objectives may now come under considerable strain in the next 12 to 24 months”. Yet, other asset classes won’t necessarily be outperforming real estate.
“Values will fall, with the question being by how much? The market was at an unprecedented peak in terms of value over the past few years. Even with a correction, pricing and demand will remain healthy,” submits Keith Reading, director of research with Morguard. “In the meantime, there will be fallout in equities markets across the globe.”
MSCI reported a 2015 total return in the range of 13 per cent on UK directly held standing assets — trailing only Ireland’s spectacular 25 per cent total return among 32 nations for which it produces property indexes. LaSalle’s pre-referendum analysis projected a more modest 4 to 5 per cent return over the next five years if the UK remained in the EU, or a negligible 0 to 1 per cent return “following a particularly bad Brexit.”
In that scenario, office properties in London’s financial district were forecast to lose 2.5 to 3.5 per cent of value. However, the firm’s June 24 post-vote memo also presents that as a possible plus, noting: “For our clients able to take a longer-term view of real estate, yesterday’s vote may actually open up rare mis-priced opportunities to acquire top-quality assets at discounted prices, particularly in London.”
Canadian institutional investors could be among those taking that longer view. Indeed, the biggest — Canada Pension Plan Investment Board — is already active in the country. “The U.S. and the UK would actually be the bigger (than Canada) component of our real estate program,” CPPIB director, Sharm Powell, told attendees at the REALpac/IPD Canada Investment Forum earlier this year, as she tallied the countries where the pension fund’s $40 billion in assets are found.
Looking in the other direction, uncertainty in the UK and the EU could further accentuate the attractiveness of Canadian real estate, but doesn’t alter the perception that this is a difficult market to penetrate.
“Canada has long been viewed as a safe haven by foreign investors, but, at the same time, many are aware of the strong depth of institutional ownership here that tends to dominate and hold the best assets for the long term,” explains Chris Langstaff, senior vice president, research and strategy, with LaSalle Investment Management in Canada. “They know it is hard to break into the market or they really have to pay up to get a foothold. If the shine has worn off the UK for the time being, it could make other markets around the world more appealing, but I’m not sure that will drive a lot more capital towards Canada.”
Meanwhile, there’s a more realistic threat that Brexit upheaval will have far-reaching negative consequences. “The broader issue could be a slowdown in global economic activity, at least through to the close of this year and perhaps beyond,” Reading says.
Boom market prior to June 23
Despite the uncertainty, all is much the same in the UK as it was on June 22 given the two-year period before it can formally withdraw from the EU. For now, London continues to be the continent’s dominant financial centre.
Even if this status is eroded, businesses would need some time to move their headquarters elsewhere — with Frankfurt, Paris, Zurich, Dublin, Amsterdam, Luxembourg, Milan and Madrid now identified as emergent competition for financial and professional services looking for a new EU base. Approximately 15 million square feet of new office space is currently under construction in London’s central district, while another 10 million square feet in the planning stages could now have more tentative prospects.
“Developments which have not started on site are likely to be delayed until there is more clarity about the level of demand in the economy,” a June 27 advisory from CBRE’s UK and EU research heads suggests.
The spectre of a boom market suddenly arrested may resonate with many Canadians — and, in this, there may also be some insight for Commonwealth cousins.
“In Alberta, we saw an almost immediate downturn in office market fundamentals, but industrial and retail were not as negatively impacted,” Langstaff notes. “Much of the impact in Alberta has been on the market fundamentals — space demand, vacancy, asking rents — but, 18 months later, we have yet to see any significant impact on pricing. Mostly it has been a sharp slowdown in transaction volumes, but significant re-pricing among larger institutional assets has remained elusive.”
Barbara Carss is editor-in-chief of Canadian Property Management.