After the pause? Keep calm and carry on

A short period after the UK’s historic Brexit vote, Real Estate Capital gathered together four leading market professionals to talk through the consequences – and gain some insight into what the future may hold. Andy Thomson was taking notes

Taking place as it did less than three weeks after the decision of the UK public to remove the country from the European Union, it was not surprising that participants at our UK roundtable in early July were somewhat reluctant to make too many predictions.

“We could be exposed to looking rather foolish,” noted one of the participants, perhaps not wishing to share the fate of some professional pollsters whose forecasts for both the referendum and last year’s UK general election had ended up rather wide of the mark.

Nonetheless, with the shock of the outcome having subsided a little, all present recognised that it was an appropriate time to begin assessing the new landscape for UK real estate – even if it would take some time for the mists to clear.

Edmund Craston from Rockspring
Edmund Craston from Rockspring

Edmund Craston, managing director of fund manager Rockspring, said many in the market would continue to sit on their hands for a while – at least until the summer months had segued into autumn. “Given that it’s summer, there’s an excuse for inaction,” he said. “So it’s something of a phoney war period. But there has to be some economic effect and an impact on pricing and activity.”

However, if those remarks sounded less than encouraging, he was quick to add: “We think things are not as grim as many fear and there can and will be a rebound in future. If recent events have taught us anything, it’s that what seems obvious doesn’t always happen. You have to be alert and responsive to changing situations.”

Inevitable pause

John Barakat, head of real estate finance at M&G Investments, said that a pause was inevitable amid what he stressed was a political rather than economic crisis. “Markets hate uncertainty and we’re not accustomed to this level of uncertainty and change,” he noted.

John Barakat from M&G Investments
John Barakat from M&G Investments

But while he recognised that decisions would be delayed, he also made the point that this would not last forever. “In a few months, we’ll start to have a clearer picture of where we really are. Real estate is a GDP-linked asset class and an upturn or downturn in the economy will create winners and losers; some will benefit and others will suffer. Overall, I don’t think we’re looking at a scenario as convulsive as the one we saw in 2008 but this is going to play out over the next few years, not just a few weeks or months.”

Tamara Box, chair of the financial industry group and head of structured finance at law firm Reed Smith, agreed that there would be winners and losers – and that, as a lawyer advising across many parts of the market’s life cycle, she would be well placed to observe both.

Reed Smith's Tamara Box
Reed Smith’s Tamara Box

“There is uncertainty around regulation and we see alternative lenders doing well and traditional lenders not so well – but there will be exceptions on both sides,” she observed. “For asset managers, the opportunities are tremendous with forced sales bringing deals for opportunists. We’re seeing deals moving towards default and that’s an area where I expect lawyers will be kept busy!”

Bumpy ride

Box agreed with the contention that short-term difficulties could eventually give way to a more encouraging situation. “Uncertainty around how Brexit is handled will continue. We may end up with a good deal in the long run, but it will be a bumpy ride and it seems reasonable to expect more volatility.”

LIM's Ali Imraan
LIM’s Ali Imraan

“We have to give strong consideration to where the best opportunities will manifest,” reasoned Ali Imraan of the debt investments & special situations team at LaSalle Investment Management. “This means assessing how Brexit will impact areas such as supply, leasing, tenant intentions and construction etc. At the moment it’s too early to know but we do see it as an opportunity. Throughout the last cycle, things seemed worse from the outside looking in than on the inside. We have strong relationships with partners who have committed a lot to the UK market and it forms a big part of their books. We don’t expect that to change.”

Barakat expressed the view that the current pause is a good thing. “A level of emotion has been unleashed. We all need to let that seep out of decision-making. You should never take decisions in the heat of emotion. At the current time, investors, occupiers and everyone else in the market have a chance to take a step back – and that’s a healthy thing in my view.”

Perhaps the most immediate negative effect in UK property was seen in the open-ended fund market, with some investors taking fright and some funds being suspended.

While those around the table noted the significance of this development, they did not think this presaged any kind of structural problem for the real estate market as a whole. “Open-ended funds are about 5 percent of the investment market so they’re not tiny but you have to get it in perspective,” said Barakat. “And while there are very bold headlines about funds being suspended, there has been little in the way of forced sellers.”

Craston agreed that the challenges for open-ended funds in the retail space would not cause a collapse. He went on to suggest that, although these funds were not really testing liquidity levels at the time, they might end up doing so despite the suspensions and dropping prices.

Few signs of stress

Looking to the market more generally, few clear signs of stress were appearing in the immediate aftermath – although some adjustments could be seen. Box noted a re-working of some deal terms, and lenders wanting to adjust down loan-to-values (LTVs). She said she was seeing more caution around leverage even though the market as a whole had not become over-leveraged through the cycle.

But while some difficulties were emerging, there was a consensus view that real estate still fits very well with investor requirements and that this should always stand it in good stead even during the tough times.

“There’s a solid underpinning of global appetite for yield and real assets,” said Craston. “Plus, in the UK, you have the currency effect which can also be attractive. So there is definitely support for the market – the question is when things get to the level of certainty required to allow that support to kick in.”

Imraan was keen to make the point that in certain sectors there are still attractive fundamentals despite the wider uncertainty around Brexit. “In residential, it is clear that there is an ongoing supply/demand imbalance, but also an affordability issue,” he pointed out. “Therefore, when it comes to affordable residential, we expect developments to go ahead. Historically this has been dominated by the clearing banks, but they may be more cautious going forward. As a result I would expect there to be greater opportunities for alternative lenders.”

He thinks student housing, where there is also a lot of support from the demand side, has a bright future as well. “The UK student housing market is still attractive to foreign students, more so with the currency factor,” said Imraan. “It is unlikely that you wouldn’t continue actively investing in that space.”

High capital cost

Box, however, was cautious on prospects for development finance in the current environment. “The capital risk from defaults has increased and development finance is less attractive,” she said. “If there’s a chance of something going wrong, as a bank you will probably pull out of it because the capital cost of being wrong is so high.”

She also pointed out that the loss of the Erasmus scheme, which involves the EU funding students to travel to different countries as part of their studies, could be damaging for the student housing sector. “For every asset class, there is a Brexit-related uncertainty,” she said.

Conversation then turned to the future for alternative lenders. Of the possible opportunities arising from Brexit, the one that appears to elicit agreement among many market observers is that alternative lenders have an opportunity to grab even more market share from traditional lenders.

“Our clients who are alternative lenders are very bullish about their opportunities relative to traditional lenders and much of it is to do with the creativity they are able to bring to bear,” maintained Box. “That is in part because the regulatory environment is less complicated for them. The flip side, however, is that execution risk can be higher with a non-traditional lender.”

“We see ourselves as more flexible than traditional lenders at a time of uncertainty when you have to put your thinking cap on and be nimble enough to deploy flexible structures,” asserts Imraan. “You still have the big lenders who need to deploy capital, but we see this as an opportunity going forward to partner with them as well as with borrowers.”

Harder for new entrants

Barakat thinks that the growth of alternative lenders witnessed in recent years may now be halted for a while. “There are a decent number of established alternative lenders but it might be getting harder to launch new ones because it’s questionable whether institutional investors want increased UK exposure. Over time the trend in favour of alternative lenders is likely to continue, but it may pause for a while.”

He also raised a question mark over whether performance would hold up in light of more challenging market conditions, while Box made the point that some alternative lenders have a specific focus on particular business lines – which could mean they are potentially more exposed than traditional lenders.

Craston took the view that the current environment was probably more favourable to the longstanding incumbents. “We don’t use alternative lenders as we can get what we want from the traditional lenders,” he said. “I think more people will act like us in a risk-off environment.”

Under the microscope

In a market where uncertainty reigns, regulatory change adds a further layer of complexity. That said, those around the table acknowledged the need for regulation and the need to accept it as a fact of life.

“The whole industry is under the microscope more, as is appropriate after a crisis like 2008,” said Barakat. “What you need to try and make sure is that the interests of regulation and the economy converge rather than diverge. The benefit of a regulatory review is to get more responsible and better decision making. It should not be about regulation for its own sake.”

“We are engaged in bedding in regulations and seeking to change them where there are unintended consequences,” noted Box. “We will keep seeing that, because value judgements are inherent in such regulation and those judgements may be right for the time but may need to be reversed when you realise that there are unintended consequences. Often, it’s about testing out regulatory decisions within a real environment.”

She added that uncertainty is the “new normal” and that “we will always be testing the consequences, pivoting and readjusting. And then, when we’ve done all that, new regulation inevitably comes along!”

Diversification

Barakat made the point that the diversification of lending could be a good thing from a regulatory point of view. “If a lending book doesn’t perform today, it’s less likely to cause systemic shock as the market has become more diversified through the newcomers. There are more players, each with a smaller piece of the pie, and that reduces the overall risk to the system.”

This prompted a discussion of how to evaluate risk amid such political and economic turmoil. Unsurprisingly there is no easy answer. “What’s interesting to me is that all the monetary levers that policy makers used to have appear to be untethered and unconnected to the real economy now – interest rates, inflation, etc.,” said Box. “Do we have an understanding of how those levers even work anymore?”

Perhaps pondering the implications of an essentially unknowable economic future, Barakat responded with a ‘keep calm and carry on’ type message. “The business of ‘getting on with it’ is an important element,” he noted. “We are marching along a path that is uncertain but we need to acknowledge we’re on that path and, with the passage of time, the political situation will be clearer. A bit of calmness is a good thing.”

Craston concluded proceedings with a call for appropriate context. “There are a lot of people in the industry whose careers have centred round the global financial crisis and that could make them prone to envisioning disaster. Those who have been around a bit longer realise it doesn’t have to be like that.”

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