Commercial markets: Brexit and risk catapulted to higher levels
Could UK commercial (and even Continental European) real estate be subject to a swing in risk sentiment, for example a swing triggered by the outcome of the Brexit referendum held on 23 June?
As always, a swing could be psychological rather than economic with respect to commercial real estate, yet we believe the risk-pricing pendulum might swing towards fear – thus leading to risk-aversion. But Brexit is not the only driver.
As a matter of fact, the nervousness sparked by the referendum almost immediately affected commercial values in London. But not all the “mayhem” is due to Brexit; the fact is that record prices – with very low gross initial yields as a result – have prevailed for almost all prime/core assets in London over the past few years, and in many other prime areas of Europe as well. Actually, real estate pricing was reinforced by comparing the expected real estate returns implied by the very low capitalisation rates with long-term sovereign bonds. The yield on the latter was – and still is – low (like in the UK) or even outright negative (Switzerland). As such, risk premiums have been reversing in recent years, though they are still hovering in the region of 3% given the differential between property yields and “risk-free” rates. As stated in our previous reports, the 300 bps spread can be misleading one way or another, with risk-free rates artificially kept at insignificant levels.
So even before the Brexit announcement, a healthy and probably mild re-pricing has been on the cards. And this could occur once capital markets start functioning properly with nominal interest rates ending at (slightly) higher levels than today.
A number of questions should be asked:
1. Will prime gross initial yields move up in the UK? And in Europe as a whole?
2. Will Continental Europe benefit from the overall uncertainty hanging over the UK, and will this lead to attractive investment opportunities across the continent? Will real estate grow at different paces?
3. Will volatility across property markets be long-lasting? Or is this a short-term phenomenon, with investors gradually screening the UK market for new opportunities?
Would a change in interest rates be more dangerous than Brexit?
For further analysis and conclusions on real estate markets trends, please check the executive summary of our real estate report.