Think Global, Not Brexit
Simon Hedger is a global property securities portfolio manager for Principal Global Investors, along with Anthony Kenkel and Kelly Rush, Head of Global Real Estate Securities.
With the United Kingdom (UK) due to hold a referendum on the 23rd June on whether to continue its membership of the European Union (EU), we are frequently asked about the potential impact Brexit (Britain’s exit from the EU) could have on the UK property sector.
As we see it, there are two issues that need to be taken into account to form a view on the topic. The first issue involves current market fundamentals; therefore what’s the essential status of the UK property market at the moment. The second issue is how a Brexit might impact that status should Britain vote to leave the EU.
Looking at market fundamentals the UK listed real estate sector has provided very strong returns over the past two to three years. From what we see on the horizon (an economy that continues to recover nicely and interest rates remaining relatively low), we do not expect any change in the level of leasing demand. The Central London office market, which has been a key beneficiary of the current real estate cycle, remains very strong, with a vacancy rate of just 2-3%. The vacancy rate in London’s West End is even lower.
That said, there are some market-participants projecting that new supply will spike in 2018. However, our knowledge of the UK planning regime would indicate that developers involved in those pipeline projects are not going be able to get funding or planning permission to enable the new supply to come on stream in 2018 as forecasted. Accordingly, we do not see supply in cities as an issue; the bigger issue is demand, and that is where a Brexit could be critical.
In terms of the expected outcome of the June referendum, it is likely the UK will vote to remain in the EU. In that event, financial markets should respond with heavy support for British sterling (which has fallen significantly in recent times against most major currencies) and those stocks currently discounted due to fear of a potential UK exit. If, however, a Brexit is chosen, sterling would likely fall further, along with other financial market indices as investors struggle to come to terms with the depth and duration of the impact the Brexit would have on both the UK and European economies. Given our opinion, that the UK will remain part of the EU, we have taken advantage of discounted stock opportunities focused on the London office market, in the expectation they will rally on the result of the Referendum.
While it is natural for investors’ to be concerned about the potential impact of a Brexit, the best way to protect a portfolio against the vagaries of an individual market, country, or region is diversification. In the case of listed real estate, that diversification should be global. Real estate markets across the globe are typically driven by local factors, particularly supply and demand. So, conditions in the office markets in Singapore, Sydney, London, and New York can vary significantly from each other at any single point in time. That is because each market may be at a different stage of the economic and/or real estate cycle. A globally-oriented portfolio has the flexibility to look for global opportunities, moving from a more mature market to a recovering market, while also taking advantage of mispricing in the market. In a global investment context, the UK property market, and the potential impact of a Brexit, is just one variable and possibly an opportunity! Being overweight to this theme is properly measured to contribute to alpha generation if we are proven correct.