Why Brexit will lead to a golden period for investors

Britain’s exit from the EU will create a golden period for investors in UK real estate as a confluence of variables combine to position the UK as inexpensive and offering improved returns relative to other markets and asset classes. After three years of uncertainty, the UK real estate market is on the precipice of a unique period, with many possible Brexit-related scenarios leading to different, but attractive, cases for UK investment. The key possible outcomes are: if there is hard Brexit and currency tumbles, then UK real estate will look more attractive; if there is a “good” deal with the EU, it will prompt an upward revision to the GDP outlook, improving the prospects for the growth-linked UK real estate sector; if investors flocked back to bonds and gilts, those assets would soon look expensive relative to UK real estate. In turn, the high gap between gilt and property yields will spur activity from relative value investors; and if inflation picks up, asset allocators may look to invest back into UK real estate as an inflation-hedge. Some of these four engines will likely fire at the same time, positioning UK real estate as relatively inexpensive and offering improved returns relative to other property markets and asset classes. This will create a golden period for buyers, with an optimum risk/reward period, we estimate, running from approximately Q4 2019 until at least the end of Q2 2020, and potentially for the remainder of next year. Overseas investors are capitalising on domestic investor pause Investment activity in the UK real estate market has been two-speed in 2019, divided into cross-border and domestic capital, which broadly remains a 50/50 split. On the one hand, there are “cautious” domestic institutional investors who are waiting for evidence that uncertainty has receded before committing new capital. Some of this hesitancy comes from UK pension funds, which are spooked by the potential for redemption requests in the event of a no-deal Brexit. As a result, some feel compelled to maintain high cash levels until clarity finally emerges. On the other hand, there is a flock of overseas investors with long-term, permanent capital who can look beyond near-term Brexit ambiguity. They are buying long-income UK product with limited price competition as a result of the domestic investment pause. Many of these overseas investors, notably South East Asian and Middle Eastern, now consider investment opportunities across the rest of the UK to be on par with those in London. Investors can buy regional long-income assets at discounted yields to comparable London assets with, in some cases, better growth opportunities. This provides improved cash-on-cash returns, which is the primary investment driver of such capital. Domestic pension funds’ inaction has opened the door for overseas investors who have capitalised over the year to date. UK will remain a top 3 destination for global capital As we approach the final stages of Britain’s exit from the EU, the UK real estate market will remain a top three destination for global capital, however events unfold. Over the past five years, capital has flowed into the UK from all corners of the world. In fact, in the past three years the UK has ranked as either the first or second favourite capital destination for the world’s largest global real estate investors, including US, Canadian, South Korean, Hong Kong, Australian and German capital. And it will remain a top two global real estate market, alongside New York. The UK’s capital is way ahead of the pack of global gateway cities; indeed, London has seen around £250bn (€300bn) of investment in the past decade, which is 50% more capital than Paris has secured from overseas investors, and a colossal 200% more than Berlin has amassed over the same period. Interestingly, several US private equity investors are beginning to sell out of value-add and opportunistic purchases they have managed into core and core-plus assets, that were acquired towards the end of the global financial crisis. These assets have generated interest from long-term capital from Asia, South Korea and the Middle East, who are mainly interested in quality, stable assets with a good yield. They are taking the opportunity to buy as some UK pension funds and institutions feel compelled to wait. Looking ahead to H2 2019, we expect a huge weight of capital to flow in from the Middle East. Investors in Europe and the US are also raising more money, primarily at lower return requirements, as US investors shift down the risk curve from opportunistic to value-add and even core-plus. We know that much of this capital will be allocated for UK investment in the months ahead. Latent capital waiting for sterling to bottom out A significant amount of capital is waiting for the sterling to bottom out once Brexit happens. A sharp devaluation against the US dollar is a possibility for a very limited period before the currency finds a short-term floor of around 1.5, which is prompting investors to wait before buying. When a sense of stabilisation finally emerges in the UK – across currency, politics, investment sentiment and in the broader business environment – the surge in capital returning to the market could be rapid, pushing prices back quicker than many might expect and driving an appreciation in the pound. That is because the UK is always one of the world’s fastest economies to readjust on pricing and market change. Therefore, as counterintuitive as it may feel right now, investors would be minded to not overly worry about Brexit. In fact, the UK market is probably in a better place than many believe it is and the underlying attractiveness of the UK to overseas capital has not gone away and nor will it. John Knowles is head of national capital markets and Andrew Thomas is head of international capital markets at Colliers International Picture: Shutterstock