Commercial property has generated phenomenal returns over recent years. So why has Brexit caused such a large mark down in fair values and led managers to defer redemptions for nervous investors?
Actually, even prior to the EU Referendum, property had started to come under pressure with falling transaction volumes (H2 2015 transactions were 16% lower than H2 2014). This was driven by a number of factors, namely:
- the increase in Stamp Duty Tax announced in the 2016 budget,
- a fall in property yields, and
- uncertainty created in the lead up to the Referendum.
The vote to Leave built on these worries and left a looming sense of uncertainty, causing much concern amongst foreign and domestic investors alike.
So what does this mean for commercial property investment going forward?
Whilst recent returns (pre Brexit) were driven by an increase in capital values, commercial property returns are usually driven by demand for stable rental income streams from financially sound business tenants. Economic uncertainty calls into question whether these income streams will continue and can lead to a large exodus of retail investors who tend to be sensitive to both positive and negative information flows.
It is, therefore, imperative to remember that property is “illiquid” which, by definition, means that it can rarely be monetised quickly without being subject to a discount in price. In circumstances where money is leaving their funds, almost all property managers have the ability to reduce fair values in order to protect the interests of investors who remain. The reduction means that those rushing for the door bear the costs of sale. Alternative measures, such as deferring redemptions or suspending trading, provide managers with valuable time to seek buyers of their assets at above “fire-sale” prices.
So how does this impact institutional pension schemes? The short answer is the overall impact is expected to be small for a number of reasons:
- exposure to property usually makes up a small part of total portfolios
- trustees can take a long term view and either maintain investments or sell when the pressure of retail sales has abated, and
- our clients favour funds that invest in strong tenants with long leases, so that short term economic slowdowns have little relevance.
Finally, some clients will have indirect exposure to property through their Equity or Diversified Growth Funds. While these investments, such as Housebuilders and Property Development Companies, will likely have fared poorly since 23rd June, the exposures are likely to be relatively small.