Brexit Buys: London Office Landlords Look Oversold
It is time for selective bargain-hunting in U.K. property
Fears of falling rents for London office space have seen a selloff in real estate investment trusts.
Another day, another selloff in U.K. real-estate investment trusts. Shares in London office landlords in particular languish on discounts reminiscent of 2008.
Valuations seem likely to fall as a result of Britain’s vote to leave the European Union. But the market has probably overreacted—particularly in dollar terms. Priced in greenbacks, shares in Great Portland Estates , a West End office landlord with a formidable track record, are down 34% since referendum day.
The latest trigger is news that three mutual funds invested in property have suspended redemptions following a rush of requests from skittish private investors. The last time this happened was during the banking crisis.
Regulators have since encouraged fund managers to hold a greater share of their assets in cash and shares rather than illiquid bricks-and-mortar. REITs have therefore stepped into the gap as a liquidity buffer for open-ended funds. This partly explains why their shares have fallen so dramatically since the referendum. It also explains why the selling appears somewhat indiscriminate.
There are already some hints of how Brexit will hit commercial property prices. A couple of mall transactions in the first half were priced at a 5% to 10% discount to previous valuations in anticipation of the vote. Now that the result is in, the trade press is awash with stories of big deals being pulled or renegotiated as investors scramble to anticipate the consequences.
Office rents seem likely to fall as banks and other financial institutions relocate staff to Frankfurt, Paris or Dublin. Real-estate research outfit Green Street Advisors has factored an immediate 10% decline in London office valuations into its book-value estimates. Outside London, shop rents are also set to suffer, because sterling’s fall pushes up retailers’ import costs and depresses consumer demand.
Yet even a 30% decline in Great Portland’s valuations would merely bring its book value in line with its reduced share price. Over the past five years its shares have traded roughly 10% above book value, on average. Similar value arguments can be made for the other London office specialists, Derwent London and Workspace .
Just as importantly, these companies have much less debt than in 2007. Green Street reckons the balance sheets of the London specialists would look solid even in a worst-case market scenario, allowing them to buy assets in a downturn. The same cannot be said of mall landlords Hammerson and Intu or the diversified FTSE 100 REIT British Land .
The peak-to-trough fall in U.K. property values during the 2008 banking crisis was roughly 45%. But this would be an improbably extreme outcome when investors are so desperate for the yield property provides. Apart from the mutual funds, which own perhaps 5% of Britain’s commercial property, there are no obvious forced sellers. This is a crisis of politics and potentially consumer confidence, not—as Bank of England Governor Mark Carney stressed today—of the financial system.
It is time for selective bargain-hunting in U.K. property.