Real Estate

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

(Updated )

Investors aren't waiting to see how Brexit plays out in the U.K. commercial property sector.

A rush to redeem holdings in Standard Life's main real-estate fund has forced the venerable Scottish firm to suspend redemptions and buy time to liquidate assets without taking fire-sale prices. Rival Aviva also froze one of its property funds. The moves have eerie echoes of the financial crisis. The fact that this has been done by blue-chip investment houses adds to the sense of alarm.

The funds sector is catching up with the stock market, which saw big falls in commercial property and house-building shares in the immediate aftermath of the Brexit vote. Standard Life's decision to revise down its fund's value last week was doubtless another trigger. The redemption bans are a sensible and necessary way to preserve value, but they have two unhelpful knock-on effects.

You Saw It Here First
Redemptions from Standard Life real-estate fund follow sharp falls in commercial property stocks
Source: Bloomberg

One, they may encourage investors in other illiquid funds -- whether real estate or other hard-to-sell securities -- to redeem their holdings for fear they too might soon be banned from doing so. They may even spawn redemptions from liquid funds. Small wonder the broader asset management sector sold off. The net effect is to divert capital from investment into cash; precisely the opposite of what the U.K. economy needs right now.

Relief Fades
U.K. asset managers are falling again after a brief respite from Brexit fears
Source: Bloomberg

Second, they will add to pressure on commercial real estate values. Standard Life may have bought itself some time, but it will still have to sell some assets to meet the redemption requests.

The reality is that while there needs to be a repricing of commercial property after the Brexit vote, there are so many unknowns that it's going to be a long time before a new level is established.

The share price falls so far reflect the expectation that commercial rental yields will rise as nervous investors demand higher returns to compensate them for the sector's increased riskiness. That in turn will depress net asset values (which move inversely with yields). Worse, rents will probably fall too over time. Morgan Stanley analysts tentatively expect U.K. commercial property yields to rise 25-75 percent post-Brexit, and London office rents to dip 15 percent over the next 18 months. NAVs for the London-office exposed stocks would settle about 20-25 percent down.

That sounds alarming. But the sector could absorb a 40-45 per cent drop before indebtedness started to become a worry big enough to force it to raise equity, according to Exane analysts. The U.K. sector's loan-to-value ratio, at below 30 percent, doesn't look stretched, say Morgan Stanley researchers.

Moreover, the broader policy response to Brexit may lessen the impact. Lower gilt yields will alleviate the upward pressure on property yields; government policy is already seeking to prop up business with lower corporate taxes.

It will take a long time to see how all this plays out. Bargain hunters will step in at some point. For now, everyone's spooked. Falling share prices twinned with necessary actions like Standard Life's and Aviva's can be unhelpfully self-reinforcing.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Updates from second paragraph to include Aviva's actions.)

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